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 observation coupled with a structural net order imbalance across CCPs can cause prices to persistently differ across them (“the CCP basis”). We propose a model to rationalize this basis and derive several hypotheses. Testing these on unique CCP data for interest-rate derivatives, yields broad empirical support for the model and suggests that the clearing friction costs sellers clearing in LCH $80 million daily.

Keywords: central clearing, CCP basis, collateral, fragmentation

JEL Classification: G10, G12, G14