In modern markets, particularly in derivatives, clearing houses, now commonly referred to as central counterparty clearing (CCP) houses, sit at the heart of the post-trade infrastructure between the trading environment and the settlement arena. Their essential task is to manage counterparty risk. They are the archetypal ‘risk controllers’ and vitally important participants in the complex world of wholesale financial markets.

Since the global financial crisis, regulators have obliged more financial transactions to be backed by CCPs to decrease risk. CCP companies have therefore become larger and more significant.

In the world of CCPs it is all about understanding risk and always having a clear picture of potential issues. One of the crucial techniques in clearing at the disposal of CCPs is that of ‘margining’. Approaches differ amongst CCP operators, but fundamentally they all have the same underlying objective – risk management.

The sheer amount of financial assets held in margin accounts by CCPs around the world is huge. According to the Futures Industry Association website, at the end of 2021 approximately US$800bn was held in aggregate by the four leading CCP organisations: the Options Clearing Corporation (Chicago), LCH Group (London), ICE Clear (part of the Intercontinental Exchange), and the Chicago Mercantile Exchange’s CME Clearing. This was held as cover for initial margin requirements across house and client accounts from their clearing participants. Unprecedented political and economic events in the first part of 2022 have almost certainly driven these figures higher.

Why is margin important?

Margining systems must be logical, fair and must truly reflect risk. CCPs design appropriate systems for achieving this as part of their risk management governance, which involves clearing member representatives and others from both the exchanges and the markets they serve. They try to be ahead of the game, knowing that market emergencies might occur without notice.

Beyond the CCPs, treasury activities in the management of collateral and cash are also a sophisticated matter for participating firms and their bankers. For those involved in derivatives, foreign exchange and securities, considerable attention must be directed towards this task supported by reliable technology. As all involved are reliant upon their systems, there must be confidence in the technology and its resilience.

The war has placed extraordinary pressure on all asset classes

Collateral such as government securities or prime-currency cash must be posted by clearing members to the CCPs to provide protection against potential losses or default in their positions. This margin payment, known as initial or original margin, moves in tandem with the price of the underlying asset or contract. It is designed to cover the risk of a ‘normal’ price movement in a single day. In addition, profits and losses are calculated daily, giving rise to variation margin calls using a process of ‘marking to market’. There are also further margin components, all of which contribute to the overall margin assessment.

Margin calls are immediate. They involve two separate relationships: CCPs and their members and in turn from those members on to their clients. Calls for financial cover for all forms of margin are made by CCPs to their clearing participants, usually taking the form of an automated request – effectively a direct debit system – to the specific bank designated by the clearing member. The named bank thus provides a facility agreed mutually with the clearing member firm, operating with a daylight and cumulative limit.

Margin parameters are always monitored closely by CCPs. Times of market price volatility give rise to changes. For example, the London Metal Exchange’s CCP subsidiary, LME Clear, this year tripled its initial margin requirements for nickel contracts owing to heightened price volatility. The nickel price had soared after the commencement of the war in Ukraine.

It should be stressed that this particular episode was unprecedented and impacted the LME, its members and clients in other ways as well. The war has placed extraordinary pressure on all asset classes.

Margin calculation methods

Margin is one of the first lines of defence that CCPs have in place in their risk management framework. Their responsibility is to provide a financial guarantee for the fulfilment of registered contracts to their clearing member participants, which are primarily large financial institutions. Price swings and sudden increases in price volatility present basic challenges. They affect how quickly clearing houses can calculate up-to-date figures and issue calls for margin cover, as indicated earlier. Traditionally, this calculation could only be performed after the close of the business day. Close of day market prices derived from the exchanges or market operators would be used to determine required cash variation margin by marking to market all positions. Additionally, another computation was necessary to calculate the required amount of initial margin to support the open positions of clearing members.

This task is sufficiently demanding in itself. However, from time to time and as recent events in 2022 have illustrated, market stability can swing in the other direction in times of crisis. Speed is of the essence when seeking to manage risk in the light of market volatility.

