By the end of 2012, all standardised over-the-counter (OTC) derivatives must be cleared with central counterparties (CCPs). In this paper, we estimate the amount of collateral that CCPs should demand to clear safely all interest rate swap and credit default swap positions of the major derivatives dealers. Our estimates are based on potential losses on a set of hypothetical dealer portfolios that replicate several aspects of the way that derivatives positions are distributed within and across dealer portfolios in practice. Our results suggest that major dealers already have sufficient unencumbered assets to meet initial margin requirements, but that some of them may need to increase their cash holdings to meet variation margin calls. We also find that default funds worth only a small fraction of dealers' equity appear sufficient to protect CCPs against almost all possible losses that could arise from the default of one or more dealers, especially if initial margin requirements take into account the tail risks and time variation in risk of cleared portfolios. Finally, we find that concentrating clearing of OTC derivatives in a single CCP could economise on collateral requirements without undermining the robustness of central clearing.
JEL classification codes: G24, G28
Keywords: central counterparties, clearing, collateral, derivatives, default funds, initial margins, variation margins