43 Setting the stage – definitions and industry setting VALUE-ADDED SETTLEMENT Settlement Benefits VALUE-ADDED TRADING CCP SERVICE RISK MANAGEMENT NETTING NOVATION Trading Benefits CLEARING VALUE-ADDED Risk Reduction Balance Sheet Benefits Operational Efficiency • Reallocation of counterparty risk to a high quality counterparty and exposure to a standard credit risk. • Centralised holding of open interest. • Reduction of risk exposure. • Reduction of cash/collateral requirements. Mutualisation of all or part of the risk of default.• • Centralised and transparent risk management and continuous exposure monitoring, incl. revaluation of positions on a daily or intra-day basis using mark-to-market, collection of margins. • Mark-to-market and collateralisation disciplines create savings at the operational level, free up credit lines and reduce collateral requirements. • Through cross-margining, various correlation exposures can be offset against each other. • Continuous centralised position records, monitoring and control. • Up-to-date and consistent view of portfolio. • Use of central collateral/cash pool. • Calculation, collection and custodial management of margin and collateral payment. • Simplified, standardised and rationalised back-office processes. Reduced operational errors.• TRANSACTION / POSITION MANAGEMENT COLLATERAL / CASH MANAGEMENT DELIVERY MANAGEMENT • Increased straight- through processing. • Reduction of delivery/ payment instructions. • Net settlement economises on collateral. • Reduced settlement costs. • Mitigation of settlement risk. Post-trade anonymity.• • Creditworthiness of original counterparties irrelevant. • Counterparties can trade more on a given capital base. • Freed-up credit lines and cash flow. Capital Efficiency Figure 2.9 Microeconomic benefits of CCP clearing Source: Author’s own. requirements. 148 Finally, cross-margining allows various correlation expo- sures to be offset against each other; through the use of a central pool of collateral, the amount of tied-up capital at the clearing facility is reduced. 149 Additional benefits are offered through sophisticated transaction/position management, which allows for continuous centralised position records, mon- itoring and control as well as an up-to-date and consistentview of the portfolio. Simplified, standardised and rationalised back-office processes result from the use of a central collateral/cash pool and the calculation, collection and custo- dial management of margin and collateral payment; 150 delivery management client trading volume, making a different but equally significant contribution to profitability. Improved reserves can also assist in maintaining or enhancing credit ratings.’ LCH.Clearnet (ed.) (2003a), p. 30. 148 Cf. LCH.Clearnet (ed.) (2003a), p. 31. 149 Cross-margining could, for example, also further allow traders to use positive cash flow generated in the futures market to cover losses in the equity market and accrued profits on equity options to reduce margin required on offsetting futures positions. Cf. Dale (1998a), p. 25. Also refer to Parkinson et al. (1992), p. 184. 150 Cf. LCH.Clearnet (ed.) (2003a), p. 29. 44 Clearing Services for Global Markets services offer many of the same benefits. By standardising processes, docu- mentation and systems as well as processing trades through a single channel, STP can be increased and operational errors reduced. 151 Finally, CCP services result in settlement benefits. A considerable reduc- tion in the value and volume of trades eligible for settlement can be achieved by netting. 152 The reduced number of delivery/payment instructions trans- lates into lower settlement costs 153 and a reduced administrative burden. 154 Additionally, the adoption of procedures like ‘delivery versus payment’ (DVP) mitigates settlement risk. 155 Not all markets are necessarily suitable for central counterparty clearing. Its potential benefits come at a cost and it is simply not available in some markets. 156 The trade-off between potential costs and benefits to market participants determines the suitability of a CCP for a given market. 157 This balance depends on factors such as the volume and value of transactions, trading patterns among counterparties, the characteristics of the traded goods, the credit quality of market participants and the opportunity costs associated with settlement liquidity. 2.2.2 Macroeconomic view Clearing and settlement systems are critical to the stability of the financial system, a system that is increasingly interconnected and global in scope. 158 Central counterparty clearing creates value-added not only for individual market participants, but for capital markets as a whole. ‘Central Counter- parties are among the crucial building blocks of any well-organised financial system. They facilitate the allocation of resources and their deployment within a financial system.’ 