Mario Draghi’s suggestion last year to set up a single European CCP is just one of the signs that consolidation in the clearinghouse industry is a hot topic. But will a house that serves parallel marketplaces make the combined market work better? On Thursday, the WFEClear conference saw Aniket Bhanu of India’s NSE Clearing present academic evidence supporting that it will. However, smaller venues could lose “informed-trader” volumes to larger exchanges who list the same shares.
Aniket Bhanu is both an experienced academic in the field and a senior industry professional, holding a vice president title with NSE Clearing, a division of India’s leading exchange group. Based on a close look at trading data from before and after India’s CCP interoperabily reform some years ago, he could show a tendency of share price spreads to narrow when a clearinghouse came to offer their clients cross-marketplace clearing for securities that were listed at two exchanges. In other words, the change generated a more liquid capital market overall.
On Thursday, 3 April, he presented his findings, in a session titled “The effect of clearing de-fragmentation on fragmented trading”, at the WFEClear conference in Seoul. (His 27-page paper is downloadable here.)
So everybody happier? Not necessarily. With a big volume difference between two exchanges, the cross-clearing possibility should tend to even further imbalance their activity of so-called “informed traders”. In India, this effect benefited NSE.
Siloed, shared, or interoperable
As the title of the paper implies, the word “fragmented” can refer either to the exchange, the CCP, or both. The study starts from a situation with two marketplaces, each with a separate CCP that clears its trades. In theory, the CCP defragmentation can then happen in either of two ways. Either the two CCPs are replaced by a single one that serves both markets, or both CCPs are allowed to compete on both marketplaces. India’s real case saw the latter outcome: an interoperability regime with two clearinghouses both serving both markets.
The dominant marketplace in the setup was the Aniket Bhanu’s employer NSE, which is one of the world’s four largest exchanges. The smaller competitor, BSE, was only about a tenth of NSE’s size – but still making it onto the world’s top-20 list, so not actually small. The opportunity for an A–B test was optimal. Input data was huge, and with both markets being in India, no differences in national regulation were in play. The CCPs’ margining models were not changed around the reform.
“Dominant” versus “satellite”
Aniket Bhanu’s study starts by setting up a simplistic theoretical model. It shows how, under certain assumptions, the reform of the CCP regime should generate narrower spreads for shares that are listed on both exchanges, while shares that were traded on only one exchange should not be notably affected. In short, the analysed data came to support the hypothesis (together with some other hypotheses examined).
The paper takes into account that one exchange was a dominant in the market, while the other played a “satellite” role in comparison. This has a number of implications in how market participants behave on each. For price discovery, most would look more to the larger marketplace.
