CCP Auction Design

Summary

Focus

When a clearing member defaults, the central counterparty (CCP) organises an auction to sell the member's portfolio to surviving members. The higher the price of the auctioned portfolio, the lower the default loss, and thus the smaller the extent to which the CCP taps into the so-called guarantee fund, which is prefunded by members. To safeguard its resilience and reputation, the CCP seeks to encourage active bidding and minimise the default loss. We propose a tractable model to examine the design of CCP auctions.

Contribution

CCPs are systemically important. We contribute to the ongoing policy discussions of CCP auctions and to the academic literature on auction design and central clearing. Our model incorporates salient institutional aspects of CCP auctions and delivers novel results. In particular, we analyse a key design feature of CCP auctions – juniorisation, ie the process by which the CCP first uses the prefunded cash of members who submit less competitive bids. Concretely, we assume that each clearing member participates in covering the CCP's default loss with a fraction of its contribution to the guarantee fund, and that this fraction is adjusted downward in proportion to the amount that the member purchases at the auction. Our results shed light on how juniorisation affects the CCP's default loss as well as members' bidding behaviour and profits.

Findings

We find that juniorisation increases the price of the auctioned portfolio and reduces the default loss. It is possible to design a juniorisation scheme that almost eliminates the need to use the guarantee fund, which protects the CCP's reputation. However, juniorisation penalises members with small guarantee fund contributions: their auction-related profits decline as they are sidelined by the more aggressive bids of larger members. It also penalises members with the largest contributions, which end up being the only ones covering the CCP's default loss. All these penalties benefit members with intermediate contributions.

Abstract

Central counterparties (CCPs) are systemically important. When a clearing member defaults, the CCP sells the defaulted portfolio to surviving members in an auction, and losses, if any, are partly absorbed by a cash pool prefunded by the surviving members. We propose a tractable auction model that incorporates this salient feature. We find that "juniorization" – the CCP first uses prefunded cash of members who submit bad bids – increases the auction price. Aggressive juniorization can push the auction price above the fair value and almost eliminate the need to use prefunded resources. Nonetheless, juniorization generates heterogeneous impact on members of different sizes.

JEL classification: D44, G01, G23
Keywords: central counterparty (CCP), auction, default management