The Impact of Clearing on the Credit Risk of a Derivatives Portfolio

Most derivative contracts are traded over-the-counter, i.e., bilaterally between two counterparties. Recently, clearing services have become available that allow to transfer over-the-counter derivatives to a central counterparty (clearing house). We develop a framework to determine the effects of clearing on the credit risk of derivatives portfolio. To facilitate our analysis, we compare the cost of credit risk of a portfolio of over-the-counter derivatives and a portfolio of similar but cleared derivatives. We show that, under certain verifiable assumptions, the cost of credit risk of a portfolio of cleared derivatives is always lower or equal than the cost of credit risk of a portfolio of un-cleared derivatives. We further show that, under the same assumptions, clearing enhances the value of a portfolio. The theoretical analysis is applied in a numerical example on a portfolio of swap contracts.