Central Counterparty Clearing House (CCP)
Candlefocus EditorIn the modern financial world, CCPs are intermediaries between buyers and sellers in the derivatives market. The most common scenario in which a CCP is utilized is when a clearing member agrees to buy a security from another clearing member (in the case of a derivative product, an option) and wishes to terminate the trade prior to its expiration. As a clearing member, the buyer is required to close out the original position and transfer the obligation to the CCP. This process is known as "issuing" a contract and the responsibility of the CCP is to ensure that the contract is met and that the trade is settled without fail.
In addition to providing a risk-mitigant solution, a CCP also carries out a number of other functions; it acts as a guarantor of contracts by means of providing guaranteed performance. Furthermore, a CCP can also provide liquidity to the market by providing access to multiple clearing members when transactions are entered into with the same clearing member. To this end, central counterparty clearing houses are becoming increasingly important components of markets today, allowing highly efficient and structured activities to take place.
A CCPs also performs a supervisory function. This means that it is responsible for ensuring that participants meet their obligations in terms of trades, particularly with regards to the collateral values of the trades in question. Furthermore, the CCPs are also responsible for supervising market integrity, providing members with up-to-date market information, and taking necessary actions to protect the markets’ integrity and fairness.
To ensure that no one participant has any special or privileged knowledge, the CCP must also remain neutral in all dealings. This means that the CCP must be seen to be equally serving all participants in a fair and just manner. Furthermore, the CCP will have to establish strict eligibility requirements and conduct stringent risk management policies to ensure that traders meet the requirements to use its services.
In summary, the CCP functions as a central counterparty in a derivatives market by performing the functions of novation, dispute resolution, market supervision, and risk management. The CCP is critical in terms of providing systemic risk reduction and arranging efficient and structured transactions, thereby providing its benefits to both buyers and sellers in the derivatives market.