Clearing Services for Global Markets A Framework for the Future Development of the Clearing Industry_13 ppt

423 The future network economy – development of the clearing industry
and define their respective market niches. Once they have done so, they can
continue to leverage their installed base and specific competitive advantage
to provide unique value-added and tailor-made services to their customers.
Implementing a customer-focused strategy will require innovation, creativit y
and determination. Ultimately, these dynamics might possibly even give rise
to newforms of cooperation between CCPs, banks/brokers and other financial
service providers, which will lead to further structural changes in the European
Value Provision Network.
10.2 European clearing in a global context
We emphasise the need to recognise that Europe is part of the global economy. It
attracts capital from the rest of the world and European investors also invest outside
the EU. EU financial market integr ation efforts should not hinder or obstruct these
activities.
28
The rapid growth of cross-border trading, which spans many clearing systems
and increases global interdependence, underscores the fact that the clearing
industry is ultimately global in coverage.
29
Therefore, any network strategy
employed to increase the efficiency of European clearing must also be evalu-
ated in a global context.
The introduction of clearing links would not only increase the efficiency
of the European clearing industry, but the strategy also appears unlikely to
hinder or obst ruct global transaction flow and processing for the following
reasons:
r
Clearing networks established through links (provided that these have been
implemented properly) have a high growth potential. They make it attractive
for other clearing houses to join the network.
r

Joining this kind of clearing network enables the partnering clearing houses
to leverage their installed base, strengthen their unique CCP level network
effects, internalise GCM 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, enhanced flexibility and adaptability, innovation opportu-
nities and high growth potential inherent to the link set-up.
28
LIBA (ed.) (2004), p. 1.
29
Also refer to Congress of the United States (ed.) (1990), p. 56.
424 Clearing Services for Global Markets
The identified prerequisites for the successful implementation of clearing links
also apply to any clearing house outside of Europe wishing to join the network.
As in the case of Europe, 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 and if clearing members are not
forced to participate in the link.
Global clearing links could serve to generate a broad scale of additional
opportunities for the involved CCP and their clearing members. Certainly,
the considerations outlined in section 10.1.5 regarding who should link to
whom also apply on a global scale. It is vital to the success of any clearing
link that its implementation be both economical for the par tnering clearing
houses and serve customer demand. Prior to the implementation of any
particular clearing link, it is thus crucial for clearing house managers to gain
an understanding of the true wants and needs of all their current and potential
clearing members.
To summarise, integrating the European clearing indust ry through a clear-

ing link set-up appears to be suited to support global growth strategies.
10.3 Summary
This chapter ser ved to identify the most preferable future clearing industry
structure and delivered recommendations on the industry’s future develop-
ment. Additionally, the research results were applied to European exchange-
traded cash equities clearing as well as to Europe with regard to its global
positioning. The conclusions derived in this chapter are summarised in the
following.
10.3.1 Future development of the European clearing industry
r
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 vol-
ume clearers. Network strategies that favour some but penalise others are
thus not regarded as viable solutions to further European market integra-
tion.
r
Given these criteria, clearing links emerged as the sole network strategy
that generates efficiency gains for all clearing members. Links are suited
425 The future network economy – development of the clearing industry
to integrate the European derivatives and cash equities clearing industry,
respectively.
r
Although clearing links are the network strategy best suited to increase the
efficiency of European clearing, the mere implementation of ‘random’ links
between European CCPs will not automatically increase the efficiency of
the clearing industry. Links require careful preparation and are not ‘quick
fixes’.
r
Should the partnering clearing houses fail to overcome the link-inherent

starting problem, a significant amount of potential for efficiency gains will
go unrealised. In this instance, a link initiative would have a negligible
impact on the efficiency of the European clearing industry.
r
Unless the partnering clearing houses have – or are given – the leeway in
terms of their ownership and governance structure to fulfil the necessary
conditions, however, the strategy of increasing the efficiency of European
clearing through links will fail.
r
A number of arguments suggest that if European clearing houses were
to operate as fully fledged corporations rather than profit-seeking CCPs
beholden to their members, they could be expected to have greater motiva-
tion and incentives to implement measures to overcome the link-inherent
starting problem.
r
Consequently, whereas Europe’s vertically integrated clearing houses have
traditionally lacked a clear stand-alone value proposition and their managers
will face hurdles in implementing such a strategy, these firms nonetheless
have the greatest incentive to implement structures that will ultimately serve
to increase the efficiency for all European clear ing members. The same is
not true for CCPs operating under the ownership or control of a subset of
their clearing members.
r
This study’s conclusions support the European Commission’s decision
to call upon the industry to establish a Code of Conduct (the Code)
and are in line with the measures detailed in the Code for cash e quities
clearing.
r
It is vital to the success of a European clearing link initiative that its imple-
mentation be both economical for the part nering clearing houses and serve

