CCP (Central counterparty)
A central counterparty (CCP) is an entity that interposes itself between the parties to trades in one or more markets, becoming the buyer to every seller and the seller to every buyer. It manages counterparty risk through membership rules, margin, a default fund and a default waterfall, and in the EU is authorised under the European Market Infrastructure Regulation (EMIR).
Roles that need it
What it is
A central counterparty (CCP) stands between buyers and sellers. When two clearing members agree a trade and submit it for clearing, the original contract is replaced by two new contracts with the CCP, a legal process called novation. From then on each member faces only the CCP.
CCPs clear exchange-traded derivatives, over-the-counter (OTC) derivatives such as interest rate swaps, cash equities, bonds and repos. They admit only clearing members that meet capital and operational standards. Clients access clearing through a clearing member. Under EMIR, EU CCPs are authorised by national authorities, with a role for ESMA; third-country CCPs are recognised by ESMA.
Why it matters
A CCP turns a web of bilateral exposures into a hub, and nets each member’s positions. This reduces the total exposure in the market and makes defaults easier to handle. EMIR makes clearing compulsory for standard OTC derivatives, and EMIR 3 adds an active account requirement to clear part of certain euro and zloty derivatives at EU CCPs.
Because risk concentrates in the CCP, its resilience is critical. It collects initial margin and daily variation margin, runs a default fund mutualised among members, and follows a default waterfall that uses the defaulter’s resources first. Regulation (EU) 2021/23 adds recovery and resolution tools for CCPs.
Worked example
Illustrative numbers. Without a CCP, members A, B and C have bilateral trades: A owes B 50 million, B owes C 40 million and C owes A 30 million. Gross exposures total 120 million.
With a CCP each member faces only the CCP. Net positions are: A pays 50 and receives 30, so owes 20; B receives 50 and pays 40, so is owed 10; C receives 40 and pays 30, so is owed 10. Total net exposure falls to 40 million.
If A defaults owing 20 million, the CCP uses A’s initial margin of 15 million and A’s default fund contribution of 3 million, then 1 million of its own capital (skin in the game), then 1 million from the default fund contributions of B and C.
Who uses it
Middle Office Analysts submit trades to clearing and manage clearing breaks. Collateral Management Analysts meet daily margin calls from the CCP. Treasury Operations Analysts fund margin in cash and track intraday calls. Liquidity Risk Analysts plan for margin spikes in stress. Credit Risk Analysts assess exposure to CCPs and clearing members. Regulatory Change Analysts follow EMIR 3 and CCP rules.
Common confusions
A CCP is different from a central securities depository: the CCP takes on counterparty risk between trade and settlement, while the CSD settles and records securities. A CCP also differs from a clearing house that only calculates net obligations without becoming a counterparty. Finally, clearing concentrates risk in the CCP and manages it there, which is why margin and default resources matter.