Where did central clearing originate? Distant history suggests that rice traders in China in 1730 began using a central administrative service to handle the settlement of rice trades. Users of the service paid up front amounts similar to margin to guarantee settlement.
In the 1800s the Chicago Butter and Egg Board facilitating trading in the US which evolved to become the Chicago Mercantile Exchange (the CME) that we know now. Central clearing became an integral part of an exchange as shown in this diagram.
In the modern exchange model the roles are these:
- Some firms join the exchange as direct members, shown here on the right as the Counterparty
- Some firms access the exchange via brokers, shown here on the left as a Fund
- The Fund uses an Executing Broker to put on trades at the Exchange
- Immediately after trades are executed, they are novated into the Clearing House. This means the Clearing House now sits legally between the Fund and its Counterparty
- The Fund uses a Clearing Broker to handle the clearing process including payments to and from the Clearing House
Until 1999 clearing was exclusively used for exchange traded business, meaning trades executed on an exchange. In 1999 the London Clearing House (LCH) launched SwapClear, the first service to accept trades executed bilaterally (OTC), and then presented to the clearing house for novation. Since 1999 SwapClear has become the biggest pool of cleared business in the world, by far.
CCP Open Interest in Millions of USD
- CRD = Credit Derivatives
- FXD = FX Derivatives
- IRD = Interest Rate Derivatives
This chart from September 2017 shows in millions of USD how large clearing has become. For example LCH SwapClear was holding USD 157 trillion of notional in OTC products, largely Interest Rate Swaps. As you can see the number of clearing houses now accepting OTC products has exploded since 1999.