Clearinghouse
A financial intermediary that interposes itself between buyers and sellers in securities and derivatives markets, becoming the buyer to every seller and the seller to every buyer to eliminate counterparty risk.
What is Clearinghouse?
A clearinghouse (also called a central counterparty or CCP) is a financial institution that sits between the two parties in a securities or derivatives trade, guaranteeing contract performance by becoming the legal buyer to every seller and seller to every buyer. By doing so, it eliminates bilateral counterparty risk: if one party defaults, the clearinghouse absorbs the loss using its financial resources — including initial margin, variation margin, a default fund, and its own equity capital — rather than letting the failure cascade to the other party. Major clearinghouses in the U.S. include the DTCC (equities), CME Clearing (futures), and LCH (interest rate swaps). After the 2008 financial crisis, the Dodd-Frank Act mandated that most standardized over-the-counter derivatives be cleared through CCPs to reduce systemic risk. Clearinghouses require participants to post collateral (margin) that is marked-to-market daily.
Example
A hedge fund buys 1,000 S&P 500 futures contracts from a bank on the CME. Instead of a bilateral contract between just those two parties, CME Clearing becomes the counterparty to both: it is the seller to the hedge fund and the buyer to the bank. Both parties post margin. If the hedge fund later defaults, CME Clearing uses the posted margin and default fund to honor the contract with the bank — preventing the bank from suffering a loss and stopping contagion from spreading through the financial system.