Clearing Services for Global Markets A Framework for the Future Development of the Clearing Industry_12 pdf

385 Checking theory against reality – case studies of network strategies
CAN
SINGLE EUROPEAN CCP (2.)
CAN’T
BY INTERVIEWEE GROUP
BY INTERVIEWEE LOCATION
10 LON
3 EU
4 LON
1 CH
1 ME
FOR – CAN’T
2 CM
FOR – CAN
3 CM
5 ME
2 EX
2 NCM
9
CAN
2 LON
3 EU
CONFLICTED – CAN
6 CM
1 CH
1 EX
1 NCM
1 CH
1 US
4 US
BENEFITS

… BE ACHIEVED DIFFERENTLY
14
4
35
AGAINST
FOR
2
0
13
CONFLICTED
20
CONFLICTED – CANFOR – CANFOR – CAN’T
1 REG
Figure 8.29 Assessment of how many interviewees who were
for
or
conflicted
about the creation of a single
European CCP believed that the potential benefits of the initiative can/cannot be achieved
differently
291
Source: Author’s own.
utility-like entities that should preferably be user-owned and/or user-
governed, the empirical study indicates that this strong sentiment is slowly
fading, at least in the derivatives arena. Finally, the US marketplace has also
wit nessed the development of both horizontal (securities and options) and
vertical (futures) structures, w ith varying degrees of user ownership and/or
user governance. The fact that most US-based respondents had a futures
background explains their reluctance to support Single CCP structures (and
indicates that they are content with the less centralised structure of the Amer-

ican futures clearing industry).
Whereas Figure 8.28 suggests that the majority of interviewees opposed
the creation of a single European CCP, a significant number nonethe-
less advocated the initiative or felt conflicted about it. The next figure
(Figure 8.29) therefore assesses how many of the interviewees who were either
291
Interviewee groups: CM – clearing member; NCM – non-clearing member; ME – market expert;
EX – exchange; CH – clearing house; and REG – regulator. Interviewee locations: US – United States;
EU – Continental Europe; and LON – London.
386 Clearing Services for Global Markets
for or conflicted about the creation of a single European CCP believed that the
initiative’s potential benefits can or cannot be achieved by different means.
Figure 8.29 illustrates that of the twenty interviewees advocating a single
European CCP, the vast majority (fourteen out of twenty) believed that the
benefits of a Single CCP can generally be achieved via other means. Most of
these individuals thought that a Single CCP is theoretically the best solution,
but that it is simply not feasible to implement this kind of structure in Europe.
Four of these interviewees suggested a clearing link initiative as an alternative,
and three argued i n support of a more harmonised environment without
further specification.
Only four of the twenty interviewees advocating a single European CCP
were of the opinion that the benefits of a single European CCP cannot be
achieved by different means.
292
Finally, of the thirteen interviewees who were
conflicted, the majority (nine out of thirteen) believed that the benefits of a
Single CCP can generally also be achieved through a different initiative.
8.3.3 Summary of findings – impact of a single CCP on efficiency
Now, the honest truth is that the small guys do not benefit from major levels of
consolidation. And all attempts to bring cross-border differences down generally hurt

niche players that are geographically constrained.
293
The purpose of this case study was to challenge the findings of Chapter 7
regarding the impact of a Single CCP on the efficiency of European clearing.
The findings obtained from this study underscore and clarify the prelim-
inary conclusions. This allows drawing final conclusions. The findings are
summarised in the following.
8.3.3.1 Scale Impact Matrix – supply-side scale effects
r
The implementation of a Single CCP involves a very high degree of value
chain, technical and legal harmonisation and integration efforts. The imple-
mentation of such a network strategy is thus very complex and time-
consuming, and likely to involve very high long-term investments.
r
Whereas the creation of a Single CCP offers high potential for increases in
scale and scope, the extremely complex and thus costly integration process
can be assumed to involve significant investments. The ultimate magnitude
292
Two respondents did not make clear whether or not they believed that the benefits of a Single CCP
structure can or cannot be achieved differently.
293
Statement made by interviewed clearing member representative.
387 Checking theory against reality – case studies of network strategies
of economies of scale and scope is therefore diminished by these counter-
acting forces.
r
Additional complexities (including regulatory and political hurdles) related
to integration and coordination, together with possible duplicated efforts,
increased communication costs and slow response times can translate into
further costs, possibly even to diseconomies of scale.

8.3.3.2 Scale Impact Matrix – demand-side scale effects
r
A Sing le CCP positively impacts the size of the CCP level network; the oppo-
site is true for the GCM level network. The full integration of the partnering
clearing houses makes it attractive for a number of market participants to
disintermediate their clearer(s).
r
Whereas a single European CCP (when fully integrated) eliminates the
opportunity for any of the involved clearing houses to establish a lead in
Europe through their installed base, it cannot be assumed that the creation of
a Single CCP would inhibit the emergence of new, competing clearing houses
within Europe. The consolidated infrastructure could thus face competition
from new market entrants.
r
This similarly suggests that the growth potential of a Single CCP network
is likely to be limited. The appeal for other clearing houses to join such a
CCP network is limited, because potential partners usually do not have the
leeway to benefit from and further leverage their installed base.
r
Single CCP initiatives (as a particular form of M&A initiatives) have the
drawback that the majority of resources must be committed to the inte-
gration of the partnering clearing houses; this type of network initiative
is thus unlikely to leave sufficient resources for additional projects or to
spur innovation. The drain on resources also hampers the potential for the
internalisation of GCM level network effects (and consequently diminishes
the attractiveness for counterparties to disintermediate their clearer(s)).
8.3.3.3 Transaction Cost Impact Matrix
r
For regionally active clearing members (CM
PR

