Basis risk: the risk of changes in the basis, that is, the difference between the price of a futures or forward contract and the price of the underlying asset.

Cash clearing: a method for clearing futures contracts in which positions are periodically marked to market and the resulting obligations are satisfied by cash payments, known as variation margin. See non­cash clearing and variation margin.

Central counterparty: an entity that is the buyer to every seller and seller to every buyer of a specified set of contracts, for example those executed on a particular exchange or exchanges.

Clearing link: an arrangement in which the same contract is traded on exchanges affiliated with two clearing houses but all positions are transferred daily to a single clearing house where they are carried until expiration or offset. See mutual offset system.

Clearing house: a department of an exchange or a separate legal entity that provides a range of services related to the clearance and settlement of trades on the exchange and the management of risks associated with the resulting contracts. A clearing house is often central counterparty to all trades on the exchange, that is, the buyer to every seller and the seller to every buyer.

Clearing member: a member of a clearing house. All trades must be settled through a clearing member. A direct clearing member is able to settle only its own obligations. A general clearing member is able to settle its own obligations as well as those of clients. Variations of these two types of clearing member may also exist.

Client: a party that is not a member of the clearing house and must settle through a clearing member. Also known as customer.

Close-out: the process of offsetting existing contracts. Close-out may be used by the clearing house to prevent further losses from positions carried by an entity that has defaulted.

Credit risk: the risk that a counterparty (such as a clearing member) will not settle an obligation for full value, either when due or at any time thereafter. Credit risk includes replacement cost risk and principal risk.

Custody risk: the risk of loss of securities held in custody occasioned by the insolvency, negligence or fraudulent action of the custodian or of a sub-custodian.

Default: failure to satisfy an obligation on time. More generally, a clearing house may declare a member in default in a variety of circumstances, including failure to satisfy obligations on time, insolvency, suspension of trading privileges on an exchange for which the clearing house provides services, or other events that the clearing house deems to have had a material adverse effect on the member's capacity to meet its obligations.

Deferred net settlement system: a system that effects the settlement of obligations or transfers between or among counterparties on a net basis at one or more discrete, pre-specified settlement times during the processing day.

Delivery versus payment: a link between a securities transfer system and a funds transfer system that ensures that delivery occurs if, and only if, payment occurs.

Derivative: an instrument whose value is determined by the value of an underlying asset.

Endogenous default: a default by a clearing member that results from losses on house or client positions carried by the clearing member at the clearing house rather than from losses from some other (exogenous) source.

Exchange member: a member of an exchange with certain trading privileges. An exchange member may not necessarily be a member of the exchange's clearing house.

Final: irrevocable and unconditional.

Forward contract: a contract that obligates one party to buy, and the other to sell, an underlying asset at a specific price and date in the future.

Futures contract: a standardised forward contract traded on an exchange.

Futures-style margining: a method of margining derivatives contracts in which positions are marked to market and current exposures are extinguished through cash payments known as variation margin. When options contracts are margined using a futures-style system, the option premium is gradually paid over the life of the option (through the cumulative variation margin payments) and fully paid once the option has been exercised. See options-style margining.

Gross margining: margining system in which the clearing member is required to deposit with the clearing house sufficient initial margin to cover the gross positions of its clients. See net margining.

Haircut: the difference between the market value of a security and its collateral value. The haircut is intended to protect a lender of funds or securities from losses owing to declines in collateral values.

Initial margin: cash or collateral that is deposited with the clearing house to ensure performance on obligations to it. Also known as performance bond and original margin.

Legal risk: the risk of loss because of the unexpected application of a law or regulation or because a contract cannot be enforced.

Liquidity risk: the risk that a counterparty (such as a clearing member) will not settle an obligation for full value when due. Liquidity risk does not imply that a clearing member is insolvent since it may be able to settle its obligations at some unspecified time thereafter.

Margin: see initial margin and variation margin.

