Central counterparty

A central counterparty is a financial institution that acts as an intermediary between security market participants. This reduces the amount of counterparty risk that market participants are exposed to.

Trades on most major stock exchanges (including London) go through a central counterparty.

The seller of a security sells to the central counter party. The central counterparty simultaneously sells to the buyer. This means that if one party defaults then the central counterparty will absorb the loss.

This eliminates both the risk of direct financial loss though a default and the risk of indirect loss through having to unwind a trade. It is therefore a more complete method of reducing counterparty risk than alternatives such as simple DVP.

Copyright Graeme Pietersz © 2005-2020