/CM
AR
), indirect transaction
costs are likely to increase if their home clearing house engages in M&A
initiatives leading towards the creation of a Single CCP. The nature of
these initiatives gives clearers no choice of participation; participation is
obligatory. The magnitude of the increase of indirect costs depends on the
structure of the initiative and the char acteristics of the clearing member.
294
294
One of the most crucial issues in this context is which clearing system will ‘survive’.
388 Clearing Services for Global Markets
Clearers must thus potentially bear investments that will not be outweighed
by cost savings or increased revenues.
r
Reg ionally-to-globally active clearing members (CM
PR-G
/CM
AR-G
)benefit
significantly from the opportunity to clear many markets through their
home clearing house, thus disintermediating their away market(s) clearer(s).
The magnitude of such a cost reduction depends on the structure of the
initiative and the characteristics of the clearing member. Cost reductions
can b e counteracted by investments resulting from the need to implement
and adapt to a new system, acquire knowledge, etc.
r
For globally active clearers with an agency focus (CM
AG
), the main benefit of

a Single CCP rests in the ability to centralise their various clearing relation-
ships into a single relationship with one clearing house, which significantly
reduces their indirect costs. For these clearers, cost reductions are unlikely to
be counteracted by investments resulting from the need to implement and
adapt to a new system, because they are already members of all European
CCPs.
r
Globally active clearing members with a prop. focus (CM
PG
), on the other
hand, strive to benefit from reductions in clearing house fees as a result of
a Single CCP.
8.3.3.4 Efficiency Impact Matrix
r
A single European CCP does not tr anslate into efficiency gains for all clearing
member types. Regionally active clearers (CM
PR
/CM
AR
)infactsufferfrom
efficiency losses as a result of a Single CCP.
8.3.3.5 Business Model Impact Matrix
r
Whereas a single European CCP benefits globally active clearing members
with a prop. focus (CM
PG
) or an agency focus (CM
AG
) in terms of efficiency
gains, clearers with an agency focus are likely to suffer from revenuedecreases

due to disintermediation. It is thus doubtful that g lobally active clearing
members with an agency focus would support the creation of a Single CCP,
unless they were somehow able to retain a significant stake in the CCPs’
governance and/or ownership.
r
User governance and/or user ownership is the only means for clearers with
an agency focus (CM
AG
) to exercise control over the rules of European
clearing and restrict access to the CCP network – and thus the only way to
circumvent disintermediation and the associated revenue losses.
389 Checking theory against reality – case studies of network strategies
8.4 Final assessment – impact of network strategies on efficiency
The purpose of Chapter 8 is to challenge the conclusions of Chapter 7 with case
study findings and insights from the empirical study. For this purpose, three
case studies were performed analysing clearing links, mergers and acquisitions,
and a Single CCP initiative. The results of the analyses support the preliminary
findings: the network strategy best suitedto enhance the efficiency of European
derivatives clearing is a clearing link set-up, because it is the only network
strategy that facilitates efficiency gains for all clearing member types.
Besides supporting the findings of Chapter 7, the case studies also serve to
provide more detailed insights into the complexities inherent to the imple-
mentation of different network strategies in Europe.
8.4.1 Clearing links
r
Many interviewees found it difficult to assess the suitability of a clearing
link solution for European clear ing. One of the obstacles to judging clearing
links is that no link set-up actually exists that could serve as an adequate role
model for Europe. Clearing links have so far been implemented with the
primary objective of serving trading purposes – a fact that was also found to

apply to the case study of the link between Eurex Clearing and The Clearing
Corporation.
r
The GCL (Phase I) is a prime example of a clear ing link initiative whose
dedicated purpose was not necessarily to enhance the efficiency of the clear-
ing industry, and it thus consequently failed to deliver significant benefits
and to overcome the starting problem. It showed that whereas such a clear-
ing link can serve to increase slightly the efficiency of clearing for some
market participants, there remains a huge unrealised potential for efficiency
gains.
295
r
The case study thus illustrates that if a link interconnects too few clearing
networks, does not compensate for the lost intermediary (GCM) level by
providing most of these services themselves (thereby successfully internalis-
ing GCM level network effects) and neglects to offer a full choice of clearing
location (including all products), it will ultimately fail to gain t raction.
Consequently, if the partnering clearing houses do not adequately attempt
295
The unrealised potential for efficiency gains is a direct result of the limitations of the GCL initiative,
which have been identified in the context of the section 8.1.2.6.
390 Clearing Services for Global Markets
to overcome the link-inherent starting problem, a significant amount of
potential for efficiency gains will go unrealised. Such a link initiative is not
designed to increase significantly the efficiency of the European clearing
industry.
r
Additionally,the failure of relevant clearing members to recognise the poten-
tial value proposition of a clearing link set-up, low internal prioritisation of
implementing the link, mandatory open interest transfers, regulatory and

political issues can create further uncertainty about the future development
of a clearing link initiative and inhibit clearing members from expecting
positive future network effects and thus aggravate the starting problem.
r
The case study also suggested that not all stakeholders have a comprehensive
grasp of the concept and value proposition of clearing links in general.
Surprisingly, clearing houses in particular proved to know little about the
Global Clearing Link. Although the GCL was never a concept intended to
invite other CCPs to participate, for a European clearing link initiative to
be successful, it is important that all European CCPs understand the value
of interconnecting. A link initiative can only flourish if clearing houses
truly understand the value of leveraging their installed base, internalising
the GCM level network effects and using the initiative to strengthen their
unique CCP level network effects.
8.4.2 Mergers and acquisitions
r
The case study of the merger between the London Clearing House and
Clearnet revealed that the complexities of successfully implementing M&A
initiatives between European clearing houses are even greater than assumed
in Chapter 7. In reality, the counteracting forces, such as necessary long-
term investments as well as additional regulatory and political hurdles,
significantly impede mergers. Within Europe, the full integration of the
part nering CCPs, which is necessary to achieve the maximum efficiency
gains, has proved to be next to impossible.
r
The very high complexity of integration inherent to M&A initiatives also
decelerates the CCPs’ ability to innovate and increases costs. If M&A strate-
gies are employed to increase the efficiency of European clearing, it is thus
likely that many potential efficiency gains will remain unrealised.
r

