How does standardization affect OTC markets? Evidence from the Small Bang reform in the CDS market

Focusing on the most liquid segment of the European CDS market, this paper studies the impact of key standardization reforms. We document that the introduction of an upfront fee to standardize the cash flow of CDS contracts created an initial capital cost for traders, leading to higher CDS prices. This relation holds after accounting for well-known determinants of spreads, suggesting a separate funding channel driven by the greater capital intensity of trading. This effect is stronger when dealers are likely to bear the initial capital cost and is present across all industries, except for swaps written on financials.