The Cost of Clearing Fragmentation

Abstract

Fragmenting clearing across multiple central counterparties (CCPs) is costly because global dealers cannot net positions across CCPs. They have to collateralize both the short position in one CCP and an offsetting long position in another CCP. This, coupled with a structural net order imbalance across CCPs, can cause prices to persistently differ across them (“the CCP basis”). Tests based on unique CCP data for interest-rate derivatives (IRDs) yield broad empirical support for this intuition and suggest that the clearing friction costs sellers clearing in LCH, the largest European CCP for IRDs, $80 million daily. This paper was accepted by Victoria Ivashina, finance. Funding: This work was supported by the Netherlands Organization for Scientific Research (NWO). A. Menkveld gratefully acknowledges the support of NWO Vici grant. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.4867 .