As market participants and regulators alike focus on solutions to prevent a future financial crisis, clearing has a center spot on the global stage. And there’s a reason: central clearing is a proven, highly transparent, regulated means of managing counterparty risk and reducing systemic risk.
Clearing houses maintain market integrity and capital protections by standing in the middle of each trade; once a trade is matched, the clearing house becomes the central counterparty (CCP) - the buyer to every seller’s clearing member and the seller to every buyer’s clearing member. The CCP also risk-manages trades to minimize any impact on clearing members and the larger market in the event of a default.
Why the CCP Model Works
Simply put, clearing protects clearing members and the broader market from defaults because it manages risk in an appropriate, disciplined and transparent manner - collateralizing (margining) each and every cleared position.
Each clearing house has unique risk management practices based on the products it clears and the risk associated with those products. The methods the ICE clearing houses use to manage risk include:
As noted above, clearing houses help safeguard the market by managing the risk associated with extreme but plausible default scenarios. At ICE, we have detailed plans and procedures in place for the recovery of our clearing houses should circumstances require. In the unlikely event that a clearing member default is not absorbed through the margin and guaranty fund contributions of the defaulting clearing member, a recovery plan will be implemented that utilizes the significant financial resources of the clearing houses’ default waterfall.
To learn more about our recovery plans, read “Beyond the Waterfall: Essential Elements of a Clearing House Recovery Plan" written by Scott Hill, CFO, Intercontinental Exchange, and published in the June 2017 issue of MarketVoice.