ISDA highlights a selection of research papers on derivatives and risk management                

The Impact of Central Clearing on the Market for Single-Name Credit Default Swaps

By Mohamed-Ali Akari, Ramzi Ben-Abdallah, Michèle Breton, and Georges Dionne

The paper evaluates the impact of central clearing on the single-name credit default swap (CDS) market. The study compares the spreads of single-name CDS contracts of cleared reference entities that are members of the clearinghouse and non-cleared reference entities and demonstrates that CDS spreads increase when the reference entity becomes centrally cleared. The authors argue that this surge is an indication of the amount of counterparty risk that was reduced thanks to the clearinghouse. The study also shows that cleared reference entities do not experience any improvement in their liquidity following central clearing and central clearing does not have any impact on trading activity.

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The Impact of the Leverage Ratio on Client Clearing

Bank of England Staff Working Paper No.735
By Jonathan Acosta-Smith, Gerardo Ferrara and Francesc Rodriguez-Tous

This paper examines the effect of the leverage ratio on client clearing activity in the interest rate derivatives markets. The Basel III leverage ratio framework requires banks to count customer cash collateral held at central counterparties towards their leverage exposure and to ignore the exposure-reducing effect of initial margin. Therefore, banks could be less willing to offer clearing services to clients due to increased capital costs. The paper concludes that the leverage ratio can disincentivize client clearing, both in terms of daily transactions as well as the number of clients, but this impact seems to be driven by a reduced willingness to take on new clients. The paper also suggests that if some institutions lose access to clearing, it could be more difficult for them to implement hedging and they might seek alternative strategies that are riskier or more expensive.

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The Credit Default Swap Market: What a Difference a Decade Makes

BIS Quarterly Review
By Iñaki Aldasoro and Torsten Ehlers

The paper analyzes the changes in the size and structure of the global credit default swap (CDS) market from the financial crisis of 2007-2009 to the end of 2017. The authors outline several important changes, including significant reduction in the outstanding notional amount of CDS, large part of which is due to compression of bilateral and multilateral portfolios. The report also covers the decline in inter-dealer positions and the rise of central counterparties (CCPs), noting a significant increase in outstanding amounts of CDS contracts cleared on CCPs. The authors argue that two types of CDS risk–underlying credit risk of the reference entity and the counterparty risk faced by the CDS protection buyer–have diminished and underlying credit risks have shifted towards sovereigns and portfolios of underlying reference securities with overall better credit ratings. Despite the changes in the market, reporting dealers continue to be net buyers of CDS protection and hedge funds have markedly reduced their net purchases of protection from dealers.

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