What is a central counterparty clearing house (CCP)?
A central counterparty clearing house (CCP) is an entity that facilitates trading in various European derivatives and equity markets. Generally managed by the main banks in each country, central counterparties strive to introduce efficiency and stability in various financial markets. It reduces counterparty, operational, settlement, market, legal and default risks for traders.
Central counterparty clearing house
Understanding a central counterparty clearing house (CCP)
Central counterparty clearing houses (CCPs) fulfill two main functions of intermediary in a transaction: clearing and settlement. As counterparties to buyers and sellers, central counterparties guarantee the terms of an exchange, even if a party does not respect the agreement. Central counterparties assume the lion’s share of the credit risk of buyers and sellers when clearing and settling market transactions.
The CCP collects enough money from each buyer and seller to cover potential losses incurred by not following an agreement. In such cases, the PAC replaces the transaction at the current market price. Monetary requirements are based on the exposure and open obligations of each operator.
Key points to remember
- A central counterparty clearing house (CCP) is an organization, generally managed by a large bank, which exists in European countries to facilitate trading in derivatives and shares.
- Central counterparty clearing houses (CCPs) fulfill two main functions of intermediary in a transaction: clearing and settlement.
- A CCP acts as counterparty to both sellers and buyers, collecting money from each, which enables it to secure the terms of an exchange.
Functions of a central counterparty clearing house (CCP)
As a means of protecting privacy, central counterparties protect the identities of the associated merchants from one another. Central counterparties also protect trading companies against default by buyers and sellers who are matched by an electronic order book and whose creditworthiness is unknown. In addition, central counterparties reduce the number of transactions being settled. This makes it easier to trade while reducing the value of the bonds, which helps the money to move more efficiently between traders.
In the United States, the equivalent of a central counterparty is known as a derivatives clearing agency (DCO) or a derivatives clearing house and is regulated by the Commodity Futures Trading Commission (CFTC).
Moody’s rating methods for central counterparty clearing houses
In January 2020, Moody’s Investors Service made headlines by unveiling its new CCP rating methodology around the world. In his Clearing Counterparty Rating (CCR) report, Moody’s is assessing how a central counterparty can fulfill its clearing and settlement obligations effectively, and how much money is likely to be lost if a trader fails to fulfill his obligations. The CCR report takes into account the following considerations:
- Management capacities of a CCP for breaches of obligations and associated protections
- The commercial and financial bases of a CCP
- The operating environment of a CCP
- Quantitative metrics and qualitative issues of a central counterparty, which Moody’s is used to determine the creditworthiness of a given central counterparty
Blockchain and CCP technology
Blockchain technology, which is described as an incorruptible digital register of economic transactions that can be programmed to record financial transactions, undoubtedly represents a new frontier for central counterparties. In November 2020, clearing houses from several countries joined forces to create a think tank known as the Post Trade Distributed Ledger Group. The Group, which started collaborating with the Global Blockchain Business Council in 2020, now includes around 40 financial institutions around the world.
The PTDL Group is convinced that new technologies can reduce risk and margin requirements, save on operating costs, increase the efficiency of the settlement cycle and facilitate greater regulatory oversight, both before and after negotiation. . And because members of this group represent different parts of the securities settlement process, they fully understand how blockchain technology can help the settlement, clearing and reporting processes.