The Demand for Central Clearing: To Clear or Not to Clear, That is the Question

This paper is a first attempt at empirically analyzing whether post-crisis regulatory reforms have created appropriate incentives to voluntarily centrally clear Over-The-Counter (OTC) derivative contracts. We use confidential European trade repository data on singlename sovereign Credit Derivative Swap (CDS) transactions and show that both the seller and the buyer manage counterparty’s exposures and capital costs, strategically choosing to clear when the counterparty is riskier. The clearing incentives seem particularly responsive to seller’s credit risk, in line with the notion that counterparty credit risk is asymmetric in CDS contracts. The riskiness of the underlying reference entity also enters the decision to clear as it affects both Counterparty Credit Risk (CCR) capital charges for OTC contracts and CCP margins for cleared contracts. Lastly, we find evidence that when the transaction helps netting positions with the CCP, and hence lower margins, the likelihood to clear is higher.