FN: CCPs vulnerable to sovereign bonds bust

11 June 2012

Despite being hailed by regulators as the panacea to the ills of the over-the-counter derivatives markets, central counterparty clearing is under fire from a group of influential banking experts.

JP Morgan analysts, led by Kian Abouhossein, produced research last month that suggested that the widespread adoption of clearing in the OTC markets could result in a shift of systemic risk from banks to clearing houses, overburdening the providers and making them susceptible to tail-risk events, particularly in the sovereign markets. The note read: “Bank regulation is likely to transfer banking risk to highly leveraged and potentially under-resourced clearing houses, which may not be able to sustain a correlated tail-risk scenario, in our view”.

The note represents a challenge to the post-crisis reform agenda, which involves pushing standardised OTC derivatives through clearers, which reduce risk by sitting between a trade to guarantee payment in the event that either party defaults

Analysts say clearers are particularly sensitive to sovereign risk events because they: accept government debt as a form of collateral; reinvest their own cash into government-backed securities; and, perhaps most crucially, they are key counterparties in the repo markets.

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