customer demand. The European Commission should thus refrain from
forcing any particular link on to the market.
r
Although the results of this study revealed that to exhaust clearing links’ full
potential for efficiency gains, the partnering clearing houses 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.
426 Clearing Services for Global Markets
r
It is neither necessary nor economical to establish clearing links between
virtually all European CCPs from the ver y start in order to increase success-
fully the efficiency of European clearing. Rather, clearing members must
trust that the scope of the clearing link set-up will gradually be extended
over time to cover all major European markets.
r
A basic framework was provided that can serve as a starting point for
European CCP managers to determine which European clearing houses
actually ought to be linked and to thus derive their European clearing link
strategy:
(i) To assess the economic value of any particular clearing link and its
respective potential to increase efficiency, CCPs must understand how
their various customers value particular links. This will require Euro-
pean CCPs to analyse their customers’ usage patterns in detail. The
clearing link strategy for Europe should be for mulated on the basis of
these findings.
(ii) According to Coyne/Dye (1998), three distinct usage patterns can
generally emerge: zero concentration, zone concentration and lane
concentration. Each of these three patterns requires a different
strategy.
(iii) For CCPs, the key to formulating a successful European clearing link

strategy is in knowing and understanding the needs and wants of
their current and potential clearing members. A European clearing
link strategy must build on this knowledge to serve to overcome the
link-inherent starting problem and effectively increase the efficiency of
European clearing.
r
Clearing links could spur structural changes in the European VPN by
increasing the economic attra ctiveness for counterparties to self-clear
(many) markets instead of employing intermediary services. This could
cause the majority of the European market share to shift from hig h volume
clearers to medium and low volume clearers. The currently strong position
of high volume clearers within the European VPN could thus be diluted if a
clearing link set-up were to be implemented. However, high volume clearers
would still benefit from substantial cost reductions.
r
Structural changes in the European VPN could also result from the compet-
itive dynamics between European CCPs and high volume GCMs. European
CCPs and high volume GCMs will face great challenges and opportunities
in the e vent that such a European clearing link scenario is implemented.
Most importantly, clearing houses and GCMs alike will be required to refo-
cus and rethink their strategies. Both groups will need to acquire a better
427 The future network economy – development of the clearing industry
and more detailed understanding of their customers in order ultimately to
develop and define their respective market niche.
10.3.2 European clearing in a global context
r
The introduction of clearing links would not only increase the efficiency of
the European clearing industry, but the strategy also appears to be suited
to support global transaction flow and processing as well as global growth
strategies.

In a final step, Chapter 11 recapitulates the most important findings of this
study, provides a c ritical discussion of the research results and concludes with
suggestions for further areas of research.
11
Summary, discussion and
recommendations for future research
This study examined both the efficiency and structure of the clearing industry.
Clear-cut definitions together with a concise characterisation and descriptive
analysis of the current state of the clearing industry set the stage for the fol-
lowing analytical objectives. Besides defining the efficiency of clearing and
identifying ways to measure it, this study aimed to determine the efficiency
impact of various integration and harmonisation initiatives within the clear-
ing industry. The ultimate research objective was to identify the network
strategy best suited to increase the efficiency of clearing, benefiting all clearing
members. Based on these findings, the most preferable future clearing indus-
try structure was identified and recommendations on the industry’s future
development were delivered. Although the focal point of the research was
the European exchange-traded derivatives clearing industry, the results of the
analysis were eventually applied to European exchange-traded cash equities
clearing and to European clearing in a global context.
This final chapter summarises the study’s most important findings (section
11.1). A critical discussion of the research results leads to recommendations
for future research (sec tion 11.2).
11.1 Summary of research results
This section summarises the study’s most important findings, chapter by
chapter .
11.1.1 Chapter 2 – Setting the stage – definitions and industry setting
Depending on the type of service provider, the process of clearing encom-
passes a number of services. Most clearing houses today act as a so-called
central counterparty (CCP). Central counterparty clearing has become an

integral part of clearing services and can even be said to constitute the core
429 Summary, discussion and recommendations for future research
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. While market participants benefit signifi-
cantly from the CCP services and additional value-added clearing services
provided by these clearing houses, there is another important category to
consider: complementary clearing services. These services are not required to
maintain the life cycle of a trade, but market participants benefit enormously
from them. Nonetheless, today’s CCPs rarely provide a full range of comple-
mentary clearing services. These clearing services are u sually delivered by the
banks/brokers acting as clearing members of various CCPs.
A start ing pointfor the study was provided by identifying and characterising
the tiered structure in w hich the provision of clearing services usually takes
place: the so-called Value Provision Network (VPN). The VPN consists of two
levels of access to the clear ing house, direct and indirect. This study concerned
the first level of direct access, and to this end, six different clearing member
types were differentiated according to their focus of activity and average
European cleared market share: regionally active (low volume) clearers with
a prop. or an agency focus, regionally-to-globally active (medium volume)
clearers with a prop. or an agency focus, and globally active (high volume)
clearers with a prop. or an agency focus.
The study also had to consider the particularities of the current structure
of the European VPN. First, while there are a number of CCPs, two of them
dominate the European market: Eurex Clearing and LCH.Clearnet. Second,
a relatively small number of European high volume clearers account for the
bulk of the total annual European cleared market share (i.e. approximately
seventeen clearing members account for over 70 per cent of the market share).
11.1.2 Chapter 3 – Defining the core issues – efficiency and network strategies
The two core research issues were industry efficiency and industry structure.

