Contracting innovations and the evolution of clearing and settlement methods at futures exchanges

Defining futures contracts as substitutes for associated cash transactions enables a discussion of the evolution of controls over contract nonperformance risk. These controls are incorporated into exchange methods for clearing contracts. Three clearing methods are discussed: direct, ringing and complete. The incidence and operation of each are described. Direct-clearing systems feature bilateral contracts with terms specified by the counterparties to the contract. Exchanges relying on direct clearing system chiefly serve as mediators in trade disputes. Ringing is shown to facilitate contract offset by increasing the number of potential counterparties. Ringing settlements reduce counterparty credit risk by reducing the accumulation of dependencies as contracts are offset. Ringing settlements also lower the cost of maintaining open contract positions, chiefly by lowering the amount or required margin deposits. Exchanges employing ringing methods generally adopted a clearinghouse to handle payments. Complete clearing interposes the clearinghouse as counterparty to every contract. This measure ensures that contracts are fungible with respect to both the underlying commodity and counterparty risk.