The study focuses on the relation between liquidity in financial markets and post-trading fees (i.e. clearing and settlement fees).
The clearing and settlement agent (CSD) faces different marginal costs for different types of transactions. Costs are lower for an internalised transaction, i.e. when buyer and seller originate from the same broker. Two fee structures are studied that the CSD applies to cover its costs. The first is a uniform fee on all trades (internalised and non-internalised) such that the CSD breaks even on average. Traders then maximise trading rates and higher post-trading fees increase observed liquidity in the market. The second fee structure features a CSD breaking even by charging the internalised and non-internalised trades their respective marginal cost. In this case, traders face the following trade-off: address all possible counterparties at the expense of considerable post-trading fees, or enjoy lower post-trading fees by targeting own-broker counterparties only.
This difference in post-trading fees drives traders strategies and thus liquidity. Furthermore, across the two fee structures, the paper finds that observed liquidity may differ from cum-fee liquidity (which encompasses the post-trading fees). With trade-specific fees, the cum-fee spread depends on the interacting counterparties. Next, regulators can improve welfare by imposing a particular fee structure. The optimal fee structure hinges on the magnitude of the post-trading costs. Noteworthy, a fee structure yielding higher social welfare may in fact reduce observed liquidity. Finally, a number of extensions are considered, including market power for the CSD, anonymous trading and differences in broker size.
Full discussion paper
© CEPR - Centre for Economic Policy Research
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