Additionally, the insights generated by the case study underscored the
finding that M&A initiatives do not benefit all clearing members, as they
potentially have a detr imental impact on low volume clearers with a regional
business focus.
391 Checking theory against reality – case studies of network strategies
r
The LCH.Clearnet merger is a prime example of an M&A initiative between
CCPs that has so far failed to deliver on precisely those issues critical for
realising high efficiency gains for medium and high volume clearers.
r
The case study also suggests that M&A initiatives between two major Euro-
pean CCPs by no means necessarily spur the further harmonisation or
integration of the European clearing industry.
8.4.3 Single CCP
r
The insights from the empirical study and the M&A and Single CCP case
studies supported the preliminary findings of Chapter 7 regarding the com-
plexities of combining European clearing houses with different historical
backgrounds, profiles and legal environments as well as the near impossi-
bility of consolidating European CCPs into a single group.
r
Additionally, the case study insights underlined the findings regarding the
unequal distribution of benefits and costs inherent to this type of network
strateg y. A single European CCP initiative does not benefit all clearing
members; it can in fact exert a detrimental impact on low volume clearers
with a regional business focus.
r
High volume clearers with an agency focus prefer the establishment of a
Single CCP over clearing links, because clearing links can have a significantly
negative impact on their business model and it is generally easier to succeed

in lobbying for user ownership/governance (thus controlling the rules of
clearing) of one single entity than it is for various entities. High volume
clearers with an agency focus are therefore likely to oppose a Single CCP
unless they have a substantial say in the governance of the clearing house
and can influence the rules of clearing. This is the only way for them
to circumvent the risk of disintermediation and the associated revenue
losses.
r
The analysis also supported the finding that globally active clearers with a
prop. focus are likely to benefit most, in terms of efficiency gains, from the
implementation of a Single CCP. Nonetheless, this group of clearers will
only support a Single CCP if it can secure the means to control the rules
of clearing, i.e. make sure that clearing fees (i.e. their core cost driver) are
sufficiently reduced and that the consolidated infrastructure does not abuse
its dominant position. Whether or not such fee reductions truly reflect an
increase in internal efficiency of the merged entity or merely represent a
quick fix to appease the clearing members that exert control over the Sing le
CCP would require further research.
392 Clearing Services for Global Markets
r
When Single CCP initiatives fail to translate into indirect cost savings and
merely accommodate clearing members by offering fee cuts, globally active
clearers with a prop. focus benefit significantly, whilst all other clearing
member types remain unable to reduce their core cost driver (i.e. indirect
costs).
r
Regarding the issue of governance, the M&A and the Single CCP case
studies revealed that ceding partial control over a clearing house in the
context of a merger as a trade-off for efficiency gains makes sense from the
perspective of high volume clearers with an agency perspective, as long as

the resulting structure is not a monopoly. If the CCP is a monopoly, the
risk of disintermediation is likely to exceed the potential benefits for these
clearers.
Finally, the case studies also lent support to the preliminary finding that
European derivatives clearing does not constitute a natural monopoly. Despite
the widespread belief that clearing generally qualifies as a natural monopoly,
no evidence of this was found in multinational markets, such as the European
clearing industry, in which ‘[n]ew clearing arr angements are emerging all the
time’.
296
To summarise, whereas different network st rategies have varying potential
to increase the efficiency of the European clearing industry, clearing links
were found to be the only initiative that generates efficiency gains for all
clearing members. Particular attention must also be given to the impact of
harmonisation and integration initiatives on smaller regional or niche markets
and on clearing members with less negotiating and lobbying power than
Europe’s high volume clearers. Although a clearing link strategy is best suited
to benefit all clearers, the implementation of such an initiative will also be
cumbersome and demand a lot from the different stakeholders. Furthermore,
there are many kinds of clearing link initiative, and not all of them can serve
to increase the efficiency of European clearing. Therefore, the parameters and
prerequisites identified in this study as necessary for enhancing the efficiency
of the European clearing industry through a link set-up will be summarised
and further detailed in Chapter 10. Prior to that and based on the findings
of Chapters 7 and 8, Chapter 9 provides a quantitative assessment of the
efficiency impact of European network strategies.
296
Moskow (2006).
9
Quantifying the efficiency impact –

European network strategies
Analysing the impact of network strategies on the efficiency of European
clearing consists of a three-step approach: the findings derived in Chapters 7
and 8 (step 1 and 2) serve as the basis for a quantification of the efficiency
impact of European network strategies, which is presented in this chapter
(step 3).
First, the quantified efficiency impacts of a European clearing link set-
up and a single European CCP are presented in terms of total costs borne
by European clearing members (section 9.1). The next section (section 9.2)
breaks these costs down into the members’ average direct and indirect costs.
The calculation of the respective efficiency impact is based on the findings
of sections 5.2.3 and 5.2.4, as well as the conclusions derived in Chapters 7
and 8. Finally, a summary of the insights derived in this chapter is provided
(section 9.3).
9.1 Total European industry costs
Whereas section 5.2.3 introduced an estimate of the total European clearing
industry costs in 2005, this section presents the recalculated estimate under
the assumption of implemented European clearing links (section 9.1.1) and
a single European CCP (section 9.1.2), i.e. quantifies the potential efficiency
impact of each network strategy. As the calculation of costs is based on the
results presented in section 5.2.3, the same caveats apply to the figures pre-
sented in the following.
1
For details on the quantitative analysis and the
underlying assumptions, refer to Appendix 8.
1
An additional caveat applies to the estimated efficiency impact: the implementation of European clearing
links or a single European CCP is likely to impact the composition of all-in clearing costs for different
clearing member types (see Figure 5.5). When a certain network strategy enables a disproportionately
higher/lower reduction of indirect costs as compared to direct costs (or vice versa) for certain clearing

