Felix Chang, at the University Of Cincinnati College Of Law, recently posted a draft of his excellent paper, The Systemic Risk Paradox: Banks and Clearinghouses Under Regulation.  The paper will be published in the Columbia Business Law Review (congrats Felix!) in the fall.  I first read Felix’s paper in conjunction with the George Washington University C-Leaf Junior Scholar workshop earlier this spring. After the workshop, I asked him to let me know when a draft was ready to share with BLPB readers, and here is the Abstract:

Consolidation in the financial industry threatens competition and increases systemic risk. Recently, banks have seen both high-profile mergers and spectacular failures, prompting a flurry of regulatory responses. Yet consolidation has not been as closely scrutinized for clearinghouses, which facilitate trading in securities and derivatives products. These nonbank intermediaries can be thought of as middlemen who collect deposits to ensure that each buyer and seller has the wherewithal to uphold its end of the deal. Clearinghouses mitigate the credit risks that buyers and sellers would face if they dealt directly with each other. 

Yet here lies the dilemma: large clearinghouses reduce credit risk, but they heighten systemic risk since the collapse of one such entity threatens the entire financial system. While the systemic risks posed by large banks have been tackled by regulators, the systemic risks of these nonbank intermediaries have received less attention. In fact, clearinghouses have been cloaked with a regulatory mantle which encourages unchecked growth. 

This Article examines the paradoxical treatment of regulators toward the systemic risks of clearinghouses and banks. It explores two fundamental questions: Why does the paradox exist, and who benefits from it? Borrowing from antitrust, this Article offers a framework for ensuring that the entities which control a large clearinghouse (the big banks) do not abuse its market dominance.

-Anne Tucker