The central criterion for determining the efficiency of clearing was oper ational
efficiency, which is influenced by transaction costs. To increase the (opera-
tional) efficiency of clearing, it is necessary to minimise clearing members’
transaction costs. The efficiency of the clearing industry is thus increased
when the transaction costs that clearing members have to bear are reduced
(and vice versa).
The total transaction costs of clearing are composed of direct and indi-
rect costs, and can be impacted by integration and harmonisation initiatives
between clearing houses, referred to as network strategies. For the purpose of
430 Clearing services for global markets
this study, four different types of network strategy were distinguished: cross-
margining agreements, clearing links, mergers and acquisitions (M&A), and
the creation of a Single CCP (within a defined asset class and economic area).
11.1.3 Chapter 4 – Collecting empirical insights – introduction to the empirical study
Due to a lack of existing research on the issues of efficiency of clearing and
industry st ructure, which could have served as a basis for this study, the author
conducted a comprehensive original empirical study. This empirical study
consisted of seventy-nine one-to-one interviews w ith different stakeholders
in clearing and the distribution of a questionnaire. Although the attempts
to collect quantitative data ultimately proved unsuccessful, the interviews
provided extensive qualitative data that was used as the basis for the analyses
of Chapters 5 and 8.
11.1.4 Chapter 5 – Analysing costs of derivatives clearing – transaction cost studies
To determine the efficiency impact of the different network strategies within
the clearing industry, it was first necessary to research the transaction costs of
European derivatives clearing. With regard to the relevance of clearing costs
to different clearing member types, the analysis revealed the following. For
low and medium volume clearers with a prop. or an agency focus, as well
as for high volume clearers with an agency focus, indirect costs are the core
cost drivers. For high volume clearers with a prop. focus, however, direct costs

constitute the core cost drivers.
The cost analysis also brought to light reasons for the structural partic-
ularities of the European VPN and for the competitive advantage that high
volume clearers have over medium and low volume clearers. First, the analysis
revealed the existence of economies of scale that allow high volume clearers
to leverage their fixed cost base. Due to their scale of business, high vol-
ume clearers further benefit from a strong negotiating position. Additionally,
clearing houses tend to grant high volume clearers preferential treatment in
the form of discounts. These factors explain the dominant position of high
volume clearers in the European VPN, i.e. why a very high percentage of the
average annual European cleared market share in derivatives is concentrated
on a few high volume clearers. These clearers’ cost structures allow them to
offer intermediary services, and for low and medium volume clearers, it makes
economic sense to utilise these services.
431 Summary, discussion and recommendations for future research
According to the analyses, network strategies that encourage low and
medium volume clearers to self-clear their own markets instead of employ-
ing intermediary services could have a significant impact on the structure of
the European VPN. Self-clearing enables these market participants to reduce
intermediary costs and leverage their internal infrastructure. The research also
revealed that NCMs are becoming increasingly aware of clearing costs; many
of them view obtaining clearing membership as a viable cost-cutting strategy.
The cost analysis also provided the critical step of generating a quantitative
estimate of the total European costs of derivatives clear ing borne by clearing
members, which amounted to roughly €2.173 billion i n 2005. At €725 million,
direct costs represented 33 per cent of total industry costs, whereas indirect
costs of roughly €1.448 billion accounted for 67 per cent of total costs.
1
A
benchmarking of the European costs of derivatives clearing to other market

infrastru cture costs suggested that European derivatives clearing constitutes
the most efficient part of the European financial mar ket infrastructure.
11.1.5 Chapter 6 – Exploring theoretical basics – scale effects in clearing
Network strategies can give rise to demand- and supply-side scale effects,
which can in turn influence the costs of clearing. To establish a basis for
analysing the efficiency impact of different network strategies, both demand-
and supply-side scale effects in clearing were first classified and explored.
The network structure of the VPN was found to consist of two layers
(product layer and system layer) and two levels (CCP level and GCM level)
and to exhibit a number of positive and negative network effects. Although
many of the network effects on the CCP and GCM level are similar, the CCP
level gives rise to unique positive network effects that are difficult for GCMs
to replicate. Furthermore, by engaging in network strategies and enlarging
their range of complementary clearing services, CCPs can internalise network
effects that occur on the GCM level. Internalising the strong and important
GCM level network effects by the CCP level network is beneficial due to
the associated potential for reducing clearing-related transaction costs, thus
increasing the industry’s efficiency.
Evidence further suggested that economies of scale and scope are likely to
exist in clearing, but whether or not increases in either one translate into
positive economies for CCPs is highly dependent on the type of network
1
Due to the shortcomings and limitations inherent to the calculation of the estimate, however, it can be
assumed that the true indirect cost figure is higher than suggested.
432 Clearing services for global markets
strategy pursued and the characteristics and cost structure of the partner ing
clearing houses.
11.1.6 Chapter 7 – What theory reveals – framework for efficiency analysis of network
strategies
The ultimate research objective of this study was to determine the efficiency

