Efficiency of central clearing under liquidity stress
By Marco Bardoscia, Fabio Caccioli and Haotian Gao
We explore the impact of central clearing on the demand for collateral arising from variation margin calls in the derivatives market. We find that the aggregate demand for collateral is not necessarily minimal when all contracts are centrally cleared. Hence, at least in this respect, increasing the scope of central clearing is not always beneficial. Previous work finds instead that the demand for collateral is minimal when all contracts are centrally cleared, but rely on the crucial assumption that all institutions have centrally cleared and bilateral contracts with exactly the same underlying counterparties. In this special case we prove a stronger result: that the aggregate demand for collateral is (weakly) decreasing with the fraction of centrally cleared notional. We also prove that, in this case, the aggregate demand for collateral starts decreasing only when the fraction of centrally cleared notional is larger than a critical value, suggesting that the benefits of central clearing kick-in only when a sufficiently large portion of the market has moved to central clearing.
The full paper is available at https://www.bankofengland.co.uk/working-paper/2022/efficiency-of-central-clearing-under-liquidity-stress