159 The following section briefly explains how the efficiency of capital markets can be affected by CCPs. 160 CCPs impact the allocation of 151 Cf. DTCC (ed.) (2000a), p. 4. 152 Cf. Milne (2002), p. 6. Net settlement systems can also economise on collateral; in situations where collateral is needed to effect settlement, a net settlement system may require less collateral than a gross settlement system. Cf. Kahn/McAndrews/Roberds (1999), pp. 27–31. Green (1997)showsthatanet settlement system can improve welfare by allowing agents’ original obligations to be replaced with a set of enforceable net claims. 153 Cf. Bressand/Distler (2001), p. 4; and Hardy (2004), p. 58. 154 Cf. LCH.Clearnet (ed.) (2003a), p. 29. 155 Cf. Moskow (2006). 156 Cf. Hills et al. (1999), p. 123; Lee (2000), p. 35; Bank for International Settlements (ed.) (2001), p. 11; Ripatti (2004), p. 8; and Moskow (2006). 157 Cf. DTCC (ed.) (2000b), p. 1. 158 Bliss/Steigerwald (2006), p. 22. 159 Blattner (2003), p. 1. 160 Efficient capital markets are both allocationally and operationally efficient. In an allocationally efficient market, scarce savings are optimally allocated to productive investments in a way that benefits the 45 Setting the stage – definitions and industry setting risk and capital and can positively influence market liquidity ; these aspects are detailed in the following . 161 2.2.2.1 Allocation of risk Whereas the CCP structure offers significant benefits and risk-reducing attributes, 162 the funnelling of market activity through one institution concen- trates risk as well as the responsibility for risk management. 163 By definition, CCPs have a higher concentration of risk than the single participants of a decentralised market. This concentration poses both advantages and dangers for capital markets. A CCP itselfdoes not remove credit risk from a market; rather, it re-allocates counterparty risk, replacing a firm’s exposure to bilateral credit risk (of vari- able quality) with the standard credit risk of the CCP. 164 As outlined above, CCPs thus enable market participants to trade without having to worry about the creditworthiness of individual counterparties. 165 Due to novation, CCPs can manage and redistribute counterparty credit risk more efficiently than individual market participants. 166 Moreover, multilateral netting performed by a CCP substantially reduces the potential losses in the event of participant default 167 and permits the size of the credit risk exposures to grow at lower rates than the market as a whole. 168 Pooling risk management facilities at the CCP further benefits capital markets through risk management specialisa- tion effects: it is more efficient to have one party collect the information and monitor the other parties rather than having all parties monitor each other. 169 One potential threat associated with high risk concentration in markets is that an unsuitable system configuration or weak supervision will have a higher impact on the market than the deficiencies of any one participant. Faulty CCP risk management has the potential to severely disrupt the markets as well as other components of the settlement systems for instruments traded in the respective markets. These disruptions could spill over into payment systems and other settlement systems and negatively influence the stability market as a whole. Operational efficiency is achieved if the costs for transferring funds are minimised. Cf. Copeland/Weston (1998), pp. 330–31. Refer to section 3.1 for more details. 161 Also refer to McPartland (2005) regarding the question of how clearing systems support a sound financial system. 162 Cf. Competition Commission (ed.) (2005), p. 27. 163 Cf. Hanley/McCann/Moser (1996), p. 1; and Knott/Mills (2002), p. 163. 164 Cf. Hills et al. (1999), p. 126. 165 Cf. Russo/Terol (2000), p. 8; and Ripatti (2004), p. 12. 166 Cf. Ripatti (2004), p. 12. 167 Cf. Bank for International Settlements (ed.) (2001), p. 11. 168 Cf. Bliss/Kaufman (2005), p. 11. 169 Cf. Dale (1998b), p. 296. Also refer to Diamond (1984) for an analysis of delegated monitoring by a financial intermediary. 46 Clearing Services for Global Markets of a financial market. 170 The effectiveness of a CCP’s risk management and sufficient levels of financial resources are therefore crucial for the stability of the markets, which are served by the CCP infrastructure. 171 The CCP’s design will ultimately determine its ability to withstand market disruptions, which may carry systemic implications. 172 Consequently, a CCP’s ability to monitor and control the credit, liquidity, legal and operational risks it incurs as well as to absorb losses is essential for the sound functioning of the markets it serves. 