impact of various network strategies within the European clear ing industry.
To this end, an original framework was established that built on the insight of
the previous chapters. The analysis based on this framework provided the fol-
lowing preliminary conclusions. Besides cross-margining agreements, which
generally have little or no potential to increase efficiency, clearing links are the
only network strategy that results in efficiency gains for all clearing member
types. Whereas the efficiency impact of cross-margining agreements is neu-
tral or minimal for all clearing members, regionally active clearers potentially
suffer from efficiency losses as a result of M&A and Single CCP initiatives.
The analysis further showed that although some network strategies are cost
efficient, they are not necessarily profit-maximising for all clearing mem-
ber types. Single CCP and clear ing link initiatives, for example, can exert
a negative impact on the business model of globally active clearers with an
agency focus. The only way for these clearers to circumvent this negative
impact is to succeed in restricting access to the CCP level network. How-
ever, restricting access to the CCP level network has a detrimental impact on
other clearing member types. It would serve to reinforce the current struc-
tural particularities of the European VPN, by strengthening the competitive
advantage high volume clearers have over l ower volume clearers; globally
active clearers would thus continue to dominate w ithin the European clearing
industry.
Clearing houses could profit immensely from the implementation of a
clearing link initiative. A link set-up would enable them to internalise GCM
level network effects, strengthen their unique CCP level network effects, lever-
age their installed base and continue to offer services tailored to the specific
demands of regional markets and different regulatory environments to an
increased number of network participants.
Nonetheless, the benefits of a European clearing link set-up can only be
achieved if the clearing houses endeavour to overcome the link-inherent start-
ing problem. Links offer various opportunities for different clearing member

types. The starting problem becomes relevant for these clearers in different
ways, but it essentially concerns the question of whether the utility derived
433 Summary, discussion and recommendations for future research
from making use of the link set-up will outweigh the individual clearer’s costs
of alternation in the long run.
11.1.7 Chapter 8 – Checking theory against reality – case studies of
network strategies
The purpose of Chapter 8 was to check the preliminary conclusions of
Chapter 7 with case study findings and insights from the empirical study.
For this purpose, three case studies were performed to analyse clearing links,
mergers and acquisitions, and a Single CCP initiative. The results of the
studies suppor ted the preliminary findings and provided a more detailed
insight into the complexities of implementing these network strategies in
Europe.
The network strategy best suited to enhance the efficiency of European
derivatives clearing is a clearing link set-up, because it is the only model that
enables all clearing member types to benefit from efficiency gains. However,
certain caveats apply: should the partnering clearing houses not adequately
attempt to overcome the link-inherent starting problem, a significant amount
of potential for efficiency gains will go unrealised. Such a link initiative is
then not designed to increase significantly the efficiency of the European
clearing industry. The link-inherent starting problem can only be successfully
surmounted if the partnering CCPs:
r
are able to convince clearing members to expect positive future network
effects (clearers must trust the clearing houses that the scope of the clearing
link set-up will gradually be extended over time to cover all relevant major
European markets);
r
make up for the lost intermediary services formerly furnished by GCM(s)

by providing (most of) these services themselves, thereby successfully inter-
nalising GCM level network effects;
r
compensate for the lost participation in other CCP networks by provid-
ing a similar service level and processing all products and markets of the
linked clearing houses; thus providing for a full choice of clearing location;
and
r
engage to educate market participants, other clearing houses and stake-
holders sufficiently about the benefits of such a link set-up.
The failure of relevant clearing houses and clearing members to recognise
the potential value proposition of a clearing link set-up, low internal
priori tisation of implementing the link, mandatory open interest transfers,
regulatory and political issues can create fur ther uncertainty about the future
434 Clearing services for global markets
development of a clearing link initiative and can thus potentially aggravate
the starting problem.
Meanwhile, the mergers and acquisition study revealedthat the complexities
of successfully implementing M&A initiatives between European clearing
houses are even greater in reality than previously assumed theoretically.
The Single CCP case study supported the preliminary findings regard-
ing the inherent complexities of combining European clearing houses and
underscored the unequal distribution of costs and benefits (on the part of
Europe’s clearing members) inherent to this network strategy. The study also
revealed that high volume clearers with an agency focus are likely to prefer
a Single CCP to clearing links, because it tends to be easier to control the
rules of clearing when a Sing le CCP network is in place. However, the Sin-
gle CCP loses its appeal for high volume clearers with an agency focus if
they find themselves unable to exert such control; they will then presumably
not succeed in circumventing disintermediation and the associated revenue

