Effect of clearing de-fragmentation on fragmented trading

Abstract

In many markets, trading is distributed across multiple exchanges or venues, resulting in fragmentation. Central counterparty (CCP) clearing may either reflect this fragmentation or be consolidated via a single CCP or through interoperability among multiple CCPs. This paper examines howthe choice of the clearing model affects trader behaviour under fragmented trading and shows that, when inter-exchange arbitrage costs are high, informed traders prefer to supply liquidity on the less liquid exchange. However, when these costs are lowered due to netting from de-fragmentation of clearing, they instead prefer to supply liquidity on the more liquid exchange. As a result, clearing de-fragmentation concentrates trading activity on a single exchange. This enhances price informativeness, narrows bid-ask spreads and improves welfare by reducing adverse selection for uninformed traders.