Clearing corporation
Also written CC · Central counterparty · CCP
The entity that steps between every buyer and seller in the derivatives segment by novation, becoming the counterparty to both sides and guaranteeing that the trade settles.
In plain language
When you buy a Nifty futures contract, somebody sold it to you. You will never know who, and it does not matter — because the moment the trade is matched, the clearing corporation splits it in two and inserts itself in the middle.
You are now long against the clearing corporation. The seller is short against the clearing corporation. Neither of you has any claim on, or exposure to, the other. That substitution is the legal principle of novation, and it is the single reason an anonymous electronic market in leveraged contracts can exist at all.
The clearing corporation does not merely stand in the middle as a formality. It guarantees the financial settlement of every trade in the segment. If your counterparty defaults, the clearing corporation pays you anyway and pursues the defaulter itself.
How it works
The workbook splits the job into three activities: clearing (computing what everybody owes), settlement (actually moving the money and the securities), and risk management (setting position limits against upfront deposits and monitoring positions continuously). The work is done through clearing members and clearing banks.
Clearing starts with open positions. A trading member's open position is his proprietary position plus his clients'. Proprietary positions are netted (buy minus sell) per contract; client positions are not netted against each other — each client's net position is summed separately, so long and short both survive. A clearing member's open position is the aggregate of all the trading members and custodial participants clearing through him.
Eligibility for clearing membership, in the workbook's numbers:
| Requirement | Amount |
|---|---|
| Net worth | Rs 300 lakh |
| Net worth, if clearing only his own deals | Rs 100 lakh |
| Deposit with the clearing corporation (part of the security deposit) | Rs 50 lakh |
| Additional incremental deposit, per extra trading member cleared | Rs 10 lakh |
Since interoperability was introduced under SEBI's 2018 framework, a trade executed on any exchange can be cleared and settled by the clearing corporation of any other. A broker can pick one clearing corporation and keep margins and collateral in one place instead of several.
A worked example
The workbook's clearing example, worked through. Clearing member A clears for two trading members, PQR and XYZ, in the Nifty May contract.
Trading member PQR:
| Buy | Sell | Net | |
|---|---|---|---|
| Proprietary | 5,000 | 3,000 | +2,000 |
| Client 1 | 3,000 | 2,000 | +1,000 |
| Client 2 | 3,000 | 1,000 | +2,000 |
All three are long, so PQR is long 5,000 and short nil.
Trading member XYZ:
| Buy | Sell | Net | |
|---|---|---|---|
| Proprietary | 1,000 | 2,000 | −1,000 |
| Client 1 | 2,000 | 1,000 | +1,000 |
| Client 2 | 3,000 | 4,000 | −1,000 |
Here the signs differ, and they are not allowed to cancel: XYZ is long 1,000 and short 2,000, reported as both.
Clearing member A's open position:
| Member | Long | Short |
|---|---|---|
| PQR | 5,000 | 0 |
| XYZ | 1,000 | 2,000 |
| Total for A | 6,000 | 2,000 |
Not 4,000 net. Six thousand long and two thousand short, carried gross — and margined on that basis. If A were allowed to net them to 4,000, the clearing corporation would be collecting margin on a position that does not exist, while a client on one side defaults and a client on the other does not.
If A clears for those two trading members, his deposit with the clearing corporation is Rs 50 lakh + (2 × Rs 10 lakh) = Rs 70 lakh, against a net worth requirement of Rs 300 lakh.
Why NISM asks about it
Chapter 7 (Introduction to Clearing and Settlement System) opens with the clearing corporation as the central counterparty by novation, then covers clearing members in 7.1, the clearing mechanism in 7.2 and interoperability in 7.3. Expect the novation definition as a direct question, the net-worth and deposit figures as a recall question, and the PQR/XYZ open-position computation as a numerical one — that table has been the pattern for computation questions on this chapter for years.
Common exam traps
- The clearing corporation is not the exchange. The exchange runs the trading platform and matches orders; the clearing corporation clears, settles and guarantees. Separate entities, separate functions.
- Novation is a legal substitution, not insurance. The original contract is replaced by two new ones. The clearing corporation is not paying out on a policy; it is your counterparty.
- Client positions are carried gross, proprietary positions net. Netting a trading member's longs against his clients' shorts is the classic wrong answer to the open-position question.
- Net worth and deposit are different requirements — Rs 300 lakh and Rs 50 lakh — and the Rs 100 lakh figure applies only to a member clearing nothing but his own deals.
- The guarantee covers settlement, not your losses. If the market goes against you, you still pay. The clearing corporation guarantees that the other side pays you.
- Interoperability lets you choose a clearing corporation; it does not abolish the need for one.
