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Evangelos Benos provides an economically substantial CCP underpinning for U.S. dollar swap contracts cleared at the Chicago Mercantile Exchange (CME) and London.

Image courtesy of interviewee. February 2, 2024

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This video video is a transcript from a presentation discussing central clearing, particularly of over-the-counter (OTC) derivatives, as a response to the financial crisis of 2008-2009. The speaker emphasizes the importance of a disclaimer that the views expressed do not necessarily represent their affiliated policy institutions. Centralized clearing requires market participants to use Central Counterparties (CCPs) to collateralize their derivatives transactions, addressing a significant under-collateralization issue (around $3 trillion) that was observed before the crisis.

Over the years, centralized clearing has gained traction, with major growth in interest rate and credit derivatives volumes. A key aspect of centralized clearing is its facilitation of multilateral netting, which reduces collateral needs, especially beneficial for swap dealers who often have balanced cross positions.

The speaker highlights challenges when clearing is fragmented, such as when similar derivatives contracts are cleared by different houses across jurisdictions, making netting difficult and increasing collateral costs. As a result, dealers might pass these extra costs onto customers, leading to price discrepancies—often termed a "CCP basis"—where identical contracts trade at different prices in different markets.

The discussion references several academic papers that explore these themes, noting the economic significance of the observed price differentials, which, despite being just 1-3 basis points, can translate to substantial daily costs (around $80 million) over large volumes.

The overall conclusion stresses that maintaining centralized clearing in a concentrated manner is vital for economic efficiency, as fragmentation leads to higher collateral costs that can detrimentally affect end users in financial markets.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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This is joint work with, some colleagues who happen

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to, be affiliated with policy institutions.

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So everything we say here,

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does not necessarily represent the views

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of those policy institutions.

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That's always an important disclaimer to make,

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when in those cases.

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So the general context is, I mean,

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the general topic is that of central clearing,

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and in particular central clearing

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of over the counter derivatives markets.

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So, centralized clearing was a key regulatory reform

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that was implemented in the wake

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of the great financial crisis of 2008 and 2009.

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And what it pertains to, what is that the regulators

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required market participants

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to essentially collateralize their derivatives transactions

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via the so-called Central Counterparties or CCPs.

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These are entities that essentially innovate the trades,

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in these derivative markets, meaning they become the buyer

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to every seller and the seller to every buyer.

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And in doing so, they guarantee

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that these exposures are sufficiently robustly

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and consistently collateralized.

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Uh, and the reason why regulators did that was

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because in the run up to the financial crisis, right?

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Um, derivatives exposures were under collateralized by

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as much as 3 trillion US dollars.

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So there was a massive gap, in the extent

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of collateralization of these exposures.

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So regulators stepped in, they wanted

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to fix this via central clearing.

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And ever since, over the past,

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several years since the financial crisis,

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central clearing has really taken off, it now accounts

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for 80% right

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of the global interest rate derivatives volumes,

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and around 70% of, credit derivatives volumes.

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So it's a major, major change in the, in the architecture

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of the financial, system or financial markets.

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Um, now one key thing about,

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centralized clearing,

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and I think this is also related to the kind

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of the problem we're dealing here, is that

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it's facilitates multilateral netting,

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and it's kind of important to spend like half a minute

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to explain what that is.

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Uh, so the issue

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with multilateral netting is if you are a bank

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or a market participant and you have a long

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and a sort position, or you have long

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and sort positions with multiple counterparties, now all

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of these are gonna be collateralized

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with the clearing house.

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So the clearing house effectively is gonna take the net

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of those positions across your all,

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across your counterparties.

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And what that does is that it reduces the total amount

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of collateral that you need to pledge, right?

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Um, this is particularly relevant

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and important for swap dealers.

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These are the entities,

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the big entities in financial markets

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that provide liquidity in those markets.

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And that's because these entities, the dealers,

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they generally have very large cross positions, but

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because there are positions tend to be balanced,

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because they intermediate rates, right?

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For every buyer, they are,

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they're responsible for finding a seller.

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And for every seller, they wanna find a buyer. Their net

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Exposures are small.

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So they particularly benefit from this multilateral netting

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that clearing houses, enable.

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However, that assumes

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that all clearing is taking place in one clearing house.

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And when you fragment clearing, then things starts

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to get, tricky.

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And, that's what our paper is about.

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Central clearing has been one of the major, reforms

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that, regulators implemented in the

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wake of the financial crisis.

