What is clearing?

The following Banking & Finance practice note provides comprehensive and up to date legal information covering:

  • What is clearing?
  • Why are derivatives cleared?
  • What types of derivatives are cleared?
  • Suspension of the clearing obligation
  • Who is required to clear?
  • Exclusions from the clearing requirement
  • How are derivatives cleared?
  • Client Clearing Model—Principal Model
  • Client Clearing Model—Agency (FCM) Model
  • Reporting clearing requirements
  • More...

What is clearing?

When a transaction is centrally cleared, that transaction is 'given up' or 'novated' to a central counterparty (CCP). This means that the two parties entering into the derivative transaction do not have credit exposure to each other as they would have in a bilateral transaction. Instead, the CCP takes margin in exchange for assuming the credit risk of each of the two parties.

Margin is a payment in cash or securities equal to some or all of the exposure that those parties are subject to. Margin is typically described as initial margin (or IM) or variation margin (or VM). IM is an amount of collateral deposited with the CCP by a clearing member (CM) at the time it opens a position whereas VM is a cash payment made every trading day equal to the profit and loss on the transaction on the preceding trading day, derived from changes in the settlement price. For more information on IM and VM, see Practice Note: OTC and exchange traded derivatives—documentation—Margin (collateral).

CCPs are financially robust entities that assume the rights and obligations of counterparties to a derivative transaction. If a party to a transaction defaults, the CCP closes out positions and uses margin and/or default fund contributions to cover its exposure. This means that CMs are shielded from direct losses that may result from the default

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