2.2.2.2 Allocation of capital Clearing service provision can also positively impact the allocation of capital within markets. The services of netting and cross-margining provided by a CCP minimise the amount of collateral that has to be deposited at the clearing house for risk management purposes. The level of capital required to support risk management is therefore optimised. This results in balance sheet benefits for investors, which enhances the overall market quality. These benefits include an increased return on capital via cost reduction and improved credit standing (firms may elect to retain the released capital and thereby improve their credit standing). 173 When the level of capital required to support risk management is optimised, counterparties can execute more trades on a given capital base. 174 Since equity capital is relatively expensive and collateral is scarce, this can have a positive effect on the size of the market as well as the size of counterparties in the market. 175 2.2.2.3 Market liquidity CCPs can contribute to a market’s liquidit y by ensuring post-trade anonymity, 176 ‘keeping the cost of trade completion as low as possible’, 177 170 Cf. Knott/Mills (2002), p. 164. Whether the fact that a CCP serves multiple markets results in serious systemic consequences in the event of a risk management failure is, nonetheless, a matter of debate, and has neither been proved nor disproved in reality. As such, a CCP has the potential to either reduce or increase the systemic risk in a market. For more details refer to Gemmill (1994); Corrigan (1996); Labrecque (1996); Dale (1998a); Hills et al. (1999); Knott/Mills (2002); and Iori (2004). Regarding the question of whether the globalisation of financial markets has changed the nature and potential vulnerability of the financial system to systemic risk, refer to Eisenbeis (1997). Fortunately, CCP failures have been extremely rare, although the examples of Paris in 1973, Kuala Lumpur in 1983 and Hong Kong in 1987 demonstrate that they can occur. Refer to Hills et al. (1999) for further details. 171 Cf. Knott/Mills (2002), p. 172; and Bank for International Settlements (ed.) (2004), p. 1. 172 Cf. Hanley/McCann/Moser (1996), p. 1. 173 Cf. Ripatti (2004), p. 10. 174 Cf. Bliss/Kaufman (2005), p. 11. 175 Cf. Bliss/Kaufman (2005), p. 10. For more details on the impact of netting and CCPs on the allocation ofcapital,referto:Green(1997); and Kahn/McAndrews/Roberds (1999). 176 For more details on the effect of post-trade anonymity on liquidity, refer to Hachmeister/Schiereck (2006). 177 Bernanke (1990), p. 140. 47 Setting the stage – definitions and industry setting reducing risks to its participants 178 and providing multilateral netting. 179 Through novation, a CCP creates more certainty in trading. 180 With lower counterparty risk and an optimised level of capital created by multilateral netting, market participants using a CCP may be encouraged to trade more and establish larger positions. 181 The effects on liquidity can be substantial, especially if the size of the counterparty exposures is actually a limiting factor for trade, although this need not always be the case. 182 The positive effects of risk redistribution become more evident when the market is turbulent and risks increase: 183 in volatile markets, participants might stop trading. Some of those who cease trading during times of market turbulence would probably have continued had they had a known and secure counterparty to trade with. A central counterparty can thus contribute to more stable market liquidity. On the other hand, CCPs can also have a negative impact on a market’s liquidity if exorbitant margin requirements are imposed or if the financial integrity of a clearing house is in question. Empirical evidence suggests that exorbitant margins can have a detrimental effect on market activity. 184 A dilemma for clearing houses in setting margins is how to balance prudence against the higher cost to members – the challenge for CCPs is to set the initial margin at a level sufficient to provide protection against all but the most extreme price moves, but not so high as to damage market liquidity or discourage the use of the CCP. 185 2.2.3 Asset class view Trades executed in securities or derivatives markets possess different particu- larities and dynamics; themarkets themselves also have unique characteristics. The following section provides a brief overview of the value-added of CCPs for securities versus derivatives markets (see Figure 2.10). As outlined above, CCPs have traditionally played a more significant role in derivatives than in securities markets, because the latter particularly demands 178 Cf. Kroszner (2000), p. 6. 