Streetwise Professor

September 17, 2010

SWP Channels “Early Edition” Again

Filed under: Clearing,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 3:33 pm

I’ve written frequently about the problematic evolution of financial market structure under a clearing mandate.  One concern is the proliferation of CCPs.  One potential reason for this proliferation is that exchanges will want to control their own CCPs.

Long before before the crisis, I wrote about this vertical integration issue, in detail.  I dismissed worries that vertical integration is anti-competitive.  But I did note a fundamental tension.  Large, multi-product (and hence likely multi-exchange) CCPs have advantages from a risk-bearing perspective (although perhaps not from a systemic risk perspective).  But vertical integration likely economizes on transactions costs.  Thus, “siloed” CCPs can make sense even if it does not optimize risk bearing.  But the trade-off is a real one, and hard to evaluate.

I know some, notably the Bank of England, are worried about silos because they are concerned that they inflate the costs of managing counterparty risk.  But transactions costs are real costs too.

Apropos all this, today the FT has an article about how LSE is putting together its own CCP. It has cleared through LCH, but for strategic reasons thinks it necessary to control its clearing.  Given that LSE was once held out as the exemplar of how exchanges didn’t need to control their clearing, this is big news.  It also puts an exclamation point to my arguments that the evolution of the clearing business is not going to be driven purely to reduce systemic risks.  Clearing decisions are going to be made by for profit firms with their own particular agendas.  This means that the evolution of the market is likely to be quite complicated, and lead to results that the clearing mandate evangelists have not contemplated.  The implications of this structure for systemic risk are by no means obvious.

And a story in WSJ Europe raises yellow flags, and perhaps red ones, about the EU’s clearing mandate plans.  Read it. It will all sound very familiar to regular SWP readers.  Like in the US, however, it is unfortunate that people are coming to grips with the complexities of clearing mandates–and the potential dangers–only after they are a fait accompli.

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1 Comment »

  1. Nasdaq and GFI are at work on yet another CCP, specifically for US gas and power…

    Comment by Mike — September 21, 2010 @ 11:28 pm

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