BIS published a working paper that studies the incentives of a for-profit central counterparties (CCP) with limited liability. A CCP faces a trade-off between fee income and counterparty credit risk. The paper investigates whether such CCP incentives undermine financial stability.
Such for-profit CCPs choose how much capital to hold and set the collateral requirement for their clearing members, to maximize their own profits. They face a trade-off between fee income and counterparty credit risk. However, the limited liability of a CCP creates a misalignment between its choices and the socially optimal solution to this trade-off. In studying the factors that give rise to this misalignment, the paper derives the optimal capital regulations and examines the significant role of CCP ownership structures in safeguarding financial stability. This is the first paper that argues that a for-profit CCP would seek to hold less capital than is optimal from a social welfare perspective and, similarly, would require less collateral from its members than is optimal, thus undermining financial stability. From an empirical angle, this paper also provides the first evidence of a relationship between the capital held by CCPs and the collateral they require.
The model developed in this paper implies that better-capitalized CCPs set higher collateral requirements. Empirical evidence suggests that a 1% increase in a for-profit CCP's capital is associated with a 0.6% increase in its members' collateral. Another implication, again deriving from its capitalization and collateral choices, is that a for-profit CCP is more likely to fail than is socially optimal. By contrast, a user-owned CCP chooses to hold more capital and is, therefore, less likely to fail. The data show that user-owned CCPs hold significantly more capital, on average, than for-profit CCPs do. Optimal capital requirements are derived for different levels of the clearing fees charged by for-profit CCPs. When this fee is low, the capital requirements incentivize CCPs to demand more collateral, thus bolstering financial stability. When fees are high, capital requirements do not change a CCP's incentives but serve to boost its loss-absorbing capacity.
Keywords: International, PMI, Banking, Securities, CCPs, Financial Stability, Capital Requirements, BIS
ECB finalized the guide on assessment methodology for the internal model method for calculating exposure to counterparty credit risk (CCR) and the advanced method for own funds requirements for credit valuation adjustment (A-CVA) risk.
EBA published an Opinion addressed to EC to raise awareness about the opportunity to clarify certain issues related to the definition of credit institution in the upcoming review of the Capital Requirements Directive and Regulation (CRD and CRR).
APRA is consulting on updates to ARS 210.0, the reporting standard that sets out requirements for provision of information on liquidity and funding of an authorized deposit-taking institution.
FED released hypothetical scenarios for a second round of stress tests for banks.
PRA published updates in relation to the 2021 Supervisory Benchmarking Portfolio exercise.
FED adopted a proposal to extend for three years, with revision, the capital assessments and stress testing reports (FR Y-14A/Q/M; OMB No. 7100-0341).
HKMA revised the Supervisory Policy Manual module CR-G-14 on margin and other risk mitigation standards for non-centrally cleared over-the-counter (OTC) derivatives transactions.
EBA issued a revised list of validation rules with respect to the implementing technical standards on supervisory reporting.
EBA published its response to the call for advice of EC on ways to strengthen the EU legal framework on anti-money laundering and countering the financing of terrorism (AML/CFT).
NGFS published a paper on the overview of environmental risk analysis by financial institutions and an occasional paper on the case studies on environmental risk analysis methodologies.