New: The Cost of Clearing

Clearing members face substantial costs for capital as they post Initial Margin (IM) and are required to contribute to the Default Fund (DF) of the Central Counterparty Clearing House (CCP). In this paper, we discuss how these costs can be priced and passed on to clients. A transfer pricing policy entails three elements: the cost of capital for the Default Fund Contribution (DFC), the MVA or present value of IM posting obligations and the cost of counterparty credit risk against the exchange. The DFC is particularly delicate to cost because clearing members cannot predict the size of their contribution as this depends on the global CCP portfolio. We derive a pricing benchmark by assuming that CCPs collect incremental KVA at each trade and remunerate DFC at a hurdle rate matching that of clearing members.