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risks. at is, it creates interconnections between market participants that can lead to the same default contagion as can occur in bilateral mar- kets. Clearing does not make performance risks disappear; it just allocates them dierently than bilateral markets. Moreover, clearing creates a concentrated point of failure—the clearinghouse.

  • is concentration can increase systemic risk.

It is also argued that clearing, and exchange trad- ing, can improve regulatory oversight by central- izing the collection of information about the posi- tions that market participants hold, thereby giving regulators better information about the risks in the system and allowing them to act more eec- tively in a crisis. Clearing and exchange trading may be sucient to achieve this outcome, but not necessary to achieve this outcome. e same result could be obtained by requiring centralized report- ing of derivatives trades and positions, without restricting market participants’ ability to choose the trading and performance risk management mechanisms that are most ecient for them.

Finally, exchange trading and centralized clearing have been defended as the most eective means of combating manipulation and excessive specu- lation. Indeed, one of the main justications for the exchange trading requirement in the original Grain Futures Act was that (a) exchanges have the knowledge necessary to identify manipula- tions, and (b) the threat of losing contract desig- nation would give them an incentive to combat this conduct.16 Pirrong (1995) demonstrates that this reliance of self-regulation is not supported by the historical experience of exchanges in the US or elsewhere. Moreover, as noted above, ex post deterrence, including private actions by

parties harmed by manipulation, is a more eec- tive means of diminishing price manipulation than real time oversight, whether by exchanges or government regulators.

  • ere is no basis to believe that clearing will con-

strain “excessive” speculation more eectively than bilateral performance risk management mechanisms. Both clearinghouse and bilateral mechanisms will permit speculation by a market participant in accordance with that participant’s

  • nancial capacity to bear risk, and will make no

judgment as to whether that participant is trading in a way that causes prices to deviate from funda- mentals.

T E D M

  • e bottom line is that the diversity of trading

and performance risk management mechanisms observed in modern nancial markets makes good economic sense. e diversity of institutions in derivatives markets, that is, the co-existence of exchanges, cleared OTC, and non-cleared OTC, is a discriminating match between trading mecha- nisms, instruments, and market participants. It accommodates heterogeneity in trader prefer- ences for customization, liquidity, cash ow risk and performance risk. It similarly accommodates heterogeneity in information among market par- ticipants.

Mandating one-size-ts-all trading and perfor- mance risk management mechanisms, as envi- sioned in ACESA and other “reform” propos- als, imposes costs because it precludes market


Congress evidently despaired of dening manipulation, and punted responsibility for controlling it to the exchanges. During the debate over the Futures Trading Act (a predecessor of the Grain Futures Act that was found to violate the Constitution’s taxation provisions), Senate Agriculture Committee Chairman Norris said “[t]he diculty, as I understand it, is that these things [manipulations] are various and impos- sible of direct denition. I do not know how we could draw a denition to bring it home to the individual. At least it is the theory of the bill, as I understand it. . . that the board of trade itself could bring about these reforms, and [the House and Senate] are trying to hold the board of trade responsible” (United States Senate, 1921).




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