This uniform approach to the agreement is an integral part of the structure and part of the network-based protection offered by the framework agreement. The fact that all transactions are the sole contract enhances the ability to close these transactions and obtain a one-time net amount payable in the event of default. Centralized clearing of OVER-the-counter derivatives: bilateral compensation against multilateral clearing, Cont, R., Kokholm, T. (2014). Centralized offsetting of OVER-the-counter derivatives: bilateral compensation for multilateral compensation. Statistics and risk modelling, 31 (1), 3-22. We examine the impact of centralized clearing of OTC transactions on counterparty commitments in an over-the-counter market on several asset classes with heterogeneous characteristics. The effects of the introduction of a central counterparty (CCP) on expected interdeal exposure are determined by the trade-off between multilateral clearing relationships between distributors on the one hand and bilateral clearing on asset classes on the other. We believe that this trade-off is sensitive to assumptions about the heterogeneity of asset classes with respect to the “risk-taking” of the asset class and the correlation between asset classes. While an analysis involving independent and homogeneous exposures indicates that centralized clearing is only effective if there is an unrealistically high number of participants, the opposite conclusion is drawn when differences in risk-taking and correlation between asset classes are realistically taken into account.
We argue that the empirically plausible specifications of the model parameters lead to the conclusion that centralized compensation reduces interdeal exposures: the benefit of multilateral compensation in a central counterparty outweighs the loss of compensation on asset classes in bilateral clearing agreements. Where a central counterparty exists for interest rate derivatives, the addition of a central counterparty for credit derivatives reduces overall liabilities. These results are strong for the statistical assumptions of the model and for the choice of the risk indicator used to quantify exposures. Literally, bilateral is with two sides of one thing, while clearing is an act of combining or merging different threads to form a unique encounter.