How do cleared derivatives differ from OTC derivatives?
As mentioned above, OTC derivatives are booked bilaterally between the counterparties while cleared derivatives are booked with a clearing house. OTC derivatives counterparties therefore assume credit exposure, known as counterparty credit risk, to each other while cleared derivatives counterparties are exposed to credit risk of the clearing house. Second, cleared derivatives always involve the posting of margin to the clearing house by the parties to a trade, while margining by OTC derivatives counterparties is subject to negotiation by the parties. Finally, the terms of OTC derivatives can be customized to fit the needs of the contracting parties. The terms of cleared derivatives, in contrast, involve a high degree of standardization The reason for standardization of cleared derivatives is to facilitate the computation of required margin amounts.