losses. The analysis also supported the finding that globally active clearers
with a prop. focus stand to benefit most from the implementation of a
Single CCP in terms of efficiency gains. Nonetheless, this group of clear-
ers 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 are sufficiently reduced
and that the consolidated CCP infrastructure does not abuse its dominant
position.
11.1.8 Chapter 9 – Quantifying the efficiency impact – European network strategies
The findings derived in Chapters 7 and 8 served as the basis for a quantification
of the efficiency impact of a European clearing link set-up and a single Euro-
pean CCP. The results showed that under the assumption of implemented
European clearing links:
r
Total European costs of derivatives clearing would have been reduced by 31
per cent to roughly €1.503 billion in 2005.
r
Directcostswouldhavecometoabout€523 million; thus reduced by
roughly 28 per cent.
r
Indirect costs would have weighed in at €980 million, representing a 32 per
cent decrease.
Under the assumption of an implemented single European CCP, on the other
hand:
r
TotalEuropean costs of derivativesclearing would haveamounted to roughly
€1.958 billion in 2005 (which equals a reduction of roughly 10 per cent).
435 Summary, discussion and recommendations for future research
r
Directcostswouldhavecometoapproximately€629 million, representing
a 13 per cent reduction.

r
Indirect costs could have been reduced by roughly 8 per cent, for a total of
€1.329 billion.
The conclusion that the industry-wide cost reduction potential of a clearing
link initiative is approximately three times greater than that of a Single CCP
is rooted in the findings of Chapters 7 and 8, which showed that low volume
clearers suffer from efficiency decreases when a Single CCP is implemented,
but can benefit from efficiency gains through clearing links. Medium and
high volume clearers, on the other hand, benefit from a Single CCP, but
efficiency gains are not as great as those produced by a European clearing link
set-up. A clearing link scenario was further found to reduce the unit costs of
high, medium and low volume clearers by roughly 20, 46 and 24 per cent,
respectively. A Single CCP, on the other hand, was found to reduce the unit
costs of high and medium volume clearers by about 12 and 35 per cent,
respectively, but to actually increase the unit costs of low volume clearers by
approximately 25 per cent. For some low volume clearers, the Single CCP
scenario can thus diminish the economic appeal of self-clearing.
11.1.9 Chapter 10 – Introducing the future network economy – development of the
clearing industry
The findings of this study led to conclusions on the future clearing industry
structure and delivered recommendations on the industry’s development.
Clearing links emerged as the sole network strategy that succeeds in gen-
erating efficiency gains for all clearing members and is thus best suited to
integrate the European clearing industry. This finding is applicable to Euro-
pean derivatives and cash equities clearing alike. Furthermore, the creation of
clearing links has the potential to support European clearing with regard to
its global context and growth.
Successfully implemented European clear ing links can be expected to lead
to positive structural changes in the European VPN, such as the empower-
ment of customers. The majority market share is likely to shift from high

volume clearers to medium and low volume clearers. The VPN could also
be invigorated by the competitive dynamics between the clearing houses and
high volume GCMs.
Nonetheless, the mere implementation of ‘random’ links between virtually
all European CCPs would not automatically increase the efficiency of the clear-
ing industry. If the partnering clearing houses do not adequately attempt to
436 Clearing services for global markets
overcome the link-inherent starting problem or if clearing members are forced
to participate in the link, a significant amount of potential efficiency gains will
go unrealised. Such a link initiative is then not designed to have a noteworthy
positive impact on the efficiency of the European clearing industry.
Europe’s major clearing houses were found to have different starting posi-
tions and varying degrees of leeway – in terms of their ownership and gover-
nance structure – to reap the benefits of a clearing link initiative. A number
of arguments suggested that if European clearing houses were to operate as
(part of) fully fledged corporations, rather than profit-seeking CCPs beholden
to their members, they could be expected to have greater motivation and
incentives to implement measures to overcome the link-inherent star ting
problem.
This study’s conclusions support the European Commission’s decision to
call upon the industry to establish a Code of Conduct and are in line with
the measures detailed in the Code for cash equities clearing. Furthermore, it
was found to be vital to the success of a European clearing link initiative that
its implementation be both economical for the partn ering clearing houses
and serve customer demand. The European Commission should thus refrain
from forcing any particular link on to the market. For CCPs, the key to
formulating a successful European clearing link strategy is in knowing and
understanding the needs and wants of their current and potential clearing
members. Implementing European clear ing links without careful planning
and a dedicated strategy for tackling the starting problem will waste time and

