An entity that interposes itself between the two sides of a trade, becoming buyer to every seller and seller to every buyer, and managing the resulting risk with margin and a default fund.
Clearing removes the need to assess every trading partner's credit, because every exposure faces the same well-capitalised entity. It also allows multilateral netting, so a member's obligations across many counterparties collapse into one position.
Protection rests on a default waterfall: the defaulting member's initial-margin, then its contribution to the default fund, then a slice of the CCP's own capital, then the surviving members' contributions, and finally loss allocation tools. Members therefore mutualise each other's failures.
The system concentrates risk as well as managing it. A CCP is a single point of failure by design, which is why their margin models, stress tests and recovery plans receive intense regulatory attention. See clearing-member.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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