University of Houston Finance Professor Craig Pirrong urged the incoming Trump Administration to reevaluate the relationship between government-mandated central clearing and systemic risk. He argued that regulatory efforts to make central counterparties ("CCPs") more resilient might help to mitigate credit risk, but these efforts also exacerbate liquidity risk, which creates a "recipe for a broader market crisis."
Professor Pirrong criticized the "complacency" of regulators who extolled the benefits of clearing mandates. After analyzing CCPs' performance after the Brexit vote in the U.K. and recent stress tests conducted by the CFTC, Professor Pirrong observed that CCPs collected intra- and end-of-day margin in a timely fashion but delayed the payment of the margin, which created stresses in the markets. He pointed out that clearing mandates were "sold" as a way to meet the perceived need to address "pervasive externalities in uncleared derivatives markets, due primarily to the potential for default cascades in these markets . . . [b]ut clearing (supersized by mandates, in particular) creates externalities too." In times of stress, he argued, CCPs do things that are in their interests but impose costs on others.
Professor Pirrong urged the incoming Trump Administration to "seriously consider a major reevaluation of [Title VII of the Dodd-Frank Act] to determine how to address the serious liquidity issues that clearing mandates create."
Commentary / Bob Zwirb
In remarks delivered at the ISDA Annual Europe Conference in 2011, former ISDA CEO Robert Pickel decried "the kind of black and white analysis we all too often see" when proponents address clearing; i.e., "[c]learing good, bilateral risk management bad. We think that it's far more subtle and nuanced than that," he continued. (ISDA Executive Vice Chairman Robert G. Pickel, "Introductory Remarks," 2011 ISDA Annual Europe Conference, Shaping the Future of Derivatives, September 20, 2011.)
Similarly, in an op-ed that appeared last year in the Financial Times, Goldman Sachs President and Chief Operating Officer Gary Cohn (whom President-elect Donald Trump appointed Director of the National Economic Council) noted that clearing reduces risk, but "much of the residual risk ends up concentrated in the clearing houses themselves." If clearing houses do falter, he observed, "they may become new sources of contagion – the very problem they are meant to eliminate." Mr. Cohn went on to say, "[i]nstead of seeing clearing as a panacea, regulators should take a more nuanced view that recognizes its limits." (Gary Cohn, Clearing Houses Reduce Risk, They Do Not Eliminate It, Financial Times, June 22, 2015.)
Mr. Pickel's and Mr. Cohn's words offer wise counsel to those who will oversee the regulated markets under the Trump Administration.
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