What Is the Process of Novation in a CDS Trade Cleared through a CCP?

Novation is the legal process by which a central clearing party (CCP), like a clearinghouse, inserts itself into a bilateral trade, becoming the buyer to every seller and the seller to every buyer. When two parties agree to a CDS trade and submit it for clearing, their original contract is legally extinguished and replaced by two new contracts.

The original buyer now has a contract with the CCP, and the original seller also has a contract with the CCP. This substitution effectively transfers the counterparty risk from the original participants to the CCP.