Clearing converts a trade into a set of enforceable obligations and, in many markets, places a central counterparty between the parties through novation (the clearinghouse becomes the counterparty to both sides), reducing bilateral credit risk. It also enforces risk controls, sets required collateral (margin), and uses multilateral netting to minimize the funding needed at settlement.
After a trade is confirmed, clearing identifies the exact terms and the counterparties. The clearinghouse—often a central counterparty (CCP)—interposes as the counterparty to both sides (novation). It monitors positions, maintains collateral, and applies initial and variation margins to cover potential losses. By netting multiple trades, it reduces gross exposures to a net obligation.
On settlement, cash and securities are transferred through designated settlement systems, frequently under a delivery-versus-payment (DVP) arrangement so that the two legs occur together. Clearing lowers systemic and participant risk by centralizing counterparty risk through the CCP and standardized post-trade procedures.
After a trade is executed, the clearinghouse becomes the counterparty to both sides through novation, posts initial margin, and schedules settlement for the following business day.
Settlement · Netting · Novation · Central counterparty (CCP) · Delivery-versus-Payment (DVP) · Margin