Vertical Integration, Competition, and Financial Exchanges: Is There Grain in the Silo?

Abstract

We investigate the incentives for vertical or horizontal integration in the financialsecurity service industry, consisting of trading, clearing and settlement. We thereby focus on firms' decisions but also look on the implications of these decisions on competition and welfare. Our analysis shows that the incentives for vertical integration crucially depend on industry as well as market characteristics. A more pronounced demand for liquidity clearly favors vertical integration whereas deeper financial integration increases the incentives to undertake vertical integration only if the efficiency gains associated with vertical integration are sufficiently large. Furthermore, we show that market forces can suffer from a coordination problem that end in vertically integrated structures that are not in the best interest of the firms. We believe this problem can be addressed by policy measures such as the TARGET2-Securities program. Furthermore, we use our framework to discuss major industry trends and policy initiatives. c We are grateful to Kai-Oliver Maurer and Martin Reck (Deutsche Börse) as well as their teams for very helpful conversations on the structure of the industry. Furthermore, we would like to thank participants in the CFS round table on the economics of exchanges for comments on an earlier version of the paper. The paper benefitted significantly from comments and suggestion by seminar participants at

Competition in the clearing and settlement industry

“…However, competition should increase in all other clearing and settlement services at the domestic level, but even more so at the European level. An abuse of the clearing and settlement institutions' monopoly position can be contained by regulating the terms and pricing of access (see also Milne, 2007b;Juranek and Walz, 2010) and by careful scrutiny of potential antitrust practices by the competition authorities 8 . Serifsoy and Weiß (2007) find that market forces coupled with a regulatory framework can provide for a contestable monopolies outcome that ensures a high degree of static, dynamic, and systemic efficiency.…”