Evaluating the Adequacy of Skin in the Game in Central Counterparties- Investigating the Theory-Practice Gap

Abstract

Central counterparties (CCPs) are increasingly important in modern financial markets. They lower the counterparty credit risk for their members, usually a bank or a brokerage firm, by acting as an intermediary between the buyers and sellers to secure trade settlement. "Skin in the game" (SITG), the own capital of a CCP that can be used when one of its members defaults, acts as a safety mechanism by encouraging the CCP to manage risk diligently. By ensuring the CCP itself carries some of the financial burden in extreme loss situations, such as financial shortfalls from member defaults, SITG thus seeks to reduce moral hazard, where the CCP might be less motivated to manage risk given the absence of potential losses. However, the sufficient amount of SITG needed remains a subject of ongoing discussion. Theoretical models, such as Cont and Ghamami (2025), often propose more SITG than is generally found in practice. Focusing on Cont and Ghamami (2025)’s "Cover 2" resilience standard, which requires CCPs to withstand simultaneous defaults of the two largest clearing members, we investigate this gap between theory and reality using data from major international CCPs for the period from 2019 to 2024. To determine whether the observed SITG levels align with the Cont and Ghamami (2025)’s incentive compatibility assumptions on tail risk, we conduct sensitivity analysis and examine key model parameters implied by market data. Our findings indicate that actual SITG contributions are frequently inconsistent with the underlying framework and often fall short of what the theory implies. These results suggest that CCPs may not have enough capital for severe but uncommon events, and raise questions about whether their incentives align with those of members. We conclude that continuous and focused efforts by regulators and the industry are necessary for strengthening the financial system from extreme shocks.