Academic paper argues against procyclical risk at CCPs

The recent crises and central counterparty risk practices in the light of procyclicality: empirical evidence
Olga Lewandowska and Florian Glaser

The mandatory central clearing for standardized over-the-counter derivatives, which was introduced by recent financial market reforms, makes central counterparties (CCPs) the most systemically important market participants. However, the theory suggests that, aside from their potential to reduce systemic risk, CCP risk management practices such as margining and collateral haircuts may exacerbate financial cycle fluctuations. Based on almost ten years of empirical data from a leading clearing house, we investigate if and to what extent the procyclical effects suggested by the literature can be statistically confirmed. Our results for the period encompassing the credit crisis and European sovereign debt crisis do not confirm the hypothesis from theoretical research that CCP risk practices are procyclical. Instead, they reveal only a low average level of conditional correlation between market stress and the margin/haircut requirement in the investigated period. Moreover, increases in CCP haircuts do not make clearing members (CMs) systematically drop the bonds with increased haircuts from their portfolios. Our results indicate that the effectiveness of regulatory action in the form of macroprudential haircut add-ons is doubtful, as the systematic overcollateralization of open positions by CMs, as observed in our data set, may already act as a countercyclical break.

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