resources and do very little to enhance the efficiency of the European clearing
industry.
11.2 Discussion and recommendations for future research
In a final step, this study closes by providing a critical discussion of the
research results, which leads to recommendations for areas of future research.
This study went beyond a simple emulation of analyses designed for other
industries and developed new insights into the specific features of clearing
and the particularities of the clearing industry. Due to the current dearth of
research on clearing, it was not possible to address succinctly and accurately
all relevant issues. Many areas for future studies thus exist in this field. The fol-
lowing suggestions are predicated upon the research conducted in this study:
r
This research focused on the transaction costs that clearing members have to
bear (first level transaction costs). Although the study touched upon second
437 Summary, discussion and recommendations for future research
level transaction costs, additional research analysing the costs of clearing
faced by NCMs and other customers should be conducted. This research
should address whether cost reductions on the clearing member level are
truly passed on to NCMs and other customers.
r
The extensive qualitative data obtained from the interviews served as vital
input and formed the basis for the cost analyses and case studies. Nonethe-
less, more research based on quantitative data is needed on the different
cost categories and total costs of clearing. This should particularly strive to
address the shortcomings and limitations inherent to the calculation of the
indirect cost estimates presented in this study.
r
The analyses conducted throughout this study concerned the costs of deriva-
tives clearing, but these costs are merely a subset of the transaction costs
that an investor faces when carrying out a t rade. Future research is required

to provide an integrated analysis of the complete range of costs faced by
investors.
r
While this research served to identify and characterise different network
effects in clearing, further research on the magnitude of these positive and
negative effects could shed light on their significance and characteristics.
Theoretical studies would be useful in this context.
r
It was also observed that CCP and GCM level network effects can have spill-
over effects on to the trading and settlement layers. Future studies could be
devoted to a more detailed investigation of these effects.
r
Another important interrelation concerns the CCP and the GCM network
levels and the associated positive and negative network effects. While this
study centred on the issue of internalising GCM level network effects by the
CCP le vel network, other dynamics were left aside. To analyse the interrela-
tion of the network effects on both levels, it would be revealing to adopt the
network economic two-sided markets’ view.
r
It was found that every established CCP network has built an installed base
that influences the dynamics of competition and cooper ation between clear-
ing houses. GCM networks also benefit from their installed base. Clearing
houses and GCMs alike should strive to le verage their installed base. An
in-depth analysis of the dynamics of CCP versus GCM level network effects
in the context of European clearing links will regard more details of the
future structure of the European VPN.
r
More network economic research is also needed with regard to standard
setting in the clearing industry.
r

The analysis suggested an inverse relationship between average costs and the
number of contracts cleared, but empirical research is needed to examine
438 Clearing services for global markets
and substantiate the existence of economies of scale in clearing, including
an estimate of a translog cost function.
r
More empirical research is also needed to underscore the existence of
economies of scope in clearing.
r
This study identified the complexities of combining European clearing
houses due to their disparate historical backgrounds, profiles and legal
environments. The ongoing harmonisation and integration of European
clearing processes and alignment of legal and regulatory environments will
have an impact on the potential to realise economies of scale and scope
through network initiatives. Future research is required to evaluate this
impact.
r
If at any point in the future, European rules and regulations are harmonised,
and processes are standardised, a reviewed analysis of the dynamics of the
clearing industry should take place to reassess the issues of network effects
as well as economies of scale and scope.
r
It was concluded that qualitative evidence suggests that European derivatives
clearing does not constitute a natural monopoly. However, more empirical
research is needed to examine this aspect.
r
Clearing links were identified as the network strategy best suited to increase
the efficiency of European clearing. A basic framework was provi ded that
could serve as a preliminary guide for European CCP managers to identify
the most appropriate clearing link strategy. Additional research is nonethe-

less required to determine which European CCPs should ultimately establish
clearing links.
r
Additional econometric analyses measuring the efficiency of clearing and
the efficiency impact of network strategies would be useful to complement
the insights and conclusions derived in this study.
r
This study showed that the final success of a European clearing link set-up
depends on the extent to which the partnering CCPs comply with certain
prerequisites. However, the ultimate success of a European clearing link
set-up will also depend on the resolution of the political, legal and technical
issues surrounding the requirements for interoperability. More research
addressing these details is therefore required.
r
The case study analysis suggested that mandatory open interest transfers
can potentially aggravate the link-inherent starting problem. More research
is needed on the issue of who actually owns the open interest that CCPs hold
on behalf of their clearing members. Such research should also provide a
more detailed analysis of the economic impact of mandatory open interest
transfers.
439 Summary, discussion and recommendations for future research
r
This study found that European clearing houses should be interested in pur-
suing clearing link initiatives because they can then 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 net-
work participants. Nonetheless, the motivation and driving factors encour-
aging or impeding CCPs to engage in particular network strategies should
be studied in g reater detail. Such a study should also take into account an

