Samim Ghamami (Joint with Paul Glasserman), UC Berkeley
Abstract: The reform program for the over-the-counter (OTC) derivatives market launched by the G-20 nations
in 2009 seeks to reduce systemic risk from OTC derivatives. The reforms require that standardized OTC
derivatives be cleared through central counterparties (CCPs), and they set higher capital and margin
requirements for non-centrally cleared derivatives. Our objective is to gauge whether the higher capital
and margin requirements adopted for bilateral contracts create a cost incentive in favor of central
clearing, as intended. We introduce a model of OTC clearing to compare the total capital and collateral
costs when banks transact fully bilaterally versus the capital and collateral costs when banks clear fully
through CCPs. Our model and its calibration scheme are designed to use data collected by the Federal
Reserve System on OTC derivatives at large bank holding companies. We find that the main factors
driving the cost comparison are (i) the netting benefits achieved through bilateral and central clearing;
(ii) the margin period of risk used to set initial margin and capital requirements; and (iii) the level
of CCP guarantee fund requirements. Our results show that the cost comparison does not necessarily
favor central clearing and, when it does, the incentive may be driven by questionable differences in
CCPs' default waterfall resources. We also discuss the broader implications of these tradeoffs for OTC
derivatives reform.