member types, then this affects the ratio of direct to indirect costs. This kind of de velopment is not
394 Clearing Services for Global Markets
QUANTIFYING THE EFFICIENCY IMPACT –
EUROPEAN NETWORK STRATEGIES
Total European Industry Costs
9.1
9
Quantifies efficiency impact of a European clearing
link set-up and the creation of a single European
CCP.
Quantifies the impact of European clearing links
and a single European CCP on total European
derivatives clearing costs.
Quantifies the impact of European clearing links
and a single European CCP on clearing members’
average direct and indirect costs.
European Clearing Members’ Average Costs9.2
PURPOSECHAPTER
Summary
9.3
Figure 9.1 Structure of Chapter 9
9.1.1 Efficiency impact of clearing links
This section furnishes a recalculation of the 2005 total costs borne by European
clearing members according to the assumption of implemented clearing links
between Eurex Clearing, LCH.Clearnet, OMX Clearing, MEFF and CC&G.
Figure 9.2 outlines the quantitative results of the analysis.
2
Under the
assumption of implemented European clearing links, total European costs
of derivatives clearing would have amounted to roughly €1.503 billion in

2005, representing a reduction of 31 per cent when compared with the orig-
inal estimate. Although this figure pertains to the first level of transaction
costs, i.e. all of the direct and indirect costs borne by clearing members, any
such cost reduction also benefits market participants with indirect access to
the market infrastructure. NCMs and other customers, for example, benefit
from cost reductions when the savings are redistributed within the VPN and
are ultimately passed on (either directly or indirectly as part of commissions)
by the clearers to their respective NCMs and/or other customers. Under a
clearing link scenario, direct costs would have come to about €523 million, or
been trimmed by roughly 28 per cent. Indirect costs would have weighed in
at €980 million, representing a 32 per cent decrease compared to the original
2005 estimate.
Figure 9.3 outlines the per cent stake the different clearing members would
have held in the costs of European derivatives clearing in 2005 under the
accounted for in this quantitative analysis. This is due to the lack of a basis for providing well-founded
assumptions as to how different network strategies affect the composition of all-in clearing costs for the
different clearing member types.
2
Figures are rounded to millions of euros; €100,000 to €499,000 are rounded down, whereas €500,000
to €999,000 are rounded up.
395 Quantifying the efficiency impact – European network strategies
Direct
Costs*
Service Provider Charges
Indirect
Costs*
Cost of Capital
Risk Management Costs
IT Costs
Back-Office Costs

Total European Industry Costs* in 2005
Clearing House Charges
Total European Direct Costs
Total European Indirect Costs
STATUS QUO
250,000,000
128,000,000
94,000,000
579,000,000
647,000,000
475,000,000
2,173,000,000
1,448,000,000
725,000,000
1,503,000,000
173,000,000
90,000,000
64,000,000
386,000,000
440,000,000
350,000,000
980,000,000
523,000,000
WITH CLEARING LINKS
* Costs in EUR
–28%
–31%
–32%
Figure 9.2 Total European derivatives clearing costs in 2005 – efficiency impact of clearing links
Source: Author’s own.

assumption of implemented European clearing links. Although the results
have to be interpreted cautiously for the reasons described in the introductory
part of section 9.1, the findings suggest that high volume clearers with a
prop. focus can be expected to continue to have a strong lobbying interest in
pushing clearing houses to reduce their fees if clearing links are introduced
in the future. As for cutting indirect costs further, the other clearing member
types would likely have an interest in advocating additional external as well as
pursuing internal measures (as identified in section 5.2.7).
9.1.2 Efficiency impact of a single CCP
The following presents the efficiency impact of a Single CCP on the total
costs of European derivatives clearing in 2005. This section thus furnishes
a recalculation of the 2005 total costs borne by European clearing members
according to the assumption of an implemented Single CCP created through
a merger between Eurex Clearing, LCH.Clearnet, OMX Clearing, MEFF and
CC&G.
396 Clearing Services for Global Markets
0
500,000,000
1,000,000,000
1,500,000,000
2,000,000,000
Indirect CostsDirect CostsTotal Costs
European Derivatives Clearing Industry Costs in 2005
Percentage per Clearing Member Type
With Clearing Links
1,503,000,000
523,000,000
980,000,000
39%
29%

32%
62%
24%
14%
27%
32%
41%
Costs in EUR
Low Vol. (Regional)
Medium Vol. (Reg Glob.)
High Vol. (Global)
Clearing Member Types:
Figure 9.3 Per cent stake of different clearing member types in European derivatives clearing costs in 2005 –
under the assumption of implemented European clearing links
Source: Author’s own.
Figure 9.4 outlines the quantitative results of the analysis.
3
Under the
assumption of an implemented single European CCP, total European costs of
derivatives clearing would have amounted to roughly €1.958 billion in 2005.
As compared to the status quo ante, the implementation of a Single CCP
would have reduced total costs by roughly 10 p er cent. Direct costs would
have come to approximately €629 million, or roughly 13 per cent less than
the or iginal 2005 estimate of €725 million. Meanwhile, indirect costs could
havebeenreducedbyroughly8percent,foratotalof€1.329 billion, under
thesameschema.
When comparing the effect of clearing links and a Single CCP on total costs
(Figures 9.2 and 9.4), it has to be kept in mind that the figures being compared
represent the aggregate of individual cost impacts for each of the 219 European
clearing members.

