To link or not to link? : netting and exposures between central counterparties

This paper provides a framework to compare linked and unlinked CCP configurations in terms of total netting achieved by market participants and the total system default exposures that exist between participants and CCPs. A total system perspective, taking both market participant and CCP exposures into account, is required to answer an important policy question faced by some smaller jurisdictions: whether or not to consider linking a domestic CCP with one or more offshore CCPs. Generally, a single global CCP results in the lowest total system exposure as it allows for multilateral netting across all participants while avoiding the creation of inter-CCP exposures via links. However, global clearing may not be appropriate for all markets. 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 and can result in a decrease in overall netting efficiency and higher total system exposures when the number of participants at the local CCP is small relative to the number of participants at the global CCP. As the relative weight applied by decision makers to CCP exposures as compared to market participants' exposures increases, so does the number of domestic participants required to make the linked case preferred from a total system perspective. 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.