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So there's been a lot of work, by academics

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and practitioners as well, in trying to understand

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what the implications of centralized clearing are.

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Uh, there's a vast literature on that,

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but I'm not gonna, you know, dwell on that literature.

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I'm just gonna mention a few papers

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that I think are related, to what we are doing here.

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Um, one of the key papers that, first came out about,

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you know, central clearing was the paper

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by Duffin Zoo in 2011 in the published in the Review

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of Asset Pricing Studies.

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And it was the first paper to actually, explain

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and articulate what the netting benefits associated

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with multilateral Ben,

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multilateral netting aren't associated

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with central clearing are, it's not as trivial

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as one might have thought because of, the fact that,

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you know, if you don't do central clearing,

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you do bilateral clearing.

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In other words, one bank gets

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to collateralize their exposures on a bilateral basis

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with another bank without multilateral netting.

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Uh, but in doing so, they might get to net their ex their,

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exposures across different asset classes, right?

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Which is not the case when you do centralized clearing,

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because when you do centralized clearing, you have a CCP,

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which deals with one asset class at a time, okay?

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Uh, you do have multilateral netting,

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but no netting across asset classes in central clearing.

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Whereas in bilateral clearing,

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you don't have multilateral netting,

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but you do have netting across asset classes.

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So there's this kind of question as

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to which one is actually better from a collateral

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saving point of view.

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And, Duffy Zu were the first ones to kind of articulate

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and make the comparison, and also say

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that if you're gonna do central clearing in order to reduce,

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your collateral costs, you're gonna have to go

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with a single CCP, right?

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And that's the starting point, essentially of,

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of our discussion because you know,

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what our paper is about is

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what happens when you don't have one CCP.

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Um, there's been another, another, a number of other papers

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that are related, to what we're doing.

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Uh, there's a paper by Gar

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and Paterson also published in 2011, the Review

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of Financial Studies that basically says that

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if you are a market participant who,

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who's bearing collateral costs,

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and you need to fund this collateral, somehow,

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this is gonna have asset pricing implications,

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which is exactly what our paper, sos or does

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or documents, by, so that the, you know,

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the fragmentation in clearing actually,

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has asset pricing implications,

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which we're gonna discuss in a minute.

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Uh, there's also paper by Hendershot

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and Meckel in 20, published in 2014 in JFE,

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where it's basically looks at how dealers respond to,

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various costs that they face when they make markets.

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And the key insight from that paper is that, well, you know,

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when dealers are faced, with inventories

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that are basically away from

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what they themselves are targeting,

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they're gonna basically quote prices such

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that the inventories are gonna come back to where,

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they would like them to be.

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Um, which is again,

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what is essentially happening when clearing is fragmented,

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and how dealers respond by quoting prices in

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that, in that situation.

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So these are the, gonna be the key papers.

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Uh, I think that, set the, set the background, so

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to speak, of, what we're doing centralized clearing,

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facilitates and enables, multilateral netting.

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This is particularly beneficial to dealers, right?

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Because it reduces their collateral costs.

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Now, let's think, and let's kind of, imagine

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what happens when, you know, clearing is not,

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is fragmented, which means that you might have, the same

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or related asset classes, right?

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Being cleared in multiple jurisdictions, right?

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So we're kind of deviating and departing from this canonical

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and ideal world

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where everything is basically being processed

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by just one clearing house.

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Uh, and we're departing from this canonical world

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because that's what reality is, right?

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In practice, what you do, what you see is that you have,

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the same or similar derivatives contracts being cleared

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around the world by multiple different,

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you know, clearing houses.

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Um, so that's in reality,

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clearing is fragmented in the real world.

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And the question is, what are the implications of that?

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And the key implication of that,

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or at least one of the implications of that is that,

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these net benefits

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that we discussed are now going to be reduced.

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And, to give you an example, if you have a dealer,

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who is basically, who has,

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a long position in London, right?

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So they're trading with, a client in London who happens

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to be selling, so the dealer is buying in London,

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and at the same time, there are inter, you know, the other,

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you know, the counterparty on the other side of

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that transaction is a client in the US in Chicago, say,

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who is buying, right?

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So the Chicago client is buying,

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so the dealer is selling in Chicago.

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Uh, the dealer cannot net these two trades via

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a single clearinghouse.

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Instead, they would have to take the London, trade

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and clear it through LCH in London,

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and they would have to take the Chicago trade

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and clear it via,

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the Chicago Mercantile Exchange in Chicago.