4
This means that a particular clearing member might have
experienced more substantial reductions in, say, the cost of capital under a
3
Figures are rounded to millions of euros; €100,000 to €499,000 are rounded down, whereas €500,000
to €999,000 are rounded up.
4
Refer to section 2.5.1 for details on the structure of the European VPN and the total number of clearing
members.
397 Quantifying the efficiency impact – European network strategies
Direct
Costs*
Indirect
Costs*
Total European Industry Costs* in 2005
Total European Direct Costs
Total European Indirect Costs
STATUS QUO
WITH SINGLE CCP
250,000,000
128,000,000
94,000,000
579,000,000
647,000,000
475,000,000
2,173,000,000
1,448,000,000
725,000,000
1,958,000,000
221,000,000

123,000,000
85,000,000
522,000,000
599,000,000
408,000,000
1,329,000,000
629,000,000
*
Costs in EUR
Service Provider Charges
Cost of Capital
Risk Management Costs
IT Costs
Back-Office Costs
Clearing House Charges
–10%
–13%
–8%
Figure 9.4 Total European derivatives clearing costs in 2005 – efficiency impact of a single European CCP
Source: Author’s own.
Single CCP initiative, whereas another clearer might have reaped better gains
from clearing links.
Figure 9.5 outlines the per cent stake that the different clearing mem-
bers would have held in the European costs of derivatives clearing in 2005
under the assumption of an implemented Sing le European CCP. Again,
even though certain caveats have to be kept in mind (see the introduc-
tory part of section 9.1), the results nevertheless suggest that high volume
clearers with a prop. focus can be expected to continue to pressure clearing
houses to reduce their fees if a Single CCP is introduced in the future. To
reduce indirect costs further, on the other hand, other clearing member types

would likely advocate additional external and internal measures (as identi-
fied in section 5.2.7). Figure 9.5 also illustrates that under the Single CCP
scenario, low volume clearers would likely suffer from significant efficiency
losses.
398 Clearing Services for Global Markets
0
500,000,000
1,000,000,000
1,500,000,000
2,000,000,000
2,500,000,000
Costs in EUR
Indirect CostsDirect CostsTotal Costs
European Derivatives Clearing Industry Costs in 2005
Percentage per Clearing Member Type
With Single European CCP
629,000,000
1,329,000,000
33%
27%
40%
57%
23%
20%
22%
28%
50%
1,958,000,000
Low Vol. (Regional)
Medium Vol. (Reg Glob.)

High Vol. (Global)
Clearing Member Types:
Figure 9.5 Per cent stake of different clearing member types in European derivatives clearing costs in 2005 –
under the assumption of an implemented single European CCP
Source: Author’s own.
9.2 European clearing members’ average costs
Section 5.2.4 presented an estimate of European clearing members’ average
direct and indirect costs. This section assesses the average costs for different
clearing member types assuming the implementation of either European
clearing links (section 9.2.1) or a single European CCP (section 9.2.2). Again,
this analysis does not claim to deliver results applicable to any particular
clearing member, but instead provides an archetypical assessment of clearing
costs.
The estimated costs enable a better understanding of the efficiency impact
that European clearing links or a Single CCP can have on different clearing
member ty pes’ average costs and also serves to illuminate the possible effect
that certain network strategies could thus have on the structure of the Euro-
pean VPN.
5
The calculation of these costs is based on the results presented in
section 5.2.4 and the findings of Chapters 7 and 8.
6
5
A detailed interpretation of these results and their possible effect on the structure of the European VPN
are discussed in more detail in section 10.1.
6
The calculation of European clearing members’ average costs under the assumption of implemented
European clearing links and a Single CCP are based on the results of the calculation as outlined in
399 Quantifying the efficiency impact – European network strategies
Ø TOTAL Costs

Market
Share
Ø Indirect CostsØ Direct Costs
10.00%
4.00%
3.00%
2.00%
1.00%
0.50%
0.30%
0.01%
52,509,000 35,006,000
87,515,000
25,256,000 30,869,000
56,125,000
21,685,00024,453,000
46,138,000
15,145,000 22,718,000
37,863,000
25,450,0008,483,000
33,933,000
4,756,000 21,665,000
26,421,000
14,092,0003,093,000
17,185,000
4,880,000861,000
5,741,000
STATUS
QUO
CLEARING

LINKS
42,288,000
24,860,000
19,694,000
8,288,000
4,643,000
2,603,000
2,358,000
656,000
STATUS
QUO
CLEARING
LINKS
27,673,000
19,966,000
17,142,000
12,195,000
13,661,000
11,629,000
10,738,000
3,718,000
69,961,000
44,826,000
36,836,000
20,483,000
18,304,000
14,232,000
13,096,000
4,374,000
STATUS

QUO
HIGH VOLUME CLEARER
MEDIUM VOLUME CLEARER
LOW VOLUME CLEARER
Costs in EUR
CLEARING
LINKS
Figure 9.6 Average annual direct and indirect costs for clearing member archetypes – under the assumption of
implemented European clearing links
Note: Ø = average.
Source: Author’s own.
9.2.1 Efficiency impact of clearing links
This section presents an estimate of the average annual direct and indirect costs
European clearing member archetypes would incur under the assumption
of implemented European clearing links (Figure 9.6). From these figures,
the clearing members’ average unit costs can be derived, and the efficiency
impact of clearing links for these clear ing member archetypes can be gauged
(Figure 9.7).
Figures 9.6 and 9.7 show that increasing volumes continue to lead to
economies of scale on the part of the clearers; unit costs thus decrease with
an increase of the number of contracts cleared. The figures reinforce the pre-
vious findings of Chapters 7 and 8 with quantitative cost data, showing that
all clearing member types benefit from European clearing links in the form of
efficiency gains.
Appendix 8. These results enable the identification of the efficiency impact of the network initiatives on
the direct and indirect costs of different clearing member types and finally lead to the results outlined in
Figures 9.6, 9.7, 9.8 and 9.9.
400 Clearing Services for Global Markets
Market
Share

