The Risk Controllers: Central Counterparty Clearing in Globalised Financial Markets

2

The Modern Central Counterparty Clearing House

2.1 THE CCP'S UNIQUE SELLING POINT

The near meltdown of the global financial system following the bankruptcy of Lehman Brothers refocused the attention of markets and policy makers on the original and unique purpose of CCPs.

Just as the forerunners of today's CCPs were set up in the 19th century to neutralise counterparty risk in commodity markets, the core responsibility of today's central counterparty clearing house is again to ensure that a security or derivatives trade between two of its users will not fail because the buyer or the seller are unable to fulfil their side of the bargain. By becoming the buyer to every seller and the seller to every buyer, the CCP assures completion of the trade if a trading partner defaults.

The trade might take place on an exchange, an alternative electronic trading platform or be bilaterally negotiated in an OTC trade. The legal substitution of the clearing house as the counterparty in two new trades, in which the seller sells to the clearing house and the buyer buys from the clearing house, is generally known as novation.

Thanks to advanced technology, modern CCPs clearing for exchanges novate and become counterparties to trades instantaneously at the time of their execution. Under traditional methods – still used for OTC trades – novated trades are registered on the CCP's books just after the trade and the details of the original bargain have been verified or matched. Novation takes place before ...