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So the problem that this generates, that this gets rise

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to is that these two trades now cannot be edit,

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and the dealer is gonna have

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to pledge collateral individually with its clearing house.

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That's gonna be expensive for the dealer.

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The dealer won't like that, right?

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And, we can discuss, you know,

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later on why they might not like that.

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But generally speaking, in natural,

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this is gonna be expensive to fund, right?

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When you kind of have to pledge, collateral with,

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somebody else, you need to fund this somehow.

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And funding it is expensive.

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It's costly because you need to raise some money to be able

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to get the collateral and then

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pledge it with a clearing house.

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So that's gonna be expensive, okay?

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So what, what's the big deal if the

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dealers find that expensive?

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And the big deal is

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that the dealers are not gonna just sit back

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and take the hits.

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The dealers are gonna try to recoup this cost somehow,

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and they're gonna do it the old fashioned way,

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which is they're gonna try to buy low and sell high.

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Now, what does that mean in practice?

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Let's remember, the dealers in those OTC deliveries markets

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are the, are the entities who set the prices, right?

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So what the dealers are gonna do in order

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to recoup this collateral cost is

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that they're gonna set a low price in London

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where our clients are selling,

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and they're gonna set a higher price in Chicago

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where our clients are buying so effectively, right?

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Uh, our clients in Chicago are gonna be buying this contract

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at a higher price, not good for them.

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And our clients at London are gonna be selling their

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contracts to the dealer at lower price, not good for them.

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Um, so the dealers are gonna recoup these costs, right?

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Through this, differential,

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through this price differential, so as to speak.

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Uh, and this cost is going to effectively be passed on

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to the clients, whether they're in London or Chicago.

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Now, a couple of, interesting points,

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as we said, the dealer set prices in those OTC derivatives

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markets, and they're gonna try

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and pass this cost on to end users.

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So the, the, the first conclusion that one kind

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of arrives at is that when you fragment clearing,

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this is gonna become ultimately costly

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for the market end users, right?

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Because the dealers are gonna pass this cost onto end users.

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That's number one. Number two is that by doing so,

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by setting, these different prices in different

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jurisdictions, they effectively create,

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what we call a CCP basis.

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In other words, you have the same

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or similar contracts effectively being traded at

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different prices, right?

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The exact same thing is being traded at different prices.

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One last point about the mechanism that's I think worth,

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talking about is one might think, hold on a second,

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why can't the Chicago clients do the trade

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or book the trade in London to benefit from the lower price?

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And the answer to that is that oftentimes, you know,

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some clients, which are sophisticated,

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which have international pre

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who have international presence, et cetera,

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might be able to, to do that.

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And our, in fact, our analysis shows that,

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but there are a lot of clients out there who don't have,

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you know, the capacity

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or the size to be able to book trades internationally.

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And of course, there are other clients who are restricted

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by local regulations in having

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to clear their trades locally.

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So this is in a nutshell, the mechanism that our paper,

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describes and, and particularly validates.

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We're extremely fortunate, to basically, have access

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to supervisory data from the United Kingdom to be able

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to test, you know, the presence

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and, the workings of this mechanism.

11:45.425 --> 11:50.165
So as effectively, what we got access to was, data from,

11:50.265 --> 11:55.125
the swap clear service of L-C-H-L-C for the benefit

11:55.225 --> 11:56.285
of, you know,

11:56.285 --> 11:58.965
the viewers is the world's largest clearinghouse.

11:58.995 --> 12:00.725
It's based in London,

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and it's the world's largest, especially in the domain

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of interest rate, derivatives that we're kind

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of discussing and analyzing our paper.

12:08.505 --> 12:12.845
Um, so the, we got data from L Cs

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and in particular, we got data on the amount of collateral

12:15.485 --> 12:18.485
that various dealers get to pledge with,

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the swap clear service of L Cs.

12:21.065 --> 12:24.325
And I should say here that the swap clear services,

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that brands and within L Cs that's responsible

12:27.485 --> 12:28.805
for interest rate derivatives.

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Um, and we also got data on actual interest

12:31.885 --> 12:33.005
rate swap transactions.

12:33.435 --> 12:36.765
Okay? So we have these two pieces, key pieces of data

12:36.875 --> 12:40.365
that allowed us to essentially test some of the,

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hypothesis that basically flow from the

12:42.805 --> 12:44.005
mechanism we just described.