10.00%
4.00%
3.00%
2.00%
1.00%
0.50%
0.30%
0.01%
Ø Unit Costs in EUR
0.20
0.26
0.35
0.43
0.78
1.21
1.32
13.19
0.16
0.21
0.28
0.24
0.42
0.65
1.00
10.05
STATUS
QUO
CLEARING
LINKS
HIGH VOLUME CLEARER

MEDIUM VOLUME CLEARER
LOW VOLUME CLEARER
–20%
–46%
–24%
Figure 9.7 Average unit costs for clearing member archetypes – under the assumption of implemented
European clearing links
Note: Ø = average.
Source: Author’s own.
In particular, medium volume clearers benefit from reduced unit costs. If
European clearing links were implemented, some of these clearers would enjoy
unit cost levels comparable to those currently exhibited by high volume clear-
ers. This illustrates the finding that under a European clearing link scenario,
it would make sense for medium volume clearers to self-clear all European
markets in which they are active. It would thus be logical for a number of
medium volume clearers to consider disintermediating their away markets’
GCM(s).
Section 5.2.4 described unit costs as the central decision criterion for
clearing members when assessing the economic prudence of becoming a
direct member of one or more clearing houses in relevant markets. Network
initiatives were also identified as possibly having an important impact on
the structure of the European VPN, in particular when initiatives result in
increased economic attractiveness for regionally-to-globally active clearers
of self-clearing many markets instead of employing intermediary services.
Figure 9.7 therefore suggests that the currently strong position of high volume
401 Quantifying the efficiency impact – European network strategies
Ø TOTAL Costs
Market
Share
Ø Indirect CostsØ Direct Costs

10.00%
4.00%
3.00%
2.00%
1.00%
0.50%
0.30%
0.01%
52,509,000 35,006,000
87,515,000
25,256,000 30,869,000
56,125,000
21,685,00024,453,000
46,138,000
15,145,000 22,718,000
37,863,000
25,450,0008,483,000
33,933,000
4,756,000 21,665,000
26,421,000
14,092,0003,093,000
17,185,000
4,880,000861,000
5,741,000
STATUS
QUO
SINGLE
CCP
STATUS
QUO

SINGLE
CCP
STATUS
QUO
HIGH VOLUME CLEARER
MEDIUM VOLUME CLEARER
LOW VOLUME CLEARER
Costs in EUR
SINGLE
CCP
46,517,000
27,346,000
21,663,000
10,034,000
5,620,000
3,150,000
3,863,000
1,075,000
30,620,000
22,092,000
18,968,000
14,673,000
16,438,000
13,993,000
17,586,000
6,090,000
77,137,000
49,438,000
40,631,000
24,707,000

22,058,000
17,143,000
21,449,000
7,165,000
Figure 9.8 Average annual direct and indirect costs for clearing member archetypes – under the assumption of
an implemented single European CCP
Note: Ø = average.
Source: Author’s own.
clearers within the European VPN could be diluted if a clearing link set-up
were to be implemented.
7
9.2.2 Efficiency impact of a single CCP
This section presents an estimate of the average annual direct and indirect
costs European clearing member archetyp es would have to bear under the
assumption of an implemented single European CCP (Figure 9.8). From
these figures, the clearing members’ average unit costs can be derived, and the
efficiency impact of a Single CCP for these clearing member archetypes can
be identified (Figure 9.9).
Figures 9.8 and 9.9 show that increasing volumes continue to lead to
economies of scale for the clearers; unit costs thus decrease with an increase of
the number of contracts cleared. The figures also illustrate the findings from
Chapters 7 and 8 with quantitative cost data: they show that medium and
7
A detailed interpretation of these results and their possible effect on the structure of the VPN are
discussed in more detail in section 10.1.
402 Clearing Services for Global Markets
Market
Share
10.00%
4.00%

3.00%
2.00%
1.00%
0.50%
0.30%
0.01%
φ Unit Costs in EUR
0.20
0.26
0.35
0.43
0.78
1.21
1.32
13.19
0.18
0.23
0.31
0.28
0.51
0.79
1.64
16.46
STATUS
QUO
SINGLE
CCP
HIGH VOLUME CLEARER
MEDIUM VOLUME CLEARER
LOW VOLUME CLEARER

–12%
–35%
+25%
Figure 9.9 Average unit costs for clearing member archetypes – under the assumption of an implemented single
European CCP
Note: ø = average.
Source: Author’s own.
high volume clearers benefit from a Single CCP, but that the efficiency gains
are not as great as those produced by European clearing links.
In particular, medium volume clearers benefit from reduced unit costs.
Figure 9.9 shows that when a single European CCP is implemented, some of
these clearers enjoy unit cost levels comparable to those currently exhibited
by high volume clearers. This lends credibility to the finding that it makes
sense for a number of medium volume clearers to self-clear all European
markets in which they are active – thus disintermediating their away markets’
GCM(s) – if a single European CCP is in place.
Last but not least, the figures illustrate that not all clearing member types
stand to benefit from the implementation of a single European CCP – low
volume clearers are negatively affected by significant efficiency losses, i.e. cost
increases. For low volume clearers, the Single CCP scenario diminishes the
economic appeal of self-clearing, because their costs of production increase.
8
8
A detailed interpretation of these results and their possible effect on the structure of the VPN are
discussed in more detail in section 10.1.
403 Quantifying the efficiency impact – European network strategies
9.3 Summary
This chapter constitutes the final phase of a three-step approach to analyse the
impact of network strategies on the efficiency of European clearing. Based on
the findings derived in Chapters 7 and 8, this chapter presents a quantification

