What Is the Concept of “Novation” in the Clearing Process?

Novation is the legal process where a Central Counterparty (CCP) steps in and legally substitutes itself for the original counterparty in a derivatives trade. The original contract between the buyer and seller is discharged, and two new contracts are created: one between the CCP and the buyer, and one between the CCP and the seller.

This is the mechanism that centralizes and mutualizes counterparty risk.