Clearing for Securities or Derivatives
What clearing does
Clearing is the post-trade layer: trade capture and matching, novation, netting, margining, settlement and default management. The exam tests the clearing house's legal role, who may be a participant, and how risk is mutualised.
- In Malaysia, Bursa Malaysia Securities Clearing handles securities and Bursa Malaysia Derivatives Clearing handles derivatives; both are approved clearing houses under the CMSA.
- By novation the clearing house becomes buyer to every seller and seller to every buyer, replacing bilateral counterparty risk with exposure to the clearing house.
- Only clearing participants clear directly; other intermediaries and their clients clear through a participant, which remains responsible to the clearing house for their obligations. Admission requires capital, operational capability, margining arrangements and a default fund contribution.
- Securities settlement is delivery-versus-payment by book entry in the Central Depository System; settlement is final and irrevocable once effected, and listed securities exist only as electronic entries.
- Derivatives clearing runs daily mark-to-market with variation margin, plus initial margin against potential future exposure, with position limits and intraday risk monitoring.
- Default waterfall: the defaulter's own margin and default fund contribution, then the mutual default fund, then the clearing house's own resources, with assessment powers over surviving participants.
Worked example
Participant A buys contracts from Participant B, and the clearing house novates, so A and B each face the clearing house. A fails to pay a variation margin call and is declared in default. The clearing house closes out A's positions, applies A's collateral, then draws on the default fund, and keeps meeting its obligations to B. B is unaffected by A's failure - clearing protects against counterparty default, not against market losses on B's own position.
Traps
- Believing the clearing house insures investors against poor investment decisions.
- Confusing the depository (which holds securities) with the clearing house (which settles trades).
- Assuming a dealing licence makes the firm a clearing participant.