Because of its role in fostering a sound financial system, the Federal Reserve Bank of Chicago has taken a keen interest in clearing and settlement systems for derivatives products, in particular, the risk-management, banking and payment systems that support such clearing and settlement systems. The Seventh Federal Reserve District is home to over half a dozen exchanges and four systemically significant clearing organizations, or central counterparties (CCPs). As these markets have grown, their potential systemic implications for the nation’s financial system have similarly increased. Previous Chicago Fed Letter articles have explained the concepts of clearing and settlement in general, and the settlement of foreign exchange contracts in particular. This Chicago Fed Letter expands upon the general clearing theme, discussing specifically how derivatives CCPs’ margining and settlement systems work and how they affect payment and settlement systems and foster public confidence in organized markets and the financial system in general.
Derivatives are a class of financial instruments that derive their value from some underlying commodity, security, index, or other asset. Futures and options are common forms of derivatives. This article explains how clearing and settlement systems for exchange traded derivatives work.