Where this is taught
- Series XVI · Chapter 1: Introduction to Commodity Marketsintroduced here
- Series XIX-E · Chapter 1: Investments Landscapeintroduced here
- Series XIX-D · Chapter 1: Investments Landscapeintroduced here
- Series VIII · Chapter 1: Basics of Derivativesintroduced here
- Series II-A · Chapter 14: Secondary Market Transactionsintroduced here
- Series III-A · Chapter 1: Introduction to the Financial Systemintroduced here
- Series VI · Chapter 2: Introduction to Depositoryintroduced here
- Series XIX-C · Chapter 1: Investments Landscapeintroduced here
- Series X-A · Chapter 5: Introduction to Indian Financial Marketsintroduced here
- Series XXI-A · Chapter 5: Derivativesintroduced here
- Series XVI · Chapter 6: Trading Mechanism
- Series VIII · Chapter 7: Clearing, Settlement and Risk Management
- Series VI · Chapter 3: Depository and its business partners
Related terms
- NovationThe clearing corporation stepping into the middle of every trade — becoming the buyer to every seller and the seller to every buyer — so that neither side carries the other's default risk.
- Clearing bankA bank empanelled by the clearing corporation, where every clearing member keeps a dedicated clearing account through which all funds pay-in, pay-out, margin and collateral movements are made.
- InteroperabilityA clearing member choosing one clearing corporation to clear and settle everything it trades, across all exchanges, instead of being tied to a separate clearing corporation per exchange.
- Professional Clearing MemberA clearing member — typically a bank or custodian — who clears and settles trades for other trading members and institutional clients but is not itself a trading member of the exchange.
- Daily Settlement PriceThe price at which every open futures position is marked and reset at the end of each day — the last 30 minutes' volume weighted average price of that contract, computed separately for each expiry.
- Trading cum clearing memberA clearing member who is also a trading member of the exchange, and may clear and settle its own trades, its clients' trades, and the trades of other trading members and custodial participants.
- Settlement Guarantee FundA fund held by the clearing corporation, built from contributions by the exchange, the clearing corporation and clearing members plus a share of settlement penalties, used to complete settlement if a member defaults.
- Central counterpartyThe clearing corporation that interposes itself in every exchange trade, becoming buyer to every seller and seller to every buyer, so neither side carries the other's credit risk.
- OTC derivativeA non-standard derivative contract settled directly between counterparties on mutually agreed terms, relying on trust between them rather than on an exchange and clearing house.
- Request for Quote (RFQ) platformThe exchange platform, launched in early 2020, on which participants seek and respond to quotes to execute and settle trades in debt securities, with an audit trail that brings pre-trade transparency to an OTC market.
- Online Bond Platform ProviderA person operating an online bond platform — an electronic system, other than a stock exchange or EBP, where listed or to-be-listed debt securities are offered and transacted, chiefly for non-institutional investors.
- Position limitsThe maximum open positions the whole market and each trading member or client may hold in interest rate derivatives — set as the higher of a percentage of open interest or a rupee amount, and always specified in lots.
- Clearing member accountThe special demat account a broker or custodian opens to settle exchange trades, through which clients' sold shares go to the clearing corporation and bought shares arrive; also called the pool account.
- Systemic riskThe risk that one participant's default triggers defaults by others until the settlement system itself fails — the domino risk, not the market risk.
- ClearingThe daily accounting step that reconciles what every party owes and is owed on its open and closed positions, and turns a day of trades into one net obligation per member.
- Secondary marketThe market where securities already issued are traded between investors — the money goes to the selling investor, not to the company, and the issuer's capital is unchanged.
- Settlement cycleThe time window, fixed by the exchange, within which securities and funds for a trade must be delivered — T+1 in Indian secondary markets since 27 January 2023, meaning one trading day after the trade.
- Capital marketThe market in which companies and governments raise long-term funds — for periods longer than a year — through shares and bonds, together with the secondary market where those securities later trade.
- Exchange traded derivativeA derivative traded on an organised exchange on standardised terms, with prices set by anonymous auction and performance guaranteed by a clearing corporation — as against a bilateral, customised OTC contract.
- Stock exchange bye-lawsThe rules each stock exchange frames for its own trading members — admission, listing, fees, trading and settlement, members' rights, arbitration — approved by SEBI and consistent with the SCRA, SCRR and SEBI Act.
- Stock exchangeA body of individuals, or a body incorporated under the Companies Act, that assists, regulates or controls the business of buying, selling or dealing in securities.
- CCILThe Clearing Corporation of India Ltd, the central counterparty that guarantees settlement of government securities, repo and OTC interest rate derivative trades by novation.
- Market Infrastructure InstitutionsThe institutions that form the plumbing of the securities market — stock exchanges, depositories and clearing corporations, and under SEBI's cyber framework also KRAs and QRTAs.
- Credit Default SwapA contract in which a protection buyer pays a regular premium to a protection seller, who agrees to pay any loss in value on a specified reference obligation if a credit event such as default occurs.
