Counterparty risk management at the advent of central clearing for swaps

Abstract

Mandated clearing of certain over-the-counter (OTC) derivative swaps has a goal of reducing systemic risk exposure in the financial system. As Central Counterparties (CCPs) will become counterparty to market participants in large sections of the swaps markets, counterparty risk will indeed be mitigated, but not eliminated. It is incumbent upon market participants, especially counterparty risk managers, to understand and monitor the risk structure of CCPs and how the evolving market for cleared swaps may affect CCPs. The multiple strengths that the CCP model provides, as well as the costs, are examined in this paper.