Will Central Counterparties become the New Rating Agencies?

TL;DR

This paper argues that Central Counterparties (CCPs) may develop business characteristics similar to Rating Agencies, potentially leading to systemic risks and repeating pre-crisis issues due to over-reliance on their prices.

Contribution

It highlights the analogy between CCPs and Rating Agencies, warning of similar business pressures and systemic risks that could undermine financial stability.

Findings

CCPs share business traits with Rating Agencies.

Over-reliance on CCP prices may pose systemic risks.

Regulatory focus on CCPs could replicate pre-crisis vulnerabilities.

Abstract

Central Counterparties (CCPs) are widely promoted as a requirement for safe banking with little dissent except on technical grounds (such as proliferation of CCPs). Whilst CCPs can have major operational positives, we argue that CCPs have many of the business characteristics of Rating Agencies, and face similar business pressures. Thus we see a risk that prices from CCPs may develop the characteristics attributed to ratings from Rating Agency pre-crisis. Business over-reliance on ratings of questionable accuracy is seen as a cause of the financial crisis. We see the potential for same situation to be repeated with prices from CCPs. Thus the regulatory emphasis on CCPs, rather than on collateralization, may create the preconditions for an avoidable repeat of the financial crisis.