What Is the Process of ‘Novation’ in the Context of a Clearing House?

Novation is the legal process where the clearing house interposes itself between the original buyer and seller of a futures contract. Once a trade is executed on an exchange, the clearing house legally steps in and becomes the counterparty to both sides.

It assumes the credit risk of the original parties, replacing the bilateral contract with two new contracts: one between the clearing house and the buyer, and one between the clearing house and the seller. This process is fundamental to guaranteeing contract performance.