Central Counterparties: Mandatory Central Clearing and Initial Margin Requirements for OTC Derivatives

Chapter 8

The Basics of CCP Operation

These will be entities that are too-big-to-fail on steroids.

Andrew Haldane¹ (1967–)

This chapter provides an overview of CCP operation, covering aspects such as basic functions, operation, risk mitigation and default management. Chapters 9 to 11 will then explore in more detail aspects around margining, loss allocation and client clearing.

8.1 CCP SETUP

8.1.1 CCP ownership

CCP ownership and operation tends to work broadly via either a vertical or horizontal setup with competing structures coexisting. These structures are outlined below:

• Vertical (e.g. Eurex and CME): In this approach, the CCP is usually a division of, and owned by, an exchange. The CCP is essentially tied to the exchange and provides clearing only for products traded on that exchange. Such a CCP is typically one of a number of entities that provide services from trading to settlement of transactions that are all embedded within a single organisation and infrastructure. This model has generally developed over the years for futures exchanges, and arose as the exchanges evolved and developed a central clearing function.
• Horizonal (e.g. LCH.Clearnet and OCC): Horizontal CCPs are separately owned (typically by their clearing members), have their own financial backing and can therefore clear trades across multiple markets and asset classes. They generally exist as separate entities. This may be more appropriate for bilateral OTC, as opposed to exchange-traded, transactions.