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Abstract
In an effort to improve market infrastructure following the crisis, central counterparties (CCPs) are being put forth as the way to make over-the-counter (OTC) derivatives markets safer and sounder, and to help mitigate systemic risk. This chapter provides a primer on this topic and discusses key policy issues. It shows that soundly run and properly regulated CCPs reduce counterparty risk—the risk in a bilateral transaction that one party defaults on its obligations to the other—among OTC derivatives market participants. Importantly, systemic risk—the risk of knock-on failures from one counterparty to another—is also reduced due in part to the ability to net transactions across multiple counterparties. CCPs also have other risk-mitigating features that ensure that payments to others occur when a counterparty defaults. Nevertheless, movement of contracts to a CCP is not a panacea, since it also concentrates the counterparty and operational risk associated with the CCP itself.
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