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Clearing House

A clearing house, formally a central counterparty (CCP), legally interposes itself between buyer and seller in every cleared trade. Through novation it becomes the buyer to every seller and the seller to every buyer, so neither original party faces the other's credit risk. The CCP manages this risk with initial margin, variation margin, a default fund, and a published default waterfall. In Australia, exchange-traded futures and ETOs clear through ASX Clear (Futures) and ASX Clear respectively, both supervised by ASIC and the RBA.

Why it matters

Imagine 1,000 traders all selling and buying ASX SPI 200 futures with each other. Without a CCP each pair of counterparties would need to monitor the other's credit, post collateral, and have a legal contract. With a CCP, every trader only ever faces one counterparty, the clearing house. The CCP then nets each trader's positions across all trades, requires margin sized to plausible one-day moves, and stands behind the contract even if another trader defaults. The market behaves like 1,000 traders dealing with the same gold-rated counterparty.

Formulas

Net exposure after novation
Exposurei=ViCCP\text{Exposure}_i = V_i^{\text{CCP}}
After novation, member ii's only counterparty is the CCP. Bilateral exposure to other members becomes zero.
Default waterfall ordering
IM→DM→Default Fund→CCP Skin-in-the-Game→Survivor Funds\text{IM} \to \text{DM} \to \text{Default Fund} \to \text{CCP Skin-in-the-Game} \to \text{Survivor Funds}
Losses from a defaulting clearing member are absorbed first by the defaulter's initial margin (IM) and default fund contribution, then by the CCP's own capital, and finally by surviving members' contributions.

Worked examples

Scenario

Trader A sells 10 ASX SPI 200 futures contracts to Trader B at an index level of 7,500. The trade is matched on ASX 24 and submitted to ASX Clear (Futures) for novation.

Solution

After novation, ASX Clear (Futures) is the buyer of 10 contracts from A and the seller of 10 contracts to B. Neither trader faces the other's credit risk. Each posts initial margin to ASX Clear (Futures), recalculated daily as the futures price moves through variation margin calls. If A fails to meet a margin call, ASX Clear (Futures) closes out A's position using A's posted margin and, if needed, the default fund.

Scenario

Cleared interest rate swaps. A USD interest rate swap between Bank X and Bank Y is submitted to LCH SwapClear (London) for clearing in line with G20 Pittsburgh 2009 commitments.

Solution

LCH novates the trade into two swaps: X with LCH, and LCH with Y. Both banks post initial margin and pay daily variation margin to LCH. If Bank X defaults, LCH auctions Bank X's portfolio to surviving members. Losses beyond Bank X's margin are absorbed in waterfall order, leaving Bank Y's position intact. This is the architecture the G20 mandated to reduce the systemic damage seen when Lehman failed in 2008.

Common mistakes

  • ✗The clearing house takes a market position. It does not. The CCP holds matched long and short positions of equal size, so its net market exposure is zero. It earns fees and manages credit risk, not directional price risk.
  • ✗Clearing eliminates risk entirely. It concentrates and mutualises risk. Members share losses through the default fund, and a major CCP failure would be systemic. CCPs are now classified as systemically important financial market infrastructure.
  • ✗All OTC derivatives are cleared. Only standardised OTC products such as plain-vanilla interest rate swaps and CDS indices are mandated for clearing. Bespoke or exotic OTC trades remain bilateral, with stricter margin and capital rules under the Basel framework.

Revision bullets

  • •Central counterparty (CCP) to every cleared trade
  • •Novation transfers bilateral risk to the CCP
  • •Manages risk with initial and variation margin
  • •Default waterfall absorbs member failures
  • •ASX Clear (equities), ASX Clear (Futures) (derivatives)
  • •G20 Pittsburgh 2009 mandated CCP clearing for standardised OTC

Quick check

A clearing house reduces bilateral counterparty risk primarily by:

If a clearing member defaults and its initial margin is insufficient to cover losses, the next layer in the standard CCP default waterfall is:

Connected topics

NovationInit. MarginMark-to-Mkt

In learning paths

Foundations Path

Sources

  1. Hull (2022), §2.5
    Hull, John C. Options, Futures, and Other Derivatives. 11th ed. Pearson, 2022. ISBN 978-0-13-693997-9.
    Section 2.5 explains the clearing house, novation, and margin mechanics for futures markets.
  2. ASX Clear (Futures) overview
    Australian Securities Exchange. ASX Clear (Futures): central counterparty services for exchange-traded and OTC derivatives. ASX, accessed 2026.
    Primary reference for how Australia's derivatives CCP novates trades and manages clearing participant default.
  3. BIS Quarterly Review (2015), Central clearing trends
    Domanski, D., Gambacorta, L. and Picillo, C. Central clearing: trends and current issues. BIS Quarterly Review, December 2015.
    Surveys the post-GFC migration of OTC clearing to CCPs and the resulting concentration of risk.
  4. RBA Financial Stability Standards for CCPs
    Reserve Bank of Australia. Financial Stability Standards for Central Counterparties. RBA, accessed 2026.
    Australian regulatory standards that ASX Clear and ASX Clear (Futures) must meet, including margin, default management, and risk controls.
How to cite this page
Dr. Phil's Quant Lab. (2026). Clearing House. Derivatives Atlas. https://phucnguyenvan.com/concept/clearing-house
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