How Is the Process of ‘Novation’ Central to the Clearing House’s Role?

Novation is central to the clearing house's role because it is the legal process that transforms a bilateral trade into two separate, guaranteed contracts. When a trade is cleared, the clearing house steps in and legally replaces the original buyer and seller.

The original contract is extinguished and replaced by two new contracts: one between the clearing house and the buyer, and one between the clearing house and the seller. This mechanism establishes the clearing house as the Central Counterparty, eliminating the bilateral counterparty risk.