analysis of the potential revenue impact of different network strategies on
the par tnering clearing houses.
r
A number of findings supported the assumption that becoming fully fledged
corporations, rather than profit-seeking CCPs beholden to their members,
would be most suitable, creating incentives for clearing houses to engage
in European clearing links. However, more detailed research is needed in
the area of clearing houses’ governance, taking into account the micro- and
macroeconomic role of CCPs as well as the private and public stakeholders’
interests.
r
This study concluded that Europe’s vertically integrated clearing houses,
which are part of a quoted company structure, ought to have great incentives
to implement structures that ultimately serve to increase the efficiency for
all European clearing members. The same was not found to be true for
CCPs operating under the ownership or control of a subset of their clearing
members. Nonetheless, it remains questionable whether the managers of
vertically integrated clearing houses will in reality succeed in implementing
a clearing strategy that has a clear stand-alone value proposition; up until
now, the y have had very limited room for manoeuvre and have largely
gone along with the exchange’s strategy. More research on the issue of
vertically versus horizontally integrated clearing would be useful in this
context.
r
The focus of this research was on analysing integration and harmonisation
initiatives in the clearing industry. It was briefly outlined that the dynamics
in the clearing industry are closely linked with dynamics in the t rading
arena. More research is needed on these interrelationships.
r
The application of the finding s of this study to cash equities clearing did not

take into account the efficiency impact resulting from network strategies
on the ICSD/CSD level. Part icularly for cash e quities clearing, it seems
necessary to consider the dynamics between network strategies on the CCP
and the ICSD/CSD levels. Further research is thus required to analyse the
competitive forces and dynamics that are at play in this respect.
440 Clearing services for global markets
r
The results of this research concerned derivatives clearing and were subse-
quently applied to cash equities clearing. Whether or not it is economically
sound to strive towards clearing cash equities and derivatives through the
same clearing system and clearing links requires further analysis.
r
Broadening the scope of complementary clearing services offered by the
part nering CCPs was identified as one of the critical issues with regard
to successfully implementing clearing links and overcoming the starting
problem. While it was suggested that scenarios exist in which it could
make economic sense for CCPs to offer banking-related services, further
research is necessary to identify the opportunities and risks inherent to such
endeavours. The focus should be on analysingthe potential contagion effects
of risk that could arise if infrastructure activities are not kept separate from
banking services.
r
Risk management is a central aspect of derivatives clearing. It was outlined in
this study that network strategies can potentially increase systemic risk and
that it is therefore crucial that a network initiative encourage (or at least not
impede) cautious risk management practices. It must also be ensured that
competition does not take place with regard to marg in levels. Nonetheless,
this study did not explicitly integrate and analyse risk management issues.
Further research should thus be conducted on this topic.
r

This study concluded with a brief outlook on European clearing in a global
context. This outlook should be complemented by additional studies on
the structure of the VPN in other regions in order to evaluate and identify
whether dynamics similar to those revealed for Europe exist on a global
scale.
r
The research of this study focused on analysing current transaction costs
and the efficiency impact of known network strategies. Future studies could
take a more innovative view by identifying new forms of technology-enabled
cooperation between clearing houses that might have an even greater effi-
ciency impact than clearing links. St rongly linked to this issue is the question
of innovation in clearing: what is the future role of clearing houses? Will
initiatives emerge that successfully compete with CCPs, particularly in the
OTC market? Who are the potential competitors of clearing houses? What
impact will this have on the str ucture of the VPN and the efficiency of
clearing?
Appendices
Appendix 1: Matrix overview of clearing-related transaction
costs (part I)
Appendix 2: Matrix overview of clearing-related transaction costs
(part II)
Appendix 3: List of interviewees
Appendix 4: Questionnaire
Appendix 5: Sample interview guide clearing members
Appendix 6: Clearing house fees
Appendix 7: Total European derivatives clearing costs in 2005
Appendix 8: Efficiency impact of clearing links and a Single CCP

Appendix 1
Matrix overview of clearing-related

transaction costs (part I)
Costs of
initiating
contracts
Cost of
completing
contracts
Cost of
adapting
contracts
Cost of
executing
contracts
Cost of
controlling
contracts
Clearing House
Charges
Service Provider
Charges
IT Costs
Back-Office
Costs
• One-off admission fee
• Fixed annual/monthly
fee
• Communication
charges
• Minimum transaction
charges

• Membership fees
• Per-contract fees
• Fees for additional
services
• Option exercise
fees
• Future settlement
fees
• Fees for additional
services
• Fees charged for
additional services
• Penalties
• Charges for service
level upgrades
• Event-driven
charges
• Fees for additional
services
• Per-contract fees
• Fees for additional
services
• Initial one-off
payments
• Fixed fees
• Communication
charges
• Upgrade of
bandwidth or other
non gratuitous

changes to
infrastructure,
service levels or
fee structure
• Management of
adaptations, e.g.
connection to a
new platform,
new release
management,
testing, etc.
• Continuous
management of
IT
• Integration of new
interface
• Integration of
software and
hardware
• Initial costs, i.e.
employment of
dedicated back-office
personnel, set-up of
specific account
structures, etc.
• Replication of
processes and
structures of a CCP
• Position management
• Continuous

management of back-
office processes
• Continuous
management of back-
office processes
•
Error account
• Replication of
processes and
structures of a CCP
• Costs related to
adaptations affecting
back-office structures
and knowledge through
extension of services or
integration of new
platforms
INDIRECT COSTSDIRECT COSTS
• Option exercise
fees
• Future settlement
fees
• Fees for additional
services
• Event-driven
charges
• Fees for additional
services
Risk Management
Costs

