Skin in the game: risk analysis of central counterparties

Journal article

We introduce a quantitative framework to design the capital contribution of a central counterparty (CCP) to its default waterfall, known as CCP “skin in the game” (SITG). We show that, under inadequate SITG levels, nondefaulting members are more exposed to default losses than CCPs. The resulting risk management incentive distortions could be mitigated by using the proposed framework. Our analysis addresses investor- and member-owned CCPs; we also analyze multilayer and “monolayer” default waterfalls. The broader central clearing mandate of US Treasuries may take place under monolayer CCPs. Viewing the total size of SITG as the lower bound on CCP regulatory capital, the framework can be used to improve capital regulation of investor-and member-owned CCPs. We also show that bank capital rules for CCP exposures may underestimate risk.

Authors: Cont, R; Ghamami, S

• Publication status: Published
• Peer review status: Peer reviewed
• Publisher: Infopro Digital Services
• Journal: Journal of Financial Market Infrastructures
• Volume: 12
• Issue: 2
• Pages: 1-40
• Publication date: 2025-05-07
• DOI: 10.21314/jfmi.2025.001
• EISSN: 2049-5412
• ISSN: 2049-5404
• Language: English
• Keywords: skin in the game; financial regulation; central clearing; over-the-counter markets; the US Treasury market; risk management