179 Cf. Bank for International Settlements (ed.) (2004), p. 1; and Citigroup (ed.) (2006), p. 1. 180 Cf. Moser (1998), p. 7; and Ripatti (2004), p. 5. 181 Cf. Hills et al. (1999), p. 125; Knott/Mills (2002), p. 164; LCH.Clearnet (ed.) (2003a), p. 29; Ripatti (2004), p. 28; and Bliss/Kaufman (2005), p. 11. As a result of established practice, or in some cases regulations, market participants often limit their trading volumes to a certain percentage of their balance sheet. In these cases, the netting effect increases the participants’ scope for action. Cf. Riksbank (ed.) (2002), p. 50. 182 Cf. Riksbank (ed.) (2002), p. 52. 183 Cf. Riksbank (ed.) (2002), p. 51. 184 Cf. Telser (1981), p. 252; and Knott/Mills (2002), p. 166. Additional studies on the effect of mar- gins on trading include Fishe/Goldberg (1986); Hartzmark (1986); Kalavathi/Shanker (1991); and Hardouvelis/Kim (1995). 185 Cf. Kahl/Rutz/Sinquefield (1985), p. 107; and Knott/Mills (2002), pp. 166–7. 48 Clearing Services for Global Markets SECURITIES DERIVATIVES ASSET CLASS TRADE AND MARKET CHARACTERISTICS COUNTERPARTIES’ INTEREST CCPs’ VALUE-ADDED Immediacy of Trade Lifecycle Time Lag between Execution and Settlement Settlement Risk Increasing TurnOver Ratio Increasing Cross- Border Trades Large Number of Small Counterparties Large Exposures Collateral Intense High Volume Global Growth Market • Increased straight-through processing (STP). • Netting, margining. • Minimise settlement cycle at lowest cost. • Reduce cash/collateral requirements. • Mitigate settlement risk. • Reduce operational costs and risks. • Netting, margining. • Delivery management. .noitavoN•.seitrapretnuoc ytilauq hgih ot erusopxE• • Reduce settlement instructions. • Optimise use of collateral. • Post-trade anonymity. • Netting. • Margining, cash/collateral management. • Novation. • Reduce intermediary costs. • Minimise settlement cycle. • Reduce errors due to manual intervention. • Netting. • Increased STP. • Delivery, cash/collateral management. • Eliminate counterparty risk. • Manage risk of price fluctuations (replacement cost risk). • Possibility for close-out prior to maturity/expiration of contract. • Continuous position monitoring and control. • Reduce delivery errors. • Control and limit exposures. • Eliminate counterparty credit risk. • Sophisticated risk management. • Reduce cash/collateral requirements. • Free up credit lines. • Efficient cash/collateral management. • Post-trade anonymity. • Optimise use of cash/collateral. • Simplify, standardise and rationalise back-office processes. • Reduce operational errors. • Novation. • Margining. • Centralised holding of open interest. • Transaction and risk management. • Facilitation of STP, delivery management. • Netting, margining. • Novation. • Risk management. • Netting, margining. • Risk management. • Cash/collateral management. • Novation. • Netting, margining, risk management. • Cash/collateral management. • Delivery management. Figure 2.10 Asset class view on the value-added of CCP clearing Source: Author’s own. efficient risk reduction. Securities t ransactions are processed and settledas fast as technological, legal and regulatory restrictions will allow; the time frame usually consists of a few days. 186 Because these transactions only remain with the clear ing house for a relatively short period of time, 187 the need for risk management and t ransaction monitoring and management is relatively modest. Once a securities tr ade has been executed, the primary objective is to fulfil the legal obligations as immediately, efficiently and securely as possible, optimising the use of collateral required for securing the trade. The focus has therefore traditionally been on settlement rather than on clearing. The main value-added of CCPs in the context of securities processing is doubtlessly their 186 Cf. Bliss/Steigerwald (2006), p. 23. 187 Thetimelagbetweenthetradeexecution(T)andthesettlementdateiscommonlyreferredtoasthe ‘settlement cycle’. The settlement cycle is measured relative to the trade date, i.e. if settlement occurs on the third business day following T, the settlement cycle is referred to as T + 3. Cf. Bank for International Settlements (ed.) (2001), p. 49. 49 Setting the stage – definitions and industry setting provision of netting services and facilitation of STP. Furthermore, given that securities markets in most developed countries are characterised by a large number of small counterparties, an increasing turnover ratio 188 and a growing number of cross-border trades (which reflects the increasing integration of global markets), the CCPs’ additional services provide important value-added for the counterparties (see Figure 2.10 for details). 