Can preferred clearing reduce post-trade costs?

Abstract

Preferred clearing mechanisms can yield lower equilibrium fees than full clearinghouse interoperability. We develop a simple model with two CCPs-a leader and a follower-and heterogeneous traders who choose a CCP and pay clearing fees. Under preferred clearing, trades settle on the follower CCP only when both counterparties are affiliated; otherwise, the leader CCP clears the trade. In equilibrium, strong network effects discipline competition and reduce fees, especially when high-frequency trading is prevalent. Incumbent CCPs opt for a preferred clearing system unless the share of high-frequency traders is sufficiently high, in which case they allow full interoperability with competitors.