What is OTC derivative contract clearing?


Published by a ÑÇÖÞÉ«ÇéÍø Banking & Finance expert
Practice notes

What is OTC derivative contract clearing?


Published by a ÑÇÖÞÉ«ÇéÍø Banking & Finance expert

Practice notes
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What is clearing?

When an over-the-counter (OTC) derivative transaction between two counterparties is centrally cleared, a central Counterparty (CCP) interposes itself between the original two counterparties to transaction. After the counterparties have agreed to enter into an OTC derivatives transaction, the CCP becomes the buyer to every seller and the seller to every buyer. 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

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Jurisdiction(s):
United Kingdom
Key definition:
Counterparty definition
What does Counterparty mean?

The other party to a transaction.

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