12:44.305 --> 12:47.685
We essentially, use this supervisory data to test,

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the presence and, of this mechanism

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that we described earlier on.

12:52.185 --> 12:55.565
And it turns out that all of these hypothesis, all of these,

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you know, that we kind of are effectively articulate,

12:58.045 --> 13:00.045
we've been, and which we've been discussing

13:00.065 --> 13:01.845
so far, are true in the data.

13:01.865 --> 13:06.405
So the, the data, says that, this mechanism is,

13:06.545 --> 13:08.285
is present, is kicking,

13:08.905 --> 13:11.125
and this is what's driving the CCP basis

13:11.155 --> 13:13.325
that we are actually observing,

13:13.665 --> 13:15.845
in these very important financial markets.

13:16.425 --> 13:18.725
Now, one thing I would like to say at this point as far

13:18.725 --> 13:21.045
as the importance of these results is the following,

13:21.045 --> 13:23.725
you know, this CCP basis, you know, they kind of range

13:23.725 --> 13:26.365
between one and three basis points basis,

13:26.585 --> 13:28.845
and a, you know, a hundred basis points is 1%.

13:28.845 --> 13:31.245
So some people might think, well, is this really

13:31.825 --> 13:34.365
an economically significant price differential

13:34.365 --> 13:36.005
between these swap contracts

13:36.005 --> 13:37.925
that are cleared in Chicago versus London?

13:38.305 --> 13:39.525
And the answer is yes, because

13:39.805 --> 13:40.885
although the price differential

13:40.945 --> 13:43.485
of these contracts is very small, it's one

13:43.485 --> 13:44.565
to three basis points.

13:45.105 --> 13:48.205
If you multiply that differential with the actual volumes,

13:48.745 --> 13:51.205
of these markets, then you come up,

13:51.315 --> 13:53.925
what comes out is a pretty economically significant number.

13:53.985 --> 13:57.965
So for instance, if you look at the CCP basis in,

13:57.965 --> 14:02.245
dollar denominated swap contracts, cleared in London

14:02.345 --> 14:05.485
and Chicago, the average basis is, is one, is one

14:05.485 --> 14:07.685
to three basis points during our sample period.

14:08.385 --> 14:13.025
Um, but that needs to be multiplied,

14:13.375 --> 14:16.425
that needs to be multiplied by something like 50 billion,

14:17.085 --> 14:19.625
dollars of daily volumes, right?

14:20.245 --> 14:23.585
Uh, being of cell volumes, that's, let me repeat,

14:23.645 --> 14:24.705
let me kind of repeat myself.

14:24.705 --> 14:26.465
These are cell volumes,

14:26.835 --> 14:30.425
50 billion on average dollars every day being sold in

14:30.505 --> 14:31.625
LC eight, right?

14:31.685 --> 14:33.585
So this means, that,

14:34.525 --> 14:36.385
and once you also take into account the fact

14:36.385 --> 14:38.665
that these contracts have an average mature about 10 years,

14:38.665 --> 14:41.865
which means whatever payments you lock in when you trade

14:41.865 --> 14:44.745
these things, they're gonna be, kind of,

14:44.745 --> 14:45.865
they're gonna be recurring.

14:45.865 --> 14:47.785
They're gonna be happening over a 10 year period

14:48.375 --> 14:50.425
that translates into something like

14:50.425 --> 14:52.965
$80 million on a daily basis.

14:52.965 --> 14:55.285
Meaning that if you are, if you take all

14:55.285 --> 14:57.965
of those sellers selling in London, okay,

14:58.025 --> 14:59.565
all these clients selling in London,

15:00.065 --> 15:01.805
and you were to take those trades

15:02.145 --> 15:04.885
and, essentially price them at the

15:04.885 --> 15:06.085
Chicago prices, right?

15:06.785 --> 15:09.045
Uh, they, they would be earning an additional

15:09.205 --> 15:11.205
$80 million every single day.

15:11.665 --> 15:12.805
So despite the fact

15:12.805 --> 15:15.485
that this price differential seems small,

15:15.665 --> 15:18.485
it is actually quite large from an economic point of view,

15:18.715 --> 15:20.365
precisely because of the very large

15:20.365 --> 15:21.805
volumes involved in these markets.

15:21.955 --> 15:24.845
General. And the big picture implications of our work is

15:24.845 --> 15:26.685
to highlight the fact that, you know,

15:26.795 --> 15:30.365
centralized clearing has economies of scale precisely

15:30.365 --> 15:32.565
because it facilitates multilateral netting.

