A central clearing house, or central counterparty (CCP), interposes itself between the two sides of a trade, becoming buyer to every seller and seller to every buyer. It nets exposures, collects margin, and mutualises default risk so the failure of one member does not cascade across the market.
Through novation, a bilateral trade is split into two contracts each facing the CCP, which guarantees performance. The CCP protects itself with a default waterfall: initial margin and variation margin from each member, a mutualised default fund, and the CCP's own capital ("skin in the game"). Multilateral netting compresses gross exposures, reducing the total collateral and balance-sheet capacity the market must hold.
The SEC's 2023 mandate to centrally clear most US Treasury cash and repo trades — phased in through 2025–2026 — is the largest structural change to the world's deepest market in a generation, aimed at the dealer-balance-sheet bottlenecks exposed in the March 2020 dash-for-cash. The transition concentrates risk in CCPs even as it reduces bilateral counterparty exposure.
In March 2020, Treasury market dysfunction forced the Fed to buy roughly $1 trillion of Treasuries to restore function, exposing how thin dealer intermediation had become. In response, the SEC adopted rules in December 2023 requiring eligible Treasury cash trades to be centrally cleared (compliance phased to December 2025) and repo trades (June 2026), routing flow largely through the Fixed Income Clearing Corporation (FICC), the dominant US Treasury CCP.
Default waterfall order: defaulter's initial margin → defaulter's default-fund contribution → CCP "skin in the game" → surviving members' mutualised default fund.