To link or not to link? Netting and exposures between central counterparties

ABSTRACT This paper provides a framework for comparing linked and unlinked central counterparty (CCP) configurations in terms of total netting achieved by market participants and the total system default exposure that exists between participants and CCPs. A total system perspective - taking both market participant and CCP exposures into account - is required to determine whether or not to consider linking a domestic CCP with an offshore CCP. Using a two-country model, with a global CCP serving both markets and a local CCP clearing only domestic country participants' transactions, we show that establishing links between two CCPs leads to higher exposures for the domestic CCP. We also show that establishing links can result in a decrease in overall netting efficiency and higher total system exposure when the number of participants at the local CCP is small relative to thenumber of participants at the global CCP. As the relative importance assigned by decision makers to CCP exposures compared with market participants'exposures increases, so does the number of domestic participants required to make the linked case preferred. Our results imply that the establishment of a link between a small domestic CCP and a larger global CCP is unlikely to be desirable from a total system perspective in the majority of cases.