What are Central Counterparties (CCPs)?
Central Counterparties play a critical role in clearing deals minimising the counterparty risk. The part of the central counterparty is to become the counterparty of two counterparties having a contract and become a guarantor of the deal. In practice, exchanges use central counterparties (CCPs) to clear trades between two members.
Example of Central Counterparties (CCPs)?
Let's take an example of two parties, i.e. X and Y. Let's assume that party X and entity Y agree to a specific trade. Then the CCP acts as the counterparty to both X and Y. As a result, neither entity will have concerns about the creditworthiness of the other and may not even know the identity of the other.
The CCP will subsequently clear the transaction. In addition, the existence of the CCP allows for a more straightforward process in closing out positions.
Why are Central Counterparties (CCPs) important?
Without the CCP, if entity X wants to close out the position, it would need to do so with entity Y or another member, which might not be possible.