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OFR: CCP Attempts To Reduce Counterparty Risk, But Creates Its Own Risk 

May 11, 2015

Mark Melin, ValueWalk

As risk is transferred to a central clearing mechanism, gauging that risk and funding risk management are considered.

As large banks are more likely to be complexly structured and deeply interconnected with other banks and the financial system, a new report from the U.S. Treasury’s Office of Financial Research concludes that market concentration tends to rise.

Reverse economies of scale: risk and costs increases with size

In the report, titled Systemic Risk: The Dynamics under Central Clearing, authors Agostino Capponi, W. Allen Cheng, and Sriram Rajan develop a model to focus on concentration risks to Central Clearing Party (CCP) risks posed by large clearing members. “When risk factors driving loan books are diverse, market concentration increases and persists as the large members further increase in size,” the report concludes. Hedging, while risk-mitigating on an individual level, is increasingly costly and “contributes to the emergence of size externalities on the systemic level.”  In fact, doubling the size of certain asset managers, key components of the CCP system, would “more than double its equilibrium trade ratio.”  Perhaps as a result, large clearing members are expected to be net financiers of the systemic risk charge, while smaller clearing members are expected to be net recipients.

Read more: ValueWalk

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