Credit default swaps (CDSs) were widely criticised as the roles they played in the 2008 financial crisis. To reduce the likelihood that credit derivatives will lead to future financial distress, the Dodd-Frank Wall Street Reform and Consumer Protection Act mandates that many CDSs be traded through a centralized counterparty a clearinghouse that acts as a seller to every buyer and a buyer to every seller. Proponents of central clearing argue that this reform minimizes risk to the financial system by reducing interconnections and dispersion losses.

However, every medal has two sides, clearinghouses concentrate risk and pose enormous threats to financial stability should they fail. Due to meaningful differences between CDSs and other derivatives, clearinghouses which clear CDSs may be significantly risker than traditional clearinghouses. It seems to be a paradox that we are adding risk to a systematically important and low-risk-toleranceinstitution.

Why is clearing CDSs more risky? Should we central clearCDSs?