The report finds it is cheaper on average to use a central clearing house, which theoretically eliminates counterparty risk, than it is to buy an OTC derivative and hedge the counterparty risk exposure using a credit default swap.

The study takes account of different costs for OTC and exchange trading. For each, it includes transaction costs and the cost of protection against default. For exchange trading it also includes the cost of liquidity needed for posting additional margin and variation margin.

The calculations assume that the contract is held for one year. During this time, the cumulative total daily margin paid to a central counterparty is on average smaller than the premium paid to the seller of a credit default swap to hedge the counterparty risk. This obviously varies depending on the counterparty’s credit rating.

However, EEX concludes that although central clearing is cheaper on average, there are some situations in which trading over the counter could be cheaper.

First, the cost depends on whether the position is in or out of the money. Central clearing works out more expensive if trades go unfavourably for a party, as daily margin costs are high.

But the opposite is true if the trade looks like making money. As an OTC position moves into the money, the credit risk exposure to the counterparty grows. This means that if the risk is to be fully covered, more credit protection needs to be bought. As a result, the cost of hedging rises as the position becomes more profitable.

An exchange-traded derivative, on the other hand, requires low margin payments if it is making a profit.

“We have been told by many market participants that exchange clearing is too expensive,” said Iris Weidinger, the chief financial officer of the European Energy Exchange in Leipzig, Germany. “There is a lot of misunderstanding. It’s not true in general that clearing is too expensive. It’s important to look at all cost components, especially costs for managing credit risks in bilateral trading. “

About 1,000 Terawatt hours (TWh) of power is cleared weekly through European Commodity Clearing, which clears for EEX. The other 3,500 TWh traded in the German power market each week go over the counter and are not centrally cleared.

Not all market participants buy credit protection when they trade OTC, and some use it only rarely.

But the aim of the study is to compare like with like — studies that conclude OTC trading is cheaper often neglect to take credit protection into account.

The study factored in account processes, transaction fees, liquidity provision and credit protection. The cost of the first three is the same or lower for over the counter traders, it found; but the cost of credit protection is much higher.