- Counterparty credit riskThe risk that the other party to an OTC derivative fails before the settlement date. It does not arise in exchange-traded derivatives, where the clearing corporation becomes central counterparty.
- Custodial participantA client allowed to trade through several trading members while clearing and settling through a single clearing member, identified by a unique CP code; its CM must confirm the trades.
- Currency Derivatives SegmentThe separate stock exchange segment where exchange-traded currency futures and options, and interest rate derivatives, are traded — with membership separate from the exchange's other segments.
- RBI-SEBI Standing Technical CommitteeThe joint committee constituted after an RBI-SEBI meeting on 28 February 2008 to coordinate the regulators on exchange-traded currency and interest rate futures; its May 2008 report launched currency futures.
- T+2 rolling settlementThe settlement cycle the booklets teach: trades on day T are settled two working days later, so a Monday trade settles on Wednesday. India has since moved to T+1.
- Securities marketThe market in which securities are issued, purchased by investors and subsequently transferred among investors — the regulated channel that moves household savings to businesses.
- Multilateral nettingThe clearing corporation's method of collapsing every trade a clearing member did in a settlement into one net figure per security and one net funds figure, so each member either pays in or receives a pay-out.
- Default waterfallThe fixed order in which a clearing corporation uses its resources to cover a member default: defaulter's money first, then insurance, its own capital, the Core SGF, and last a haircut to pay-outs.
- Minimum Required CorpusThe minimum size of a segment's Core Settlement Guarantee Fund, reset every month from the previous month's daily stress-test losses and shared among the clearing corporation, exchange and members.
- UPI block facilitySecondary-market trading in which the client's money stays in their own bank account, blocked in favour of the clearing corporation through a UPI single-block-multiple-debit mandate.
- Futures contractA standardised forward traded on an exchange, where the exchange fixes every term except the price and the clearing corporation guarantees settlement, so neither side carries the other's default risk.
- Counterparty riskThe risk of an economic loss because the other party to a contract fails to fulfil its obligation — acute in forwards, and removed for exchange-traded derivatives by the clearing corporation's guarantee.
- Self-clearing memberA trading member who is also a clearing member, but may clear and settle only his own proprietary trades and his own clients' trades — never the trades of other trading members.
- Market Wide Position LimitThe ceiling on total open interest in a stock's futures and options across exchanges — 20% of non-promoter shares. Above 95% no fresh positions are allowed until it falls to 80%.
- Premium marginA margin charged at client level on option buyers equal to the premium they owe the clearing corporation, levied until the premium settlement pay-in is complete.
- L. C. Gupta CommitteeThe 24-member SEBI committee under Dr. L. C. Gupta, set up in November 1996, that designed India's regulatory framework for derivatives and recommended they be declared securities.
- J. R. Varma CommitteeThe SEBI group under Prof J. R. Varma, set up in June 1998, that worked out risk containment for India's derivatives market — margining methodology, membership net worth, deposits and real-time position monitoring.
- Cash componentThe part of a clearing member's collateral deposit held as cash, bank guarantees, fixed deposit receipts, T-bills or dated government securities — as opposed to the non-cash component.
- Non-cash componentThe part of a clearing member's collateral deposit held as approved demat securities and other non-cash forms — capped so it cannot exceed 50% of total liquid assets.
- Daily premium settlementThe daily process that nets each client's option premium payable against receivable and settles the difference through the clearing member's bank account on T+1.
- Risk arrayThe set of scenarios SPAN evaluates to estimate the maximum likely loss a derivative position could suffer over the next trading day, which is what initial margin is sized to cover.
- Standard Operating Procedure (SOP) on defaultSEBI's laid-down sequence of actions for exchanges, clearing corporations and depositories on warning signs of a member default, including settling small investors' credit balances under Rs 25 lakh first.
- Trade Guarantee FundA fund every active exchange member contributes to at inception, used to guarantee settlement of members' bona fide transactions and protect investor interests.
- MarginThe money a buyer or seller must deposit before a trade is allowed to stand, so that the clearing corporation is covered if they fail to bring in funds or to deliver securities.
- Exposure marginA derivatives-segment margin charged as a percentage of the notional value of an open position, on top of initial margin; on options it is collected only from sellers.
- Value at Risk (VaR) marginThe cash-market margin set as a multiple of a stock's volatility and expressed as a percentage of its price, so more volatile shares need a bigger upfront deposit; rates update at least five times a day.
- Bad deliverySecurities that are delivered for settlement but rejected by the depository for technical reasons such as incorrect signatures, names or details — treated like a short delivery and closed out through auction.
- Short deliveryA member's failure to pay in securities, fully or partly, on the settlement day — closed out at the shares' last closing price and made good by the clearing corporation through an auction.