The Cost of Clearing Fragmentation

The paper argues that when the same products are cleared across multiple CCPs, clearing fragmentation gives rise to economically significant price distortions. These distortions reflect dealers’ collateral costs and represent a real cost to market end users.

The paper demonstrates an economically significant price differential between the same US dollar-denominated swap contracts cleared in CME and LCH (the CME-LCH basis). The authors provide an explanation for the CCP basis using a variation of the dynamic inventory management model.

If clients in a particular jurisdiction only access their local CCP, either because they are mandated to do so or because they lack the financial resources to access overseas CCPs, it reduces the netting opportunities for dealers’ overall portfolios. This reduction in netting opportunities increases dealers’ collateral requirements as they need to post margin with each CCP. The dealers may pass these increased costs to their clients.