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Central Counterparties or CCPs have been seen by regulators as a means of reducing counterparty credit risk in the aftermath of the 2008 credit crisis.18 In reality CCPs have been a feature of the market for many years in the guise of clearing houses associated with exchanges. The London Clearing House,19 for example, was formed in 1888 to clear commodities contracts and started clearing financial futures for London International Financial Futures Exchange (LIFFE) in 1982. CCPs now provide clearing for standardised derivative contracts such as interest rate swaps and credit default swaps and in 2009 the G20 leaders mandated that all standardised OTC derivative contracts be cleared by the end of 2012 (Financial Stability Board, 2010). While regulators and world leaders have seen CCPs as critical to reducing system market risks (G20, 2009), others have suggested that CCPs themselves lead to systemic risks (Duffie and Zhu, 2011; Kenyon and Green, 2013c).

Central clearing operates in much the same way as a bilateral CSA contract in that collateral must be supplied to support the movements in the mark-to-market of the portfolio of derivatives. This collateral is known as variation margin in the context of clearing. The frequency of calls for variation margin is typically daily. The rules of individual CCPs vary but considering LCH.Clearnet SwapClear as an example, three additional elements of margining are present: initial margin, liquidity multipliers and default fund. The initial margin is similar to initial margin in CSA agreements in that it must be supplied independently of the current mark-to-market of the counterparties' derivative portfolio. However, LCH.Clearnet Swapclear specifies the initial margin as a dynamic quantity with its PAIRS methodology (LCH, 2012e) using a historical Value-at-Risk measurement. Significant intraday market moves can trigger margin calls for additional initial margin (LCH, 2012b). For positions with large net risk, LCH.Clearnet SwapClear specifies a series of liquidity multipliers to increase the margin position to reflect the limits of market liquidity should the position be required to be closed out completely (LCH, 2010b). Finally a default fund has been created from contributions from all large clearing members to allow the clearing house to survive one or more defaults by clearing members (LCH, 2012a).

Only standardised OTC derivative contracts can be cleared through CCPs. In response to a desire that all transactions between significant financial institutions be margined, the Basel Committee on Banking Supervision has issued a consultation document that will enforce similar rules on OTC derivatives traded between financial institutions (BCBS, 2012h). Most of these contracts are currently traded under CSA agreements and hence are already subject to collateral support. However, the proposal will add the requirement for both counterparties to post initial margin, although there will be no additional posting requirements such as for CCP default funds.