15:33.065 --> 15:36.645
Uh, it makes sense from a collateral saving point of view

15:36.645 --> 15:39.645
to concentrate, clearing in similar

15:39.985 --> 15:42.285
or related, financial products in

15:42.285 --> 15:43.805
as few clearing houses as possible.

15:44.345 --> 15:47.685
Um, when you try to undo this, you know, either

15:47.985 --> 15:49.605
by regulation or other ways,

15:50.315 --> 15:53.125
that means there's gonna be collateral costs associated with

15:53.125 --> 15:54.685
that, and these collateral costs are

15:54.685 --> 15:55.925
going to be non-trivial.

15:55.955 --> 15:57.965
This is something that policy makers,

15:57.965 --> 15:59.885
should bear in mind in general going forward.

00:00 - This is joint work with, some colleagues who happen to, be affiliated with policy institutions. So everything we say here, does not necessarily represent the views of those policy institutions. That's always an important disclaimer to make,

00:11 - when in those cases. So the general context is, I mean, the general topic is that of central clearing, and in particular central clearing of over the counter derivatives markets. So, centralized clearing was a key regulatory reform that was implemented in the wake of the great financial crisis of 2008 and 2009. And what it pertains to, what is that the regulators required market participants

00:39 - to essentially collateralize their derivatives transactions via the so-called Central Counterparties or CCPs. These are entities that essentially innovate the trades, in these derivative markets, meaning they become the buyer to every seller and the seller to every buyer. And in doing so, they guarantee that these exposures are sufficiently robustly and consistently collateralized. and the reason why regulators did that was because in the run up to the financial crisis, right?

01:09 - derivatives exposures were under collateralized by as much as 3 trillion US dollars. So there was a massive gap, in the extent of collateralization of these exposures. So regulators stepped in, they wanted to fix this via central clearing. And ever since, over the past, several years since the financial crisis, central clearing has really taken off, it now accounts for 80% right

01:34 - of the global interest rate derivatives volumes, and around 70% of, credit derivatives volumes. So it's a major, major change in the, in the architecture of the financial, system or financial markets. now one key thing about, centralized clearing, and I think this is also related to the kind of the problem we're dealing here, is that it's facilitates multilateral netting, and it's kind of important to spend like half a minute

02:02 - to explain what that is. so the issue with multilateral netting is if you are a bank or a market participant and you have a long and a sort position, or you have long and sort positions with multiple counterparties, now all of these are gonna be collateralized with the clearing house. So the clearing house effectively is gonna take the net of those positions across your all,

02:25 - across your counterparties. And what that does is that it reduces the total amount of collateral that you need to pledge, right? this is particularly relevant and important for swap dealers. These are the entities, the big entities in financial markets that provide liquidity in those markets. And that's because these entities, the dealers, they generally have very large cross positions, but

02:49 - because there are positions tend to be balanced, because they intermediate rates, right? For every buyer, they are, they're responsible for finding a seller. And for every seller, they wanna find a buyer. Their net Exposures are small. So they particularly benefit from this multilateral netting that clearing houses, enable. However, that assumes that all clearing is taking place in one clearing house.

03:10 - And when you fragment clearing, then things starts to get, tricky. And, that's what our paper is about. Central clearing has been one of the major, reforms that, regulators implemented in the wake of the financial crisis. So there's been a lot of work, by academics and practitioners as well, in trying to understand what the implications of centralized clearing are. there's a vast literature on that,

03:35 - but I'm not gonna, you know, dwell on that literature. I'm just gonna mention a few papers that I think are related, to what we are doing here. one of the key papers that, first came out about, you know, central clearing was the paper by Duffin Zoo in 2011 in the published in the Review of Asset Pricing Studies. And it was the first paper to actually, explain and articulate what the netting benefits associated with multilateral Ben,

04:01 - multilateral netting aren't associated with central clearing are, it's not as trivial as one might have thought because of, the fact that, you know, if you don't do central clearing, you do bilateral clearing. In other words, one bank gets to collateralize their exposures on a bilateral basis with another bank without multilateral netting. but in doing so, they might get to net their ex their, exposures across different asset classes, right?