189 By contrast, the fulfilment of the legal obligation in derivatives trading can be a matter of much longer time frames – months and years rather than days. 190 Large unsettled exposures may consequently build up between counterpar ties, 191 which underscores the need for enhanced risk manage- ment. 192 CCPs were therefore originally established to protect market par- ticipants from counterparty risk in exchange-traded derivatives markets. 193 The elimination of counterparty risk through novation, as well as the benefits of netting, margining, sophisticated risk management and position control throughaCCP,isthushighlyadvantageous.Derivativesmarketsfurtherbene- fit from the centralised holding and management of open interest at a clearing house, which allows for the fungibility of products and enhances liquidity. 194 Closing out positions pr ior to maturity is often attractive, particularly in futures markets, where the purpose of the trade is to take on price risk rather than to receive or deliver the underlying instrument. 195 In securities markets, on the other hand, market participants are typically keen to obtain or deliver the underlying instrument. 196 The actual fulfilment of the legal obligation, i.e. the delivery or purchase of the underlying, can therefore be avoided in derivati- ves markets. 197 Only the profit or loss arising from the difference between the entry and exit price remains. 198 Closing out can stimulate the market to expand further. 199 The multilateral netting provided by CCPs has had an important impact on the structure of derivatives markets. In fact, without the services provided by CCPs, the current large size, liquidity and concentra- tion of the worldwide exchange-traded derivatives markets would likely not exist. 200 188 The turnover ratio refers to the time required to circulate a given volume of securities. 189 Cf. Bank for International Settlements (ed.) (2001), p. 1; and Lannoo/Levin (2003), p. 5. 190 Of course, the time lag is minimal when day traders engage in derivatives trades, because they close-out all of their open positions at the end of each trading day. 191 Cf. Knott/Mills (2002), p. 162. 192 Cf. Riksbank (ed.) (2002), p. 48. 193 Cf. Knott/Mills (2002), p. 162; and Ripatti (2004), p. 4. 194 Cf. Bank for International Settlements (ed.) (1998), p. 9. 195 Cf. Hills et al. (1999), p. 125. 196 Cf. Hills et al. (1999), p. 125. 197 Cf. Eurex (ed.) (2003b), p. 11. 198 Cf. Eurex (ed.) (2003b), p. 11. 199 Cf. Bliss/Kaufman (2005), p. 8. 200 Cf. Bliss/Kaufman (2005), p. 8. 50 Clearing Services for Global Markets 2.3 The Value Provision Network Clearing services are usually offered in a tiered structure. 201 This section explains the structural set-up of the clearing industry, including the different layers of access to the market infrastructure. For the purpose of this study, this network, i.e. the clearing house and its customers, both direct (the ‘clearing members’) and indirect (the ‘non-clearing members’, which only have access to the clearing house through clearing members), is referred to a s the Value Provision Network (VPN). The structure of the VPN is presented first (section 2.3.1), and then the different types of clearing member are identified and categorised (section 2.3.2). 2.3.1 Structure of the Value Provision Network The fact that CCPs only grant membership to a subset of market participants accounts for the tiered structureof clearing service provision. 202 Consequently, not every trading member on an exchange is also a clearing member of the respective clearing house. By exercising selectivity, the clearing house ensures that direct participation in the clearing process is only granted to the most creditworthy subset of market participants. The practice lends the VPN its two-tiered structure. The first level comprises the clearing house and market par ticipants with direct access to the CCP; the second level involves participants with indirect access, i.e. thoserequiring the use of anintermediary (see Figure 2.11). The research focus of this study is on the first level of the VPN. The group of market participants occupying the firstleveloftheVPN enjoys direct access to a clearing house and is commonly referred to as ‘clear- ing member’ (CMs), clearers or clearing firms. 203 There are two categories of clearing members: 204 general clearing members and individual clearing mem- bers. A general clearing member (GCM) is allowed to clear its own transactions (proprietary activity) as well as those of its customers and exchange partici- pants not holding a clearing licence (agency activity). An exchange participant that does not hold a clearing licence is referred to as a non-clearing member 201 Cf. Bank for International Settlements (ed.) (1997a), p. 12; and Hart/Russo/Sch ¨ onenberger (2002), p. 13. 