What Is a Central Counterparty Clearing House (CCP)?
A central counterparty clearing house (CCP) is an entity that helps facilitate trading in various European derivatives and equities markets. Typically operated by the major banks in each country, CCPs strive to introduce efficiency and stability to various financial markets.
CCPs bear the lion's share of the buyers' and sellers' credit risk when clearing and settling market transactions.
Central Counterparty Clearing House
Understanding Central Counterparty Clearing Houses (CCPs)
A central counterparty clearing house (CCP) is a corporate entity that reduces counterparty, operational, settlement, market, legal and default risk for traders. As counterparties to the buyers and the sellers, CCPs guaranty the terms of a trade—even if one party defaults on the agreement.
The CCP collects enough money from each buyer and seller to cover potential losses incurred by failing to follow through on an agreement. In such cases, the CCP replaces the trade at the current market price. Monetary requirements are based on each trader’s exposure and open obligations.
Central counterparty clearing houses (CCPs) reduce counterparty, operational, settlement, market, legal, and default risks for traders.
Functions of a CCP
As as a means of privacy protection, CCPs shield the associated traders’ identities from one other. CCPs also protects trading firms against default from buyers and sellers who are matched by an electronic order book and whose creditworthiness is unknown. Furthermore, CCPs reduce the number of transactions that are being settled. This helps smooth operations while reducing the value of the obligations, which helps money move more efficiently among traders.
Moody’s Rating Methodology for CCPs
In January 2016, Moody’s Investors Service made headlines by revealing its new methodology for rating CCPs worldwide. In its Clearing Counterparty Rating (CCR) report, Moody’s evaluates how a CCP may meet its clearing and settlement obligations in an efficient manner, and how much money will likely be lost if a trader defaults on an obligation. The CCR report factors in the following considerations:
- A CCP’s management capabilities for obligation defaults and related protections
- A CCP's business and financial basics
- A CCP's operating environment
- A CCP's quantitative measurements and qualitative issues, which Moody’s uses when determining a given CCP’s creditworthiness
Blockchain Technology and CCPs
Blockchain technology, which is described as an incorruptible digital ledger of economic transactions that can be programmed to record financial transactions, arguably represents a new frontier for CCPs. In November 2015, clearinghouses from several nations joined forces, to create a think tank known as the Post Trade Distributed Ledger Group, which studies how blockchain technology can affect the way in which security trades are cleared, settled and recorded.
This group believes new technology can reduce risk and margin requirements and facilitate greater regulatory oversight—before and after trading. And because this group’s members represent various parts of the securities settlement process, they comprehensively understand how the blockchain technology can aid the settlement, clearing and reporting processes.