04:29 - Which is not the case when you do centralized clearing, because when you do centralized clearing, you have a CCP, which deals with one asset class at a time, okay? you do have multilateral netting, but no netting across asset classes in central clearing. Whereas in bilateral clearing, you don't have multilateral netting, but you do have netting across asset classes. So there's this kind of question as to which one is actually better from a collateral

04:53 - saving point of view. And, Duffy Zu were the first ones to kind of articulate and make the comparison, and also say that if you're gonna do central clearing in order to reduce, your collateral costs, you're gonna have to go with a single CCP, right? And that's the starting point, essentially of, of our discussion because you know, what our paper is about is what happens when you don't have one CCP.

05:18 - there's been another, another, a number of other papers that are related, to what we're doing. there's a paper by Gar and Paterson also published in 2011, the Review of Financial Studies that basically says that if you are a market participant who, who's bearing collateral costs, and you need to fund this collateral, somehow, this is gonna have asset pricing implications, which is exactly what our paper, sos or does

05:43 - or documents, by, so that the, you know, the fragmentation in clearing actually, has asset pricing implications, which we're gonna discuss in a minute. there's also paper by Hendershot and Meckel in 20, published in 2014 in JFE, where it's basically looks at how dealers respond to, various costs that they face when they make markets. And the key insight from that paper is that, well, you know, when dealers are faced, with inventories

06:10 - that are basically away from what they themselves are targeting, they're gonna basically quote prices such that the inventories are gonna come back to where, they would like them to be. which is again, what is essentially happening when clearing is fragmented, and how dealers respond by quoting prices in that, in that situation. So these are the, gonna be the key papers.

06:32 - I think that, set the, set the background, so to speak, of, what we're doing centralized clearing, facilitates and enables, multilateral netting. This is particularly beneficial to dealers, right? Because it reduces their collateral costs. Now, let's think, and let's kind of, imagine what happens when, you know, clearing is not, is fragmented, which means that you might have, the same or related asset classes, right? Being cleared in multiple jurisdictions, right?

07:02 - So we're kind of deviating and departing from this canonical and ideal world where everything is basically being processed by just one clearing house. and we're departing from this canonical world because that's what reality is, right? In practice, what you do, what you see is that you have, the same or similar derivatives contracts being cleared around the world by multiple different, you know, clearing houses.

07:24 - so that's in reality, clearing is fragmented in the real world. And the question is, what are the implications of that? And the key implication of that, or at least one of the implications of that is that, these net benefits that we discussed are now going to be reduced. And, to give you an example, if you have a dealer, who is basically, who has, a long position in London, right?

07:50 - So they're trading with, a client in London who happens to be selling, so the dealer is buying in London, and at the same time, there are inter, you know, the other, you know, the counterparty on the other side of that transaction is a client in the US in Chicago, say, who is buying, right? So the Chicago client is buying, so the dealer is selling in Chicago. the dealer cannot net these two trades via a single clearinghouse.

08:13 - Instead, they would have to take the London, trade and clear it through LCH in London, and they would have to take the Chicago trade and clear it via, the Chicago Mercantile Exchange in Chicago. So the problem that this generates, that this gets rise to is that these two trades now cannot be edit, and the dealer is gonna have to pledge collateral individually with its clearing house. That's gonna be expensive for the dealer.

08:37 - The dealer won't like that, right? And, we can discuss, you know, later on why they might not like that. But generally speaking, in natural, this is gonna be expensive to fund, right? When you kind of have to pledge, collateral with, somebody else, you need to fund this somehow. And funding it is expensive. It's costly because you need to raise some money to be able to get the collateral and then

09:00 - pledge it with a clearing house. So that's gonna be expensive, okay? So what, what's the big deal if the dealers find that expensive? And the big deal is that the dealers are not gonna just sit back and take the hits. The dealers are gonna try to recoup this cost somehow, and they're gonna do it the old fashioned way, which is they're gonna try to buy low and sell high.

