Lesson 5 of 5 · 12 min
Central clearing and central counterparties
Since 2008 most OTC derivatives must be cleared through a central counterparty, which keeps OTC flexibility for end users while handling credit risk the way exchanges do, at the cost of concentrating risk in the CCP.
In short
- After the 2008 crisis, regulators introduced a central clearing mandate for most OTC derivatives.
- A central counterparty (CCP) takes on the counterparty credit risk between the original parties and provides clearing and settlement.
- Steps: (1) dealers execute the trade on a swap execution facility (SEF); (2) trade details go to the CCP; (3) the CCP novates the trade, replacing it with identical trades in which the CCP faces each side.
- End users keep OTC customization with their dealer; trades between dealers are cleared like ETDs, gaining transparency, standardization and risk reduction.
- The downside is centralization and concentration of risk in CCPs, a systemic concern that needs strong safeguards.
Unlock this lesson free for 7 days
Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.