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Contracting innovations and the evolution of clearing and settlement methods at futures exchanges

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  • James T. Moser

Abstract

Defining futures contracts as substitutes for associated cash transactions enables a discussion of the evolution of controls over contract nonperformance risk. These controls are incorporated into exchange methods for clearing contracts. Three clearing methods are discussed: direct, ringing and complete. The incidence and operation of each are described. Direct-clearing systems feature bilateral contracts with terms specified by the counterparties to the contract. Exchanges relying on direct clearing system chiefly serve as mediators in trade disputes. Ringing is shown to facilitate contract offset by increasing the number of potential counterparties. Ringing settlements reduce counterparty credit risk by reducing the accumulation of dependencies as contracts are offset. Ringing settlements also lower the cost of maintaining open contract positions, chiefly by lowering the amount or required margin deposits. Exchanges employing ringing methods generally adopted a clearinghouse to handle payments. Complete clearing interposes the clearinghouse as counterparty to every contract. This measure ensures that contracts are fungible with respect to both the underlying commodity and counterparty risk.

Suggested Citation

  • James T. Moser, 1998. "Contracting innovations and the evolution of clearing and settlement methods at futures exchanges," Working Paper Series WP-98-26, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:wp-98-26
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    Cited by:

    1. Heath, Alexandra & Kelly, Gerard & Manning, Mark & Markose, Sheri & Shaghaghi, Ali Rais, 2016. "CCPs and network stability in OTC derivatives markets," Journal of Financial Stability, Elsevier, vol. 27(C), pages 217-233.
    2. Cyril Monnet, 2010. "Let's make it clear: how central counterparties save(d) the day," Business Review, Federal Reserve Bank of Philadelphia, issue Q1, pages 1-10.
    3. Robert M. Hunt, 2010. "Business Method Patents And U.S. Financial Services," Contemporary Economic Policy, Western Economic Association International, vol. 28(3), pages 322-352, July.
    4. Randall Kroszner, 2000. "Lessons from Financial Crises: The Role of Clearinghouses," Journal of Financial Services Research, Springer;Western Finance Association, vol. 18(2), pages 157-171, December.
    5. Elisabeth Ledrut & Christian Upper, 2007. "Changing post-trading arrangements for OTC derivatives," BIS Quarterly Review, Bank for International Settlements, December.
    6. Randall S. Kroszner, 2000. "The supply of and demand for financial regulation : public and private competition around the globe : commentary," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 137-149.
    7. Robert R. Bliss & Robert Steigerwald, 2006. "Derivatives clearing and settlement: a comparison of central counterparties and alternative structures," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 30(Q IV), pages 22-29.
    8. Jorge Cruz Lopez & Mark Manning, 2017. "Who Pays? CCP Resource Provision in the Post-Pittsburgh World," Discussion Papers 17-17, Bank of Canada.
    9. Vuillemey, Guillaume, 2018. "Completing Markets with Contracts: Evidence from the First Central Clearing Counterparty," CEPR Discussion Papers 13230, C.E.P.R. Discussion Papers.
    10. Mark Flannery, 1999. "Modernizing Financial Regulation: The Relation Between Interbank Transactions and Supervisory Reform," Journal of Financial Services Research, Springer;Western Finance Association, vol. 16(2), pages 101-116, December.
    11. Riva, Angelo & White, Eugene N., 2011. "Danger on the exchange: How counterparty risk was managed on the Paris exchange in the nineteenth century," Explorations in Economic History, Elsevier, vol. 48(4), pages 478-493.
    12. Olga Lewandowska, 2015. "OTC Clearing Arrangements for Bank Systemic Risk Regulation: A Simulation Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(6), pages 1177-1203, September.
    13. John P Jackson & Mark J Manning, 2007. "Comparing the pre-settlement risk implications of alternative clearing arrangements," Bank of England working papers 321, Bank of England.
    14. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
    15. Douglas D. Evanoff & Daniela Russo & Robert Steigerwald, 2006. "Policymakers, researchers, and practitioners discuss the role of central counterparties," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 30(Q IV), pages 2-21.
    16. Asaf Bernstein & Eric Hughson & Marc D. Weidenmier, 2014. "Counterparty Risk and the Establishment of the New York Stock Exchange Clearinghouse," NBER Working Papers 20459, National Bureau of Economic Research, Inc.
    17. Chryssa Papathanassiou, 2012. "Central Counterparties and Derivatives," Chapters, in: Kern Alexander & Rahul Dhumale (ed.), Research Handbook on International Financial Regulation, chapter 11, Edward Elgar Publishing.
    18. Eugene N. White, 2007. "The Crash of 1882, Counterparty Risk, and the Bailout of the Paris Bourse," NBER Working Papers 12933, National Bureau of Economic Research, Inc.
    19. Guillaume Vuillemey, 2020. "The Value of Central Clearing," Journal of Finance, American Finance Association, vol. 75(4), pages 2021-2053, August.

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