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In his latest post on the Streetwise Professor blog, University of Houston Finance Professor Craig Pirrong described the "horror story" of systemic clearing mandates, and explained why he remains skeptical that regulators will "take heed of the lessons of Brexit and take measures to ensure that the next time it isn't a head shot."
Professor Pirrong argued that "clearing mandates have supersized the clearing system, and commensurately increased the amount of liquidity needed to meet margin calls." He highlighted Brexit as a "harrowing example" of "how tightly coupled the system is," and listed other risk factors that clearing corporations' response to Brexit have demonstrated. Those risk factors include the following:
- "[m]uch of the additional margin was to top up initial margin, meaning that the cash was sucked into the [central clearing parties] and kept there, rather than paid out to the net gainers, where it could have been recirculated"; and
- "each [central clearing party] acted independently and called margin to protect its own interests" – which is "ironic, because one of the alleged justifications for clearing mandates was the externalities present in the [over-the-counter] derivatives markets."
Professor Pirrong observed that Brexit might prove to be as instructive as it is "horrific":
Horror stories are sometimes harmless ways to communicate real risks. Perhaps the Brexit event will be educational.
Nevertheless, he concluded, the "clearing mandate is a reality, and is almost certain to remain one." Given that reality, he maintained, it is doubtful that "whatever is done will make the system able to survive The Big One."
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