202 Cf. Bank for International Settlements (ed.) (2004), p. 7; and Deutsche B ¨ orse Group (ed.) (2005a), p. 34. 203 Cf. Loader (2005), p. 35. 204 Variations of these two types of clearing member may exist. 51 Setting the stage – definitions and industry setting 2ND LEVEL LEVEL OF DIRECT ACCESS TO CCP LEVEL OF INDIRECT ACCESS TO CCP GCM Customers Agency Activity Proprietary Activity ICM Agency Activity Proprietary Activity CLEARING HOUSE 1ST LEVEL VALUE PROVISION NETWORK RESEARCH FOCUS CLEARING HOUSE CLEARING MEMBERS NON-CLEARING MEMBERS CUSTOMERS MARKET INFRASTRUCTURE MARKET PARTICIPANTS NCM Agency Activity Proprietary Activity Figure 2.11 The Value Provision Network of clearing Source: Author’s own. (NCM). An individual clearing member (ICM), on the o ther hand, is qualified to clear its own (proprietary activity) and its customers’ transactions (agency activity), but it is not allowed to provide clearing services to NCMs. Clearing members must comply with the various membership requirements set by the clearing house (regarding minimum net capital, regulatory authori- sation requirements, fulfilment of additional operational requirements, etc.). The broader the scope of the clearing membership, the more stringent the membership requirements generally are: applicants for the GCM status must therefore, for example, comply with higher net capital requirements than ICM applicants. 205 Within the secondleveloftheVPN, market participants have no direct access to the clearing house. So-called non-clearing members are members of the clearing house’s affiliated exchange(s), but do not hold a clearing 205 For details on the legal relationships between CCPs and clearing members as well as regulatory issues regarding CCPs, refer to Huang (2006), pp. 117–95. 52 Clearing Services for Global Markets licence. NCMs may either not be eligible for or may not desire direct mem- bership in the CCP. 206 NCMs must therefore become customers of a GCM to effect clearing. 207 The GCM consequently acts as the NCM’s clearing intermediary. 208 The second level of the VPN also comprises other customers, i.e. individuals or firms that are not members of the clearing house’s affiliated exchange(s). 209 To summar ise, clearing members and non-clearing members alike can engage in agency activity or proprietary (prop.) activity. Agency activity refers to services provided to NCMs and customers, whereas prop. activity refers to servicing one’s own transactions. From the perspective of a GCM, agency activity comprises serv icing the individuals and firms that are not members of the clearing house’s affiliated exchange(s) as well as NCMs. From the perspective of an ICM, agency activit y is limited to servicing the individuals and firms that are not members of the clearing house’s affiliated exchange(s). An NCM, on the other hand, can only provide trade execution services to individuals and fir ms that are not exchange members; to clear the trades, it has to establish a relationship with a GCM. 2.3.2 Clearing member types In most markets, tiered relationships that are often varied and complex have devel- oped between the firms that provide clearing and the ultimate parties trading in the market. 210 As the research focus of this study is on the first level of the VPN, this section identifies and groups different types of clearing members according to their business focus. Consequently, for the purpose of this research, clearing 206 Cf. BNP Paribas Securities Services (ed.) (2005), p. 6. 207 Cf. B ank for International Settlements (ed.) (1997a), p. 1; and Hart/Russo/Sch ¨ onenberger (2002), p. 13. 208 Non-clearing members are often exposed to counterparty credit risk vis- ` a-vis their GCM and vice versa. Where many market participants rely on the same GCM, counterparty risk and responsibility for risk management may be concentrated to a significant degree in that clearing member. Thus, a risk management failure perpetrated by such a GCM could have effects similar to a risk management failure by a CCP. Cf. Bank for International Settlements (ed.) (2004), p. 7. 209 When such a non-member of the exchange (e.g. a retail client) executes a trade: ‘the clearing of that trade can take place through different paths . . . The retail client might choose to have its trade executed by a firm that is a clearing firm; the trade might then be executed and cleared through that one firm. Alternatively, the retail client might desire to have its trade executed by a non-clearing exchange member. That firm would be able to provide trade execution services to the client, but it would have established a relationship with a member of the clearing house for the provision of clearing services.’ (Bank for International Settlements (ed.) (1997a), p. 12). 