# Compressing Over-the-Counter Markets

## TL;DR

This paper examines how portfolio compression can significantly alter the size and structure of over-the-counter markets, especially when combined with central clearing, revealing potential risks and mitigation strategies.

## Contribution

It provides empirical estimates of compression effects on OTC markets and analyzes the impact of central clearing mandates on market structure and stability.

## Key findings

- Portfolio compression can drastically reduce notional amounts in OTC markets.
- Combining central clearing with compression can cause netting failures.
- Cross-clearing compression mitigates adverse effects of clearing mandates.

## Abstract

Over-the-counter markets are at the center of the postcrisis global reform of the financial system. We show how the size and structure of such markets can undergo rapid and extensive changes when participants engage in portfolio compression, a post-trade netting technology. Tightly-knit and concentrated trading structures, as featured by many large over-the-counter markets, are especially susceptible to reductions of notional and reconfigurations of network structure resulting from compression activities. Using transaction-level data on credit-default-swaps markets, we estimate reduction levels consistent with the historical development observed in these markets since the Global Financial Crisis. Finally, we study the effect of a mandate to centrally clear over-the-counter markets. When participants engage in both central clearing and portfolio compression, we find large netting failures if clearinghouses proliferate. Allowing for compression across clearinghouses by-and-large offsets this adverse effect.