What Is the Role of a Central Clearing House (CCP) in Mitigating Counterparty Risk?
A central clearing house (CCP) mitigates counterparty risk by becoming the buyer to every seller and the seller to every buyer. Once a trade is agreed upon, the CCP steps in as the intermediary, novating the contract.
This breaks the direct link between the original trading parties. If one party defaults, the CCP absorbs the loss, using funds from a default waterfall that includes the defaulting member's collateral and its own capital.
This prevents a single default from causing a cascade of failures throughout the financial system.
Glossar
Clearing House
Settlement ⎊ A clearing house, within cryptocurrency and derivatives markets, functions as an intermediary between buyers and sellers, mitigating counterparty risk through a process of novation ⎊ replacing original trade agreements with new ones directly with the clearing house.
Central Clearing House
Mitigation ⎊ Central clearing houses, within cryptocurrency derivatives and broader financial markets, function as intermediaries designed to reduce systemic risk by mutualizing credit exposures.
Central Clearing
Mitigation ⎊ Central clearing, within cryptocurrency derivatives and options, functions as a financial intermediary establishing itself between counterparties to reduce systemic risk.