210 Bank for International Settlements (ed.) (1997a), p. 12. [...]... world’s major financial markets, with direct access to each of the many clearing houses The globally active clearer can assume the role of a GCM or an ICM of the respective clearing houses, with either a prop or an agency focus The globally active clearer holds a direct clearing membership with all of the major clearing houses, because its core value proposition is single access to many markets When it acts... decision-makers are more likely to choose a hierarchical (firm-based) governance structure As frequency increases, the comparative advantage of using market governance structures decreases because the costs of hierarchical governance structures can be amortised across more instances of the transaction Transaction costs of clearing are defined as the total costs a market participant has to bear for using a certain... remainder of the study, because current industry structures are the framework for any harmonisation or integration initiative Such initiatives can potentially transform and impact the structure and characteristics of the clearing industry 2.5.1 Europe Although CCPs have long been a standard feature in most European exchangetraded derivatives markets, 238 few clearing houses have traditionally acted as CCPs for. .. Eurex Clearing, OMX Clearing, MEFF and CC&G) However, an equally great number of CCPs with a minimal market share operate in parallel at the local level 255 In addition to these structural characteristics, another particularity of the first level of the European VPN concerns the clearing members Figure 2.19 shows that a relatively small number of European high volume clearers account for the bulk of the. .. one European clearing member Market share estimates are based on information provided by Eurex Clearing and draw upon the insight provided by the publicly available information on clearing membership The comparisons of the European market share and the number of clearing houses apply to derivatives clearing The Value Provision Network for European securities clearing industry has a similar structure... activities as well as for their agency activities Generally, the larger the volumes cleared by a direct member, the greater the stake the member has in the development of the clearing house Clearing is of particular relevance for members with an agency focus, such as bankers/brokers, because it then becomes part of the clearer’s own value proposition towards its customers In this case, the provision of clearing. .. that are as low as possible, given the costs associated with having these services provided’.9 When analysing the efficiency of derivatives transaction services, it is important to bear in mind that the main contribution of derivatives markets lies in the allocation of risk Allocational efficiency in the context of derivatives markets therefore also accounts for their contribution and ability to transfer... alternate players in the marketplace Thirdly, the value of an asset may be tied to a particular transaction that it supports The party that is invested in the asset will incur a loss if the non-invested party withdraws from the transaction.20 Three dimensions of a transaction mainly affect the type of governance structure chosen for the transaction: asset specificity, uncertainty and frequency As asset... consequently of vital interest to central banks Given their role as the lender of last resort, these banks are required to exercise vigilance in all areas that could threaten the viability of the world’s financial markets. 224 Central banks therefore have a core interest in understanding the ways in which the increasing use of CCP services alter the distribution of risk as well as affect the likelihood of systemic... exchange(s) (i.e vertical clearing) or operating as independent entities (i.e horizontal clearing) CCP clearing constitutes the core of modern financial market infrastructure These clearing services not only benefit individual market participants, but markets as a whole, by increasing the efficiency of capital markets CCPs have traditionally played a more significant role in derivatives markets than in . Services for Global Markets of a financial market. 170 The effectiveness of a CCP’s risk management and sufficient levels of financial resources are therefore crucial for the stability of the markets, . individual market participants, but for capital markets as a whole. ‘Central Counter- parties are among the crucial building blocks of any well-organised financial system. They facilitate the allocation. 2. 1.3). For example, a bank/broker can also be a clearing member of a CCP (and thus a user of clearing services) as well as being a provider of clearing services to other market participants. Conflicting