| Abstract: |
Abstract: We study 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 internalized transaction, i.e. when buyer
and seller originate from the same broker. We study two fee structures that
the CSD applies to cover its costs. The first is a uniform fee on all trades
(internalized and non-internalized) such that the CSD breaks even on average.
Traders then maximize 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 internalized and non-internalized 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, we find 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, we consider a number of extensions including market power
for the CSD, anonymous trading and differences in broker size. |