ISDA highlighted separate economic analyses on: (i) trends in the credit default swaps ("CDS") market, (ii) clearing networks and central counterparties ("CCP") stress testing, and (iii) the cost effects of clearing fragmentation.
Recent Trends in CDS Markets
In a paper prepared by the CFTC Office of the Chief Economist, the authors observed several trends in CDS credit market activity. The authors note:
- significant reductions in portfolio notional holdings, even while portfolios themselves maintain similar risk characteristics;
- the heightened clearing of credit products due to standardized index trading in the United States and Europe and the expansion of opportunities for clearing; and
- the deterioration of liquidity in credit markets – namely, single-name credit markets – because of (i) increased costs of intermediation, (ii) unforeseen (or lack of) credit events, and (iii) the introduction of alternate credit products (e.g., credit exchange-traded funds).
Interdependencies and Stress Testing in the Euro Area Derivatives Clearing Network
In a working paper, European Central Bank ("ECB") authors found strong market integration among euro area and non-euro area CCPs, as well as at the level of clearing members. The authors explained that interconnectedness in the clearing network can reinforce its resilience by allowing for market shocks to be absorbed by a greater number of entities. The authors highlight the importance of carrying out supervisory-led, macro-prudential CCP stress testing, and assert that:
- CCPs cannot individually integrate information on market interdependencies into their respective stress tests; and
- CCPs should calibrate the size of initial margin and guarantee funds that need to be collected from members, in order to supplement stress testing.
The Cost of Clearing Fragmentation
In a working paper, economists at the Bank for International Settlements ("BIS") examined the implications of fragmentations within the clearing landscape. The authors assert that fragmentation across multiple CCPs is costly because dealers providing liquidity throughout the globe cannot net trades that are cleared in different CCPs. The authors used proprietary data to document "an economically significant CCP basis for U.S. dollar swap contracts" cleared by the Chicago Mercantile Exchange and the London Clearing House. The authors assert that the data provides evidence consistent with a collateral cost explanation of this basis. The BIS report also pointed out the importance for asset pricing of back-office processes and institutional features – including both clearing and transaction settlement.
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