Post-trade Netting and Contagion

The paper analyses how post-trade netting in over-the-counter derivatives markets affects systemic risk. It defines the notion of a post-trade netting (PTN) exercise and shows that two post-trade netting services that rely on multilateral netting techniques, namely, portfolio rebalancing and portfolio compression, are special cases of a PTN exercise. It formally characterises the relationship between portfolio rebalancing and portfolio compression. The paper then analyses the effects of post-trade netting from a network perspective by considering contagion arising from defaults on variation margin payments. It provides sufficient conditions for post-trade netting to reduce systemic risk and shows that post-trade netting can be harmful. It also explores the implications of post-trade netting when institutions strategically react to liquidity stress by delaying their payments.