This was seen most recently as a repercussion of the war in Ukraine. Similar occasions have been experienced in other periods of market volatility, for example when the Covid-19 pandemic first struck in 2020 and then in early 2021 in Wall Street. When moments such as these occur, an additional margin calculation known as ‘intraday margining’ must be undertaken to manage the CCP’s risk. This is where real-time (or near real-time) methods are so valuable. It is better for CCP organisations to be able to calculate margin figures in a real-time environment. This was for many years regarded as almost impossible. The available technology was simply not good enough. Only relatively few CCPs possessed the wherewithal to undertake real-time reviews.

The rider to this is, however, that it is difficult for firms to collect cover for margin intraday, when markets are global and the client base is spread across time zones.
A move towards real-time methods

However, by 2010, one technology vendor company, Cinnober of Sweden, had developed a clearing system in tune to the demands of the modern marketplace and enabling calculation of risk to be performed in real time. Nils-Robert Persson, the then chairman of Cinnober went on to form Vermiculus Financial Technology AB in 2019, also in Sweden. Its objective is to serve exchanges and clearing houses with state-of-the-art technology.

Speed is of the essence when seeking to manage risk in the light of market volatility In 2013, Chicago’s CME Clearing moved to expand its systems into real-time methods following regulatory announcements from the Commodity Futures Trading Commission, the US futures regulator. This chiefly addressed the clearing of over-the-counter (OTC) swaps, which posed new issues over and above exchange-traded derivatives. And in 2014, the LME’s clearing house LME Clear was launched, using a version of real-time clearing and margining via its LMEmercury system. The system enables exchange members to monitor and assess the risk they are taking on in real time, reducing risk for all participants in the global metals market.

Aspects of real-time management have been developed to varying extents by the major CCP organisations. Legacy systems, which still operate well, are being examined and updated. New thinking is being established.

As capital markets professionals will know, reducing the time between the execution of a transaction and its settlement reduces risk. Therefore, the clearing of all executed trades should best be completed more quickly. This increases the operational efficiency of the market and reduces risks, thus promoting confidence and protection. This possibly applies to derivatives markets more powerfully than to cash securities markets because the amount of margin money involved across the OTC swaps and exchange-traded derivatives world is so many times greater.

What does the concept mean in practice?

To summarise the scope, real-time clearing embraces the monitoring of positions and margin requirements together with settlements and payments.

Every event that can affect one of the above causes a recalculation. With such an event-driven design, the operators are sure always to have up-to-date information. Furthermore, a real-time clearing system makes it possible to effect real-time settlement, if the trading participants so desire.

There are two aspects of margining in real time. The first is to have the ability to calculate new margin requirements at every incoming event. The second is whether to issue a margin call as soon as the collateral requirement has been breached. This requires modern infrastructure on the clearing member side just as much as with the CCP itself. Automated, straight-through processing without human interaction is essential.

The beneficiaries of real-time clearing

The first to benefit are both the exchanges and CCPs in that any unreasonable risks being taken by the market players can be addressed more quickly. Where one day’s margin is collected the following day, CCPs need to maintain an extra level of capital to handle their risk while the margin call is being processed. If this can be accomplished in real time, this process can be accelerated and the extra margin element could be reduced or removed altogether. This benefit can be passed on to the clearing members as well as at the CCPs as it releases capital for trading. With such a system it is possible to monitor truly in real time not only the margin requirement but also the settlement and delivery instructions instead of facing a surprise if handling everything in one giant batch process at the end of the trading day. This provides an additional level of security.

The second category of beneficiary is the clearing member community. One of the most important aspects of running an efficient market is the optimal use of capital. Without real-time risk management and clearing, member firms need to post sufficient collateral to cover every possible risk scenario during the day and are only able to appreciate the true amount needed at the end of the day. This means that during the day, capital may be frozen that could be freed up and used for other purposes.

By introducing real-time risk management, clearing members have a concurrent view of the capital needed to cover the risk of their positions without the need to commit more. Therefore, margin requirements are lowered and less capital is immobilised during the active hours of the day.

Using smart functions such as ‘what-if’ scenarios, clearing members also have the possibility to test out different scenarios before trading and understand how they would impact their risk profile and collateral needs in real time.

Furthermore, benefits accrue to the wider market. By controlling risk from the moment it arises, the entire market becomes a safer place for traders, clearing members and their clients. Traders and other participants can test strategies. By allowing participants of all kinds to understand the payment flows resulting from their positions in real time rather than once a day, they are able to manage capital more efficiently throughout the day. This in return results in greater liquidity for the entire market. Everyone benefits.

