In this paper, we argue that both for-profit central counterparties (CCPs) and their clearing members should contribute to the default waterfall, with a CCP's two contributions coming directly before and directly after the tranche of clearing member contributions. This arrangement encourages the CCP and its clearing members to follow through on their responsibilities while balancing the interests of the CCP, its clearing members and the public. We argue that, in addition to affecting the incentives of a CCP's shareholders, the inclusion of CCP capital in the default waterfall affects the incentives of its clearing members, as do the CCP contribution's placement and size. CCPs and their regulators should determine the appropriate size of a CCP's waterfall contributions, taking into account the problems that could arise from contributions that are too small or too large. We conclude with a brief examination of default waterfalls at mutualized CCPs, arguing that, in most cases, they do not need a CCP capital contribution to align incentives, though it could still serve to reduce the inconvenience of replenishing a waterfall contribution after a modest default loss.
