14. What is the Role of a Clearing House in Futures Trading?
Introduction: Why Do We Need a Clearing House?
Futures trading is a contract between a buyer and seller to transact in the future. But what if one party fails to honour their promise?
This is where the Clearing House comes in — the invisible engine ensuring that futures markets run safely, smoothly, and without default risks.
What is a Clearing House?
A Clearing House (or Clearing Corporation) is a central institution that:
Acts as guarantor for all futures trades
Becomes counterparty to both buyer and seller (via novation)
Manages margins & settlements
Eliminates counterparty risk
In India:
NSE → NSE Clearing Ltd. (NCL)
BSE → Indian Clearing Corporation Ltd. (ICCL)
Core Functions of a Clearing House
Function
Description
Novation
Becomes counterparty to both buyer & seller
Margin Management
Collects Initial Margin & MTM to cover risks
Settlement
Handles daily & final settlements of contracts
Counterparty Guarantee
Eliminates risk of default
Netting of Positions
Reduces exposure by calculating net obligations
Position Monitoring
Ensures no trader takes excessive risk
Regulatory Compliance
Ensures all trades follow SEBI & exchange rules
How Does a Clearing House Work?
Step-by-Step Flowchart
Trader A wants to Buy and Trader B wants to Sell a futures contract
The trade is matched on the Exchange
Clearing House steps in
Buyer thinks they bought from the Clearing House
Seller thinks they sold to the Clearing House
Clearing House collects margins from both traders
Daily MTM settlement adjusts accounts
On expiry: contract settled (cash or delivery) via Clearing House
Real-World Example
You Buy Nifty Futures at ₹22,000
Another trader Sells Nifty Futures at ₹22,000
If the seller defaults before expiry:
Without Clearing House → You lose money due to counterparty default.
With Clearing House → Clearing House pays you using the seller’s margin or default fund.
Your trade is 100% protected.
Margins Collected by Clearing House
Margin Type
Purpose
Initial Margin
Upfront collateral to open a position
Exposure Margin
Covers market volatility risk
MTM (Mark-to-Market)
Settled daily based on price movements
Additional Margin
Extra buffer in case of extreme volatility
Why Is It Important?
Without Clearing House
With Clearing House
Risk of default
Counterparty risk eliminated
Trust-dependent trades
Guaranteed by exchange infrastructure
Manual risk monitoring
Automated & real-time tracking
Complex settlement
Smooth & standardized process
Global Examples
Country
Exchange
Clearing House
India
NSE, BSE
NCL, ICCL
USA
CME, ICE
CME Clearing, ICE Clear
Europe
Euronext, Eurex
LCH.Clearnet, Eurex Clearing
Japan
JPX
Japan Securities Clearing Corporation
Bonus Concept: Default Fund
A Default Fund is a backup reserve maintained by the Clearing House.
Used when margin is insufficient
Ensures zero disruption in the market even if large defaults occur
Key Takeaways
The Clearing House is the backbone of the futures market.
It ensures safe, reliable, and risk-free trading.
Margins, novation, and settlement systems protect traders from defaults.
Without clearing houses, futures markets would be chaotic & unsafe.