Financial Markets Operations Management

CHAPTER 9 Derivatives Clearing and Settlement

9.1 INTRODUCTION

We described some of the derivative products in Chapter 2: Financial Instruments and noted that these products can be subdivided into two types:

• Exchange-traded derivatives (ETDs)
• Over-the-counter derivatives (OTCDs).

This distinction guides us in terms of the post-transaction processing. Until recently, ETD transactions were cleared through a central counterparty (CCP) and OTCD transactions were processed between the trading counterparties. Today, it is expected that OTCD transactions are also cleared centrally; a change that has come about through regulatory pressure.

Central counterparties (CCPs) support trade and position management across a wide range of asset types including securities and derivatives. The concepts for derivatives clearing are similar to those for securities; however, there are some significant differences, including:

• After securities transactions have been cleared, settlement occurs in the appropriate central securities depository. There is no such concept of a CSD for derivatives. Cleared derivatives positions are managed by the CCP and non-cleared positions by the two counterparties involved.
• Securities are settled in full shortly after trade execution. This means that the counterparty risk between buyer and seller (in a clearing house context) is extinguished on settlement and, likewise, between buyer and CCP together with seller and CCP.
• Derivatives contracts remain open until they ...