Central Counterparty (CCP)
A central counterparty is a clearing house that steps between the two sides of a trade, becoming the buyer to every seller and the seller to every buyer, so that each party's exposure is to the CCP rather than to the other.
Also called: CCP · clearing house · central clearing · central counterparty clearing house
When a trade is submitted for clearing, the original contract between the two parties is replaced by two contracts, one between each party and the CCP. Because the CCP faces everyone, it can net each member's positions across all its counterparties (see netting), which shrinks the exposures that need to be settled and collateralised. It protects itself with layers of resources: members' initial margin, daily variation margin, a default fund to which members contribute, and its own capital.
Central clearing became the centre of derivatives reform after 2008. At Pittsburgh in September 2009, G20 leaders committed that all standardised OTC derivatives should be cleared through central counterparties by end-2012 at the latest, alongside trade reporting and higher capital for contracts that remained uncleared. CCPs are among the infrastructures covered by the CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI), the international standards for their risk management.
A CCP does not remove risk; it concentrates and transforms it. Counterparty risk between members becomes liquidity risk in the form of margin calls, and the CCP itself becomes a point whose failure would be systemic. That is why it is regulated as critical infrastructure. It is also distinct from a payment-versus-payment settlement system such as CLS, which removes settlement risk in FX without guaranteeing the trade.
In practice
Only standardised, liquid contracts can be centrally cleared. Bespoke OTC trades stay bilateral and are covered instead by margin rules for non-centrally cleared derivatives.
Example
Bank A buys a contract from Bank B and later sells the same contract to Bank C. Without a CCP, A has exposures to both B and C. With a CCP, A's purchase and sale net to zero against the CCP, and A has no remaining position to settle or margin.
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Commonly confused with
| Term | How it differs |
|---|---|
| CLS | CLS settles both legs of FX trades simultaneously so that neither side pays without receiving. It does not become the counterparty to the trade or guarantee its replacement if a party defaults before settlement. |
See also
- NettingNetting is offsetting mutual obligations so that only the difference actually moves. Two parties that have been paying each other all day settle one payment for the net amount, which cuts both the funds transferred and the liquidity each side must hold to support them.
- Margin CallA margin call is a demand that a party to a leveraged position or derivative post more collateral, usually cash, because the position has moved against it or the required margin has risen. If the call is not met, the counterparty can close the position.
- Settlement RiskSettlement risk is the risk that a payment or trade does not complete as expected because a party fails to deliver what it owes, on time or at all, after its counterparty has already performed.
- CLSCLS is the specialist institution that settles foreign exchange trades between major banks on a payment-versus-payment basis. Launched in 2002 and owned by its member banks, it settles 18 currencies and removes the risk of paying one side of a trade without receiving the other.
- DerivativeA derivative is a contract whose value comes from the price, rate or event it references, called the underlying. It lets parties take on or shed exposure to that underlying without buying or selling the underlying itself.
- Committee on Payments and Market InfrastructuresThe Committee on Payments and Market Infrastructures (CPMI) is the international standard-setter for payment, clearing and settlement systems. Hosted by the BIS, it brings together central banks to promote the safety and efficiency of the infrastructure that moves money.