A clearing house, or central counterparty (CCP), steps between the two sides of every cleared trade. It becomes the buyer to every seller and the seller to every buyer. Counterparty risk is then concentrated in one entity, which manages it through margins and mutualised resources.
How it works
Once a trade is matched, it is novated: the original contract between the two parties is replaced by two contracts with the CCP. The CCP collects initial margin, sized to cover potential losses over a few days of close-out, and variation margin, which settles daily gains and losses. Only clearing members face the CCP directly. Clients clear through a member, with positions held in omnibus or individually segregated accounts. If a member defaults, the CCP draws on resources in order: the defaulter’s margin, its default fund contribution, the CCP’s own capital, then the contributions of the other members.
Example
Hypothetical: a trader buys one index future at 5,000 points with a multiplier of €10 per point, and posts €3,500 of initial margin. The next day, the future settles at 4,950. The trader pays 50 × €10 = €500 in variation margin, which the CCP passes on to the side that sold.
On the desk
Margin is procyclical: in a stress episode, CCPs raise initial margin just as variation margin calls grow. The risk for a position is often liquidity before solvency, the cash needed to meet calls on the same day.
Educational definition. Worked examples are hypothetical. Not an offer or a recommendation.