Central Counterparties * School, the Cea Meetings 2005 and the Cepr Conference on Competition and Efficiency in Payment and Security Settlement Systems. Furthermore, We Thank the Financial Markets Infrastructure Division at the Bank of England For

Central counterparties (CCPs) have increasingly become a cornerstone of financial markets infrastructure. We present a model where CCPs are necessary to implement efficient trade when trades are time-critical, liquidity is limited and there is limited enforcement of trades. We then show that – when collateral is sufficient to avoid default – profit-maximizing CCPs “overcollateralize” trades relative to user-oriented CCPs and, hence, are less efficient. When collateral is not covering all default exposure, profit-maximzing CCPs can be efficient as they guarantee trading despite allowing for some default. User-oriented CCPs to the contrary might not be efficient due to a hold-up problem, avoiding default at the cost of less trade.