To ensure a clearinghouse can survive a default by a major trading participant without requiring a public bailout, central banks mandate a strict risk management framework known as the Default Waterfall.
The Sequential Default Waterfall
When a member defaults, the clearinghouse absorbs the resulting losses using pre-funded resources in a strict, sequential order:
[1. Defaulting Member's Margin] ---> [2. Defaulting Member's Contribution] ---> [3. CCP Skin-in-the-Game]
                                                                                          |
                                                                                          v
[Close System Out / Tear Trades] <--- [5. Non-Defaulting Members' Pools] <---- [4. Pre-funded Default Fund]

By exhausting pre-funded margins, clearinghouse equity, and shared mutual default funds before imposing losses on non-defaulting participants, this structured waterfall isolates the impact of a market failure and protects the wider financial system.
 
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