09:19 - Now, what does that mean in practice? Let's remember, the dealers in those OTC deliveries markets are the, are the entities who set the prices, right? So what the dealers are gonna do in order to recoup this collateral cost is that they're gonna set a low price in London where our clients are selling, and they're gonna set a higher price in Chicago where our clients are buying so effectively, right? our clients in Chicago are gonna be buying this contract

09:44 - at a higher price, not good for them. And our clients at London are gonna be selling their contracts to the dealer at lower price, not good for them. so the dealers are gonna recoup these costs, right? Through this, differential, through this price differential, so as to speak. and this cost is going to effectively be passed on to the clients, whether they're in London or Chicago. Now, a couple of, interesting points, as we said, the dealer set prices in those OTC derivatives

10:14 - markets, and they're gonna try and pass this cost on to end users. So the, the, the first conclusion that one kind of arrives at is that when you fragment clearing, this is gonna become ultimately costly for the market end users, right? Because the dealers are gonna pass this cost onto end users. That's number one. Number two is that by doing so, by setting, these different prices in different jurisdictions, they effectively create,

10:36 - what we call a CCP basis. In other words, you have the same or similar contracts effectively being traded at different prices, right? The exact same thing is being traded at different prices. One last point about the mechanism that's I think worth, talking about is one might think, hold on a second, why can't the Chicago clients do the trade or book the trade in London to benefit from the lower price? And the answer to that is that oftentimes, you know,

11:03 - some clients, which are sophisticated, which have international pre who have international presence, et cetera, might be able to, to do that. And our, in fact, our analysis shows that, but there are a lot of clients out there who don't have, you know, the capacity or the size to be able to book trades internationally. And of course, there are other clients who are restricted by local regulations in having

11:25 - to clear their trades locally. So this is in a nutshell, the mechanism that our paper, describes and, and particularly validates. We're extremely fortunate, to basically, have access to supervisory data from the United Kingdom to be able to test, you know, the presence and, the workings of this mechanism. So as effectively, what we got access to was, data from, the swap clear service of L-C-H-L-C for the benefit of, you know,

11:56 - the viewers is the world's largest clearinghouse. It's based in London, and it's the world's largest, especially in the domain of interest rate, derivatives that we're kind of discussing and analyzing our paper. so the, we got data from L Cs and in particular, we got data on the amount of collateral that various dealers get to pledge with, the swap clear service of L Cs. And I should say here that the swap clear services,

12:24 - that brands and within L Cs that's responsible for interest rate derivatives. and we also got data on actual interest rate swap transactions. Okay? So we have these two pieces, key pieces of data that allowed us to essentially test some of the, hypothesis that basically flow from the mechanism we just described. We essentially, use this supervisory data to test, the presence and, of this mechanism

12:50 - that we described earlier on. And it turns out that all of these hypothesis, all of these, you know, that we kind of are effectively articulate, we've been, and which we've been discussing so far, are true in the data. So the, the data, says that, this mechanism is, is present, is kicking, and this is what's driving the CCP basis that we are actually observing, in these very important financial markets.

13:16 - Now, one thing I would like to say at this point as far as the importance of these results is the following, you know, this CCP basis, you know, they kind of range between one and three basis points basis, and a, you know, a hundred basis points is 1%. So some people might think, well, is this really an economically significant price differential between these swap contracts that are cleared in Chicago versus London? And the answer is yes, because

13:39 - although the price differential of these contracts is very small, it's one to three basis points. If you multiply that differential with the actual volumes, of these markets, then you come up, what comes out is a pretty economically significant number. So for instance, if you look at the CCP basis in, dollar denominated swap contracts, cleared in London and Chicago, the average basis is, is one, is one to three basis points during our sample period.

14:08 - but that needs to be multiplied, that needs to be multiplied by something like 50 billion, dollars of daily volumes, right? being of cell volumes, that's, let me repeat, let me kind of repeat myself. These are cell volumes, 50 billion on average dollars every day being sold in LC eight, right? So this means, that, and once you also take into account the fact

14:36 - that these contracts have an average mature about 10 years, which means whatever payments you lock in when you trade these things, they're gonna be, kind of, they're gonna be recurring. They're gonna be happening over a 10 year period that translates into something like $80 million on a daily basis. Meaning that if you are, if you take all of those sellers selling in London, okay, all these clients selling in London,

15:00 - and you were to take those trades and, essentially price them at the Chicago prices, right? they, they would be earning an additional $80 million every single day. So despite the fact that this price differential seems small, it is actually quite large from an economic point of view, precisely because of the very large volumes involved in these markets.

15:21 - General. And the big picture implications of our work is to highlight the fact that, you know, centralized clearing has economies of scale precisely because it facilitates multilateral netting. it makes sense from a collateral saving point of view to concentrate, clearing in similar or related, financial products in as few clearing houses as possible. when you try to undo this, you know, either by regulation or other ways,

15:50 - that means there's gonna be collateral costs associated with that, and these collateral costs are going to be non-trivial. This is something that policy makers, should bear in mind in general going forward.

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