Market risk: the risk of losses in on and off-balance-sheet positions arising from movements in market prices.

Marking to market: the revaluation of open positions in financial instruments at current market prices and the calculation of any gains or losses that have occurred since the last valuation. See futures-style margining, options-style margining and variation margin.

Mutual offset system: a link between clearing houses in which positions entered into on one exchange can be, but need not be, transferred to the clearing house of another exchange and vice versa. See clearing link.

Net margining: margining system in which the clearing member is required to deposit with the clearing house sufficient initial margin to cover the net positions of its clients. Clients, however, are typically still obligated to deposit with the clearing member initial margin to cover their own positions. See gross margining.

Non-cash clearing: a method for clearing futures contracts in which positions are periodically marked to market and the resulting obligations are collateralised. See cash clearing.

Omnibus account: a single account for the commingled funds or positions of multiple parties. A clearing member will often maintain an omnibus account at the clearing house for all of its clients. In this case, the clearing member is responsible for maintaining account records for individual clients.

Open-outcry trading: trading that is conducted on the floor of an exchange without any electronic intermediation. See screen-based trading.

Operational risk: the risk of human error or a breakdown of some component of the hardware, software or communications systems that are critical to settlement.

Option contract: a contract that gives the buyer the right, but not the obligation, to either buy or sell an underlying asset, depending on the type of option, by a certain date for a certain price. For this right, the buyer pays the seller a "premium".

Options-style margining: a method of margining derivatives contracts in which positions are marked to market and current exposures are collateralised. When an option contract is margined using such a system, the buyer of the option pays the premium in full at the time of the purchase. The seller of the option receives the premium and collateralises current exposures as they occur. See futures-style margining.

Over the counter: a method of trading that does not involve an exchange. In over-the-counter markets, participants trade directly with each other, typically through telephone or computer links.

Position limit: a restriction on the number of contracts or share of a contract's open interest that a single entity may hold.

Principal risk (or delivery risk): the risk that the seller of a security delivers a security but does not receive payment or that the buyer of a security makes payment but does not receive delivery. In this event, the full principal value of the securities or funds transferred is at risk. See also credit risk.

Principal-to-principal relationship: a contractual relationship in which both parties are acting on their own behalf and are responsible for the performance of any contractual obligations.

Proprietary positions: positions held by a participant on its own behalf (as opposed to positions held for clients).

Real-time gross settlement (RTGS): the continuous settlement of funds or securities transfers individually on an order-by-order basis.

Replacement cost risk: the risk that a counterparty to an outstanding transaction for completion at a future date will fail to perform on the settlement date. The resulting exposure is the cost of replacing, at current market prices, the original transaction. See credit risk.

Screen-based trading: trading conducted through a network of electronic terminals. See open-outcry trading.

Segregation: a method of protecting client assets and positions by holding or accounting for them separately from those of the carrying firm or broker.

Settlement bank: either a central bank or a private bank used to effect money settlements.

Stress testing: the estimation of credit and liquidity exposures that would result from the realisation of extreme price changes.

Substitution: the substitution of one party for another in respect of an obligation. In the context of a futures or options clearing house, the term usually refers to the interposition of the clearing house as buyer to the seller of a contract and seller to the buyer.

Systemic risk: the risk that the failure of one participant in a payment or settlement system, or in financial markets generally, to meet its required obligations when due will cause other participants or financial institutions to be unable to meet their obligations (including settlement obligations in a transfer system) when due. Such a failure may cause significant liquidity or credit problems and, as a result, might threaten the stability of financial markets.

Trade matching: the process of matching trade details (such as number of contracts, contract month and price) submitted by the trade counterparties. The clearing house often guarantees a trade at the time it is successfully matched.

Trade registration: the process by which matched trades are formally recorded on the books of the clearing house. For clearing houses that act as central counterparties, registration may also be the time at which the clearing house substitutes itself as counterparty to