Post-trade netting and contagion

We analyse how post-trade netting in over-the-counter derivatives markets affects systemic risk. In particular, we focus on two post-trade netting services that rely on multilateral netting techniques: portfolio rebalancing and portfolio compression. First, we provide mathematical characterisations of their netting mechanisms and explain their relationship. Then, we analyse the effects of post-trade netting from a network perspective by considering contagion arising from defaults on variation margin payments. We provide sufficient conditions for post-trade netting to reduce systemic risk and show that post-trade netting can be harmful. We also explore the implications, particularly when institutions strategically react to liquidity stress by delaying their payments.