What can be achieved today compared to times past?

With today’s modern system architecture and hardware, it is feasible to offer end client clearing, where every customer is represented with their own client account instead of clients being merged into an omnibus account. This reduces margin requirements, as positions can be netted within end client accounts – something that is not possible with omnibus accounts.

With cloud technology, computation capacity can be added instantaneously, making it feasible to calculate risk in many ways for the same portfolio simultaneously. This is different to some current models where one algorithm is used during the day and a different algorithm at the end of the day.

Hardware and programming language development in parallel computation now allow for much more sophisticated margin algorithms than, for example, SPAN, the widely adopted 1980s system developed by the CME (and currently being updated by them). Today, it is possible to perform an historical value-at-risk calculation with, say, a five-year lookback at every position update. Furthermore, running several different algorithms in parallel offers the risk manager different views of the portfolio risk.

Netting improvements

One of the best known advantages of clearing is the ability it provides to net obligations and deliver a net lower figure. Two important aspects are position netting in preparation for risk calculations and the netting of settlement and payment instructions.

With respect to position netting, a modern CCP system can offer end client clearing to optimise margin requirements at every point in time. This may involve millions of accounts, but this is achievable with today’s architecture. This vastly reduces redundant margin requirements as the client portfolios are always visible instead of being hidden within an omnibus account.

Additionally, with payments and deliveries, systems now must be able to offer different netting models depending on the market, instrument type, situation, and clearing member. In some cases, real-time gross netting where instructions are directly sent to the payment or delivery system is the correct route. In other situations, a member may want to net payments during the day. This should be a business choice and not dictated by the system architecture.

Data management and decision-making

Data is a crucially important commodity these days in finance as in most business sectors. There is so much available to both oversee and apply effectively. Clearing members often struggle when extracting information from clearing houses. In many cases, information is distributed in reports that are optimised for printing and reading, not using automated processing. A leading-edge system must offer members the possibility to download all required information.

Many older systems are divided into bookkeeping, risk management and settlement segments. It is hard to combine information from diverse sources. A unified application programming interface (API) for members is therefore highly beneficial in terms of extracting information in a more universally usable format.

CCPs and clearing members in turn need to make decisions quickly and correctly. This is exacerbated in times of market stress or emergency, as stated earlier. They need the right tools available to enable the correct decisions to be made at the proper time and communicated.

System implementation impacts

The transition to real-time systems may seem daunting and expensive and conceivably full of uncertainty and risk. How an IT replacement project is managed and delivered is as important as the underlying technology. Employing up-to-date and flexible tools together with the use of available architecture means that implementation projects are successfully accomplished, optimising all possibilities for a better result while minimising disruption.

Agile delivery models are in vogue. Monolithic systems are outdated. Cloud-based services offer true cost savings and artificial intelligence has the potential to offer great benefit in systems management. There is currently much advantage to be gained by CCPs, exchanges and member firms in adopting third-party tools. This leads to improving management flexibility and operational efficiency. Tangible benefits are there to be derived from taking advantage of such new approaches.

Could a CCP fail?

Alan Burr, Chartered FCSI(Hon)


"I would like to record my sincere appreciation and thanks to Taraneh Derayati, partner and CEO of Vermiculus Financial Technology AB of Stockholm. She very kindly assisted me with the preparation of this article."

On the flipside of the coin in this overall story is the problem of the concentration risk that a CCP presents. It represents a single point of potential failure if it were unable to execute its responsibilities appropriately.

Clearing member defaults are rare and CCP collapses are even more extraordinary. There have been three actual CCP failures: in France in 1974, Malaysia in 1983 and Hong Kong in 1987.

On the other hand, in London in September 2008, when LCH unwound Lehman Brothers' highly complex positions, including a US$9tn interest rate swaps portfolio, LCH successfully accomplished the massive task using Lehman’s margin and default fund contributions. Neither LCH nor other clearing members suffered losses from the exercise. Hence regulators worldwide appreciated the benefit of the CCP model and it has been adopted even more widely since, particularly in addressing OTC derivatives.

In the future, exploiting the benefits of real-time methods as described will lead to even safer, more efficient clearing that will enhance the markets and their users. Deploying present-day technology makes good sense.

Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI.