Companion·Question

What are the layers of a CCP default waterfall, and in what order are they used?

Codex No. 1 · Derivatives Clearing: A Comprehensive Guide

A default waterfall is the order in which a CCP absorbs the losses left by a clearing participant that has failed. It runs outward from the defaulter. First that participant’s own initial margin, then its contribution to the default fund, then the CCP’s own capital — its skin in the game — then the default fund contributions of the surviving participants, then additional assessments called from them, and finally the measures of last resort.

The order is stable. The count is not. The same sequence is described as three steps, or four, or five, or six, depending on how finely it is cut and whose framework is being described. What matters when a default is actually running is the direction: the defaulter pays first, and the CCP commits its own money before anyone else’s mutual resources are touched.

Drawn from a book written from the clearing broker's side of the trade, for the people who run it — operations, risk, treasury and collateral, at brokers and on the buy side alike.

The order

JSCC’s own framework sets out the same direction and ends on variation margin haircutting: the amount needed is deducted from the gains of the participants whose daily mark-to-market is positive, as the final stage of loss allocation.

The MapWhose money, in what order

The gold step is the CCP’s own money. The dashed steps are conditional: they are reached only if the ones above are exhausted.

Where the auction sits

The default auction is not one of the steps. It is the procedure that fixes the number. A CCP assembles the defaulted positions into packages and puts them to competitive bidding among the surviving participants; the loss that remains once that is done is what the waterfall then absorbs. The 2018 default at Nasdaq Clearing is the worked example in the book: the auction ran, the final loss from liquidating the positions was determined, and only then was the waterfall activated.

Clients are moved out before it runs

A client’s margin is not one of the layers. Client positions and the margin behind them are ported to surviving participants as a first priority, ahead of the waterfall being applied, and the collateral behind them is legally segregated from the CCP’s own assets and from those of other participants. The waterfall is a mechanism for losses among participants; clients are meant to have left the building by the time it starts.

Which segregation model decides whether they can leave →

Skin in the game is still an argument

How much of its own capital a CCP should put at risk has been contested since 2008, and the book treats it as unsettled rather than solved — closer to a philosophical controversy than a search for a technically optimal number. The prevailing view has moved toward a risk-based one: the right level follows from each CCP’s own risk profile and business model rather than a single standard. The academic work it cites — Ghamami (2023), Capponi and Cheng (2021) — makes a single optimum hard to pin down.

What it looks like with real numbers

Through the market stress of March 2020, JSCC held initial margin of over roughly JPY 1.5 trillion — a structure in which risk is absorbed at the upper steps, before anything mutual is reached. That is what an adequately funded waterfall looks like from the outside: the lower steps never come into view.

How client clearing works in Japan →

Where the book takes this further

Chapter 5, Section 4

JSCC’s default management framework in full: porting first, then the waterfall, then the auction, with the annual fire drills that rehearse all of it.

Chapter 5, Section 5

The three lines of defence set side by side — the CCP’s, the clearing participant’s, and the clearing broker’s.

Chapter 5, Columns R and S

How much of its own money a CCP should put at risk, and whether a CCP can fail at all — recovery, resolution, and the tools at the bottom of the waterfall.

Chapter 3, Column J

The 2018 Nasdaq Clearing default, followed through from the auction to the loss the waterfall had to absorb.

What is in each chapter →

The Book

Written by Shun Yanagisawa — Director, Head of Futures, Clearing and FX Prime Brokerage, Markets Sales at Citigroup Global Markets Japan Inc. He is a Representative Director and Vice President of FIA Japan and the Chair of its Operations Committee, and sits on the JSCC Interest Rate Swap Steering Committee and the advisory board of Asia Risk.