"Centralized clearing"-it's the phrase used to describe the requirement that financial firms clear their trades in standardized over-the-counter derivatives contracts through a clearinghouse that can guarantee completion of the transaction, rather than entering transactions directly with each other.

On the surface, it sounds like a great idea. After all, it is supposed to mitigate counterparty risk by shifting the burden of making sure each party can fulfill its financial end of the bargain. The centralized clearinghouse takes on the risks of being the counterparty in the middle to each side of the transaction. This is designed to eliminate the impact of one side going unexpectedly out of business, leaving the other party holding the bag.

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