FX Clearing continues to be discussed (by academics!)


Bloomberg ran an article of a phone interview with Darrell Duffie, Stanford University Professor of Finance, who suggested that the risk of investor default in FX swaps and Forwards was large enough to justify post trade clearing through clearinghouses.

Professor Duffie is a big advocate of central clearing, and has published many papers on the subject, and is actually in the process of creating some new FX contracts for central clearing. So I would not dream of questioning his analysis.

However, it’s interesting to note that in a 2009 paper on central clearing “Does a Central Clearing Counterparty Reduce Counterparty Risk?”, Professor Duffie opening comments are that:

Clearing two or more different classes of derivatives in separate CCPs always increases counterparty exposures relative to clearing the combined set of derivatives in a single CCP

The arguments put by AFME for the exemption of FX Swaps from Dodd Frank are compelling, and the full letter is worth re-reading.

However, hypothetically, were FX Swaps to be subject to mandatory clearing, which they are not as FX Swaps and Fwds have been exempted, then according to professor Duffie, anything more than a single CCP, could actually increase rather than reduce counterparty risk.

Yet according to Satyajit Das of Euro intelligence, in his paper “The Flaws of the Central Counter Party idea”, (Mar 2011) a single CCP could result in greater concentration risk:

The CCP is designed to reduce systemic risk but in reality, the CCP may become a node of concentration. The clearing arrangement centralises contracts in a single entity – the CCP. This increases risk concentrations within financial markets

So, more than one CCP increases counterparty risk, yet only one CCP increases concentration risk. You just can’t win!

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