• Changes to risk
management
systems, i.e.
changes in
margin
calculation
method
• Continuous risk
management
processes
• Adaptation of risk
management
structures and
architecture
• Continuous risk
management
processes
• Continuous risk
management
processes
Cost of Capital
• Contribution to default
fund
• Funding effort for
minimum capital
requirements
• Funding effort for
regulatory capital
requirements
• Collateral/cash

deposited at clearing
house for variation
margin
• Amount of liquidity at
customer tied to ensure
funding of intra-day
margin calls
• (Intra-day) margin
calls
• Collateral/cash
deposited at clearing
house for initial margin
• Amount of liquidity at
customer tied to ensure
funding of intra-day
margin calls
• Continuous
management of
IT
• Continuous
management of
IT
• Position management
• Option exercises
• Continuous
management of back-
office processes
Source: Author’s own.
Appendix 2
Matrix overview of clearing-related

transaction costs (part II)
General Categories
Systematisation of Transaction Costs
Applied to Clearing Services
Mode of Measurement
Costs of initiating
contracts
Clearing House Charges
Cost of Capital
Information Technology Costs
Back-Office Costs
Service Provider Charges
DIRECT COSTS
INDIRECT COSTS
RESEARCH FOCUS
Cost of completing
contracts
Cost of adapting
contracts
Cost of executing
contracts
Risk Management Costs
Cost of controlling
contracts
Source: Author’s own.
Appendix 3
List of interviewees
Disclaimer
The views expressed by research participants in interviews are their own and do not necessarily
represent the official stance of their organisation. The interviewees are not associated with the

final conclusions of this study. The findings of this study thus do not necessarily reflect the views
of the individuals interviewed in the context of this study. Any proposition that is forwarded is
arrived at through a rigorous, independent academic methodology.
Organisation
∗
Name of Interviewee(s) and Position
at Time of Interview
Type of
Interview
Interviewee
Location
ABN AMRO Simons, Philip: Head of
Exchange-Traded Derivatives Clearing
Operations and Sales (ABN AMRO),
former Head of European
Brokerage/Global
Execution/E-Business (Cargill)
In person London
Arnold & Porter Born, Brooksley: Retired Partner
(Arnold & Porter), former
Chairperson (CFTC)
In person US
Bank of New
York (BoNY )
Bodart Paul: Executive Vice President
(BoNY), Board Member (Euroclear)
By telephone Continental
Europe
Bear Stearns Sapato, Bernard: Managing Director In person US
BNP Paribas Lloyd, Jonathan: Head of Clearing,

Settlement and Custody
By telephone Continental
Europe
Bourse Consult Cox, Peter: Partner (Bourse Consult),
former CEO (OM London Exchange
(OMLX)), former Director (LSE)
In person London
Caxton
Associates
Ostlund, Tomas: Principal By telephone US
Chicago Board
of Trade
(CBOT)
Dan, Bernard W.: President and CEO In person US
447 Appendix 3
Organisation
∗
Name of Interviewee(s) and Position
at Time of Interview
Type of
Interview
Interviewee
Location
Chicago
Mercantile
Exchange
(CME)
Davidson III, John P.: Managing
Director and Chief Corporate
Development Officer (CME), former

Member Board of Directors (OCC),
former Managing Director and
Co-Head Global Equity Operation
(Morgan Stanley & Co.)
In person US
Citigroup Kirchmann, Alfred: Vice President
Corporate and Investment Banking,
Global Transaction Services
In person Continental
Europe
The Clearing
Corporation
(CCorp)
Jaycobs, Richard: CEO (CCorp),
former CEO onExchange, founder
(Acknowledge Systems), former
Director (Computer Trading
Corporation), former Chief
Technology Officer (Tudor
Investment Corporation)
In person US
Commerzbank Gr
¨
under, Gabriele: Manager
Operations
In person Continental
Europe
Commodity
Futures Trading
Commission

(CFTC)
Lawton, John C.: Deputy Director and
Chief Counsel, Division of Clearing
and Intermediary Oversight; and
Markman, Natalie A.: Senior Special
Counsel to the Director, Division of
Clearing and Intermediary Oversight;
and Radhakrishnan, Ananda K.:
Director, D ivision of Clearing and
Intermediary Oversight
In person US
The Depository
Trust & Clearing
Corporation
(DTCC)
Callahan, Mary Ann: Managing
Director International; Henderson,
Neil: Managing Director; and Till,
Bernard M.: Vice President
In person;
except Bernie
Till via
telephone
US
Deutsche B
¨
orse
Group
Riess, Rainer: Managing Director,
Head of Stock Market Business

Development; R
¨
othig, J
¨
urgen:
Managing Director, Head of
Tr ading/Clearing/Information
Operations; and Heckinger, Richard:
Head of US Representative Office
(Deutsche B
¨
orse), former COO (Stock
In person
In person
In person
Continental
Europe
Continental
Europe
US
(cont.)