Following post-crisis reforms, financial regulations require standardized over-the-counter derivatives to clear through Central Counterparties (CCPs). [1]

A CCP reduces systemic risk by acting as an intermediary between trading counterparties through a process called Novation. This legal step breaks the direct contract between the original buyer and seller, inserting the CCP into the middle of the trade: [1, 2, 3, 4, 5]

[Original Buyer] <--- Direct Counterparty Trade ---> [Original Seller]
                               |
                               v (The Novation Process)
                               v
[Original Buyer] <---> [Central Counterparty (CCP)] <---> [Original Seller]

Following novation, the CCP becomes the buyer to every seller and the seller to every buyer. This centralization reduces counterparty credit risk through automated netting, but concentrates systemic risk within the clearinghouse itself, requiring strict central bank regulation. [1]