of the potential efficiency impact of a European clearing link set-up and
a single European CCP, the results of which are briefly summarised in the
following.
9.3.1 Total European industry costs
r
Under the assumption of implemented European clearing links, total Euro-
pean costs of derivatives clearing would have amounted to roughly €1.503
billion in 2005, representing a reduction of 31 per cent. Direct costs would
have come to about €523 million, and thus reduced by roughly 28 per cent.
Indirect costs would have weighed in at €980 million, representing a 32 per
cent decrease.
r
Under the assumption of an implemented single European CCP, total Euro-
pean costs of derivatives clearing would have amounted to roughly €1.958
billion in 2005. The implementation of a Single CCP would thus have
reduced total costs by roughly 10 per cent. Direct costs would have come to
approximately €629 million, i.e. reduced by roughly 13 per cent. Indirect
costs would have been reduced by roughly 8 per cent, for a total of €1.329
billion.
r
Figure 9.10 summarises these findings by giving an overview of the estimated
potential savings under the assumption of implemented European clearing
links or an implemented Single CCP for Europe. It reveals that while clearing
links could result in annual total cost savings of approximately €670 mil-
lion, a Single CCP would merely save European clearing members around
€215 million in total costs. Annual direct costs savings could amount to
roughly €202 million in the case of implemented European clearing links.
A Single CCP would bring about fewer annual direct cost savings of only
approximately €96 million. Total indirect costs would be reduced annually
by €468 million through clearing links, but only by €119 million in the case

of a single European CCP.
r
The finding that a Single CCP provides less overall benefits to the mar ket as
compared to clearing links, results from the fact that some clearing member
types are negatively affected by the implementation of a Single CCP.
404 Clearing Services for Global Markets
Direct
Costs
Service Provider Charges
Indirect
Costs
Cost of Capital
Risk Management Costs
IT Costs
Back-Office Costs
Total European Industry Costs in 2005
Clearing House Charges
Total European Direct Costs
Total European Indirect Costs
CLEARING LINKS
SINGLE CCP
–77,000,000 EUR
–38,000,000 EUR
–30,000,000 EUR
–193,000,000 EUR
–207,000,000 EUR
–125,000,000 EUR
–670,000,000 EUR
–468,000,000 EUR
–202,000,000 EUR

–215,000,000 EUR
–29,000,000 EUR
–5,000,000 EUR
–9,000,000 EUR
–57,000,000 EUR
–48,000,000 EUR
–67,000,000 EUR
–119,000,000 EUR
–96,000,000 EUR
POTENTIAL SAVINGS THROUGH:
Figure 9.10 Total European derivatives clearing costs in 2005 – overview of estimated potential savings under the
assumption of implemented European clearing links or an implemented single European CCP
Source: Author’s own.
9.3.2 European clearing members’ average costs
r
Under the assumption of implemented European clear ing links, all clear-
ing member types benefit from efficiency gains: high volume clearers can
potentially reduce their unit costs by 20 per cent. Medium volume clearers
enjoy significantly reduced costs; they can benefit from unit cost savings of
roughly 46 per cent. This means that some of these clearers would enjoy unit
cost levels comparable to those currently exhibited by high volume clearers.
It would thus make sense for medium volume clearers to self-clear all Euro-
pean markets in which they are active and consider disintermediating their
away markets’ GCM(s). Finally, also low volume clearers can potentially
benefit from efficiency gains and pocket a lowering of unit costs by roughly
24 per cent.
r
Under the assumption of an implemented single European CCP, however,
not all clearing member types benefit from efficiency gains: low volume
clearers are negatively affected by significant efficiency losses; their unit

costs can increase by up to 25 per cent. For some low volume clearers, the
405 Quantifying the efficiency impact – European network strategies
Single CCP scenario can thus diminish the economic appeal of self-clearing.
Medium and high volume clearers, on the other hand, benefit from a Single
CCP, but the efficiency gains are not as great as those producedby a European
clearing link scenario. High volume clearers can potentially reduce their unit
costs by approximately 12 per cent. Medium volume clearers enjoy greater
efficiency gains than high volume clearing members; their unit costs can be
reduced by roughly 35 per cent. This means that it would also make sense
for medium volume clearers to self-clear all European markets in which
they are active and consider disintermediating their away markets’ GCM(s)
in the case of a Single CCP.
Based on the findings of Chapters 7, 8 and 9 on the efficiency impact of
various network strategies w ithin the European clearing industry, Chapter 10
proceeds to determine the most preferable future European industry structure
and delivers recommendations for its development. Additionally, the research
results are applied to European exchange-traded cash equities clearing as well
as to Europe w ith respect to its global positioning.
10
Introducing the future network
economy – development of the
clearing industry
The previous chapters served to provide conclusions on the efficiency impact
of various network strategies within the European clearing industry. Based
on these findings, this chapter identifies the most preferable future clearing
industry st ructure and delivers recommendations for the industry’s future
development.
The following sections summarise and build on the insights obtained
from the previous chapters to create an outlook on the future development
of the European clearing industry (section 10.1), followed by an applica-

tion of the research results to European clearing with regard to its global
context (section 10.2). The chapter closes by summarising these findings
(section 10.3).
10.1 Future development of the European clearing industry
We want dynamic, integrated capital markets in the EU – not segmented ones. And
we are determined to achieve them. For all our customers, investors and companies.
And to strengthen the European economy.
1
This study’s objective was to identify the network strategy best suited to
increase the efficiency of European clearing. In line with the above-quoted
claim by Commissioner Charlie McCreevy (European Commission), it is con-
sidered to be a prerequisite that such an efficiency increase benefit all clearing
members. Therefore, network strategies that favour some while penalising
others (such as the Single CCP) are not regarded as viable scenarios.
In keeping with the Commission’s vision to further European market inte-
gration, a recommendation for the future development of European deriva-
tives clearing is formulated (section 10.1.1). The findings on derivatives
1
McCreevy (2006a), p. 5.
407 The future network economy – development of the clearing industry
INTRODUCING THE FUTURE NETWORK ECONOMY –
DEVELOPMENT OF THE CLEARING INDUSTRY
Future Development of the European
Clearing Industry
10.1
10
Determines the most preferable future European
industry structure and delivers recommendations
for its development.
Delivers an outlook on the future development of

the European clearing industry.
Applies the research results to European clearing
with respect to its global context.
European Clearing in a Global Context10.2
PURPOSECHAPTER
Summary
10.3
Figure 10.1 Structure of Chapter 10
clearing are then applied to European cash equities clearing (section 10.1.2).
A third step serves to gauge whether Europe’s major clearing houses are suffi-
ciently well-positioned, prepared and flexible to reap the benefits of a clearing
link structure (section 10.1.3). This assessment serves as a basis to consider the
reconcilability of this study’s conclusions with the European Commission’s
decision to call upon the industry to establish a Code of Conduct (section
10.1.4). At this juncture, the critical question is which European clearing
houses actually ought to be linked. A fifth step (section 10.1.5) therefore pro-
vides a basic framework designed to serve as a starting point for European
CCP managers to determine their European clearing link strategy. Finally, the
structural changes that clearing links are likely to spur in the European Value
Provision Network are described (section 10.1.6).
10.1.1 Recommendation for European derivatives clearing
Competition is important in achieving the overall objective of creating a safe, efficient
and integrated EU clear ing and settlement infrastructure. The basic conditions for
this goal are transparency and open access. To avoid discrimination against classes
of participants and competitive distortions, participation requirements should be
fair and open within the scope of services offered by the CCP. However, these rules
and requirements for fair and open access should be balanced against and aimed at
controlling and limiting risks.
2
The research objective of this study was to determine the efficiency impact

of different network strategies within the European clearing industry. This
2
Tumpel-Gugerell (2006).
408 Clearing Services for Global Markets
in turn served to identify the European industry structure best suited to
increase the efficiency of clearing for all clearing members. The study revealed
that particular attention must be given to the impact of harmonisation and
integration initiatives on smaller regional or niche markets and on clearing
members with less negotiating and lobbying power than Europe’s high volume
clearers.
3
Given these criteria, clearing links emerged as the sole network strategy
suited to integrate the European clearing industry and generate efficiency
gains for all clearing members. To summarise, the implementation of clearing
links between European CCPs was found to hold the following potential
benefits for stakeholders in clearing:
r
All clearing member types stand to benefit from a decrease of direct and
indirect costs, resulting in a substantial reduction of unit costs.
r
Low volume clearers would not risk being put out of business through
European clearing links and would potentially also benefit from reduced
unit costs.
r
Medium volume clearers would be given the opportunity to disintermediate
their away markets’ clearing intermediaries, which would in turn lead to
a significant unit cost reduction. Disintermediation becomes even more
attractive when clearing houses succeed in internalising GCM level network
effects.
r

Clearing links would stimulate the internalisation of GCM level network
effects by the CCP level. This internalisation process is ultimately beneficial,
because it increases the industry’s overall efficiency.
r
High volume clearers could reduce their unit costs, as they would be g iven
the option to select the CCP that will ser ve as their gateway to other European
markets.
r
European clearing houses would benefit because they could leverage their
installed base, internalise GCM level network effects, strengthen their
unique CCP level network effects and continue to offer services tailored
to the specific demands of regional market particularities to an increased
number of network participants.
r
Market participants and clearing houses alike would benefit from the com-
petitive forces,
4
enhanced flexibility and adaptabilit y, innovation opportu-
nities and high growth potential inherent to link set-ups.
3
Also refer to European Commission (ed.) (2002a), p. 2.
4
Certainly, it has to be ensured that competition between clearing houses does not lead to competition
in the area of risk management, i.e. in charging insufficient levels of margin.
409 The future network economy – development of the clearing industry
Besides increasing the efficiency of the European clearing industry, a clearing
link set-up could also be expected to have the following positive effects on
European markets as a whole:
r
Smaller regional and European niche markets could be strengthened.

r
Competition between Europe’s regional markets would be spurred, which
could also lead to the further integration and harmonisation of European
capital markets.
r
Clearing links do not lead to a concentration of risk at a single market
infrastructure and are unlikely to give rise to negative network effects. The
spreading of risk over various European CCPs could serve to increase the
market’s stability.
r
Ultimately, all market participants (including those with indirect access
to the market infrastructure) stand to benefit from such an efficiency
increase.
Whereas this study identified clearing links as the network strategy best suited
to increase the efficiency of European clearing, it also revealed that the mere
implementation of links between European CCPs does not automatically
increase the efficiency of the clearing industry. If certain prerequisites are not
fulfilled, a significant amount of unrealised potential for efficiency gains will
be left unexploited. Therefore, the parameters and prerequisites identified in
this study as necessary for enhancing the efficiency of the European clearing
industry through a link set-up are summarised and further detailed in the
following.
Clearing links’ full potential for efficiency gains can only be exhausted if the
partnering clearing houses adequately attempt to overcome the link-inherent
starting problem. In addition, clearing members should not be forced to
participate in the link. The costs of alternation and the link-inherent starting
problem can only be successfully surmounted if the partnering CCPs take the
following steps:
r
Convince clearing members to expect positive future network effects.

Although this means that the partnering CCPs must strive to replicate
the size of a Single CCP network, it does not necessarily mean that all
European CCPs must be interlinked right from the start. Rather, clearing
members must trust the clearing houses that the scope of the clearing link
set-up will gradually be extended over time to cover all major European
markets.
5
5
A more detailed framework for determining which European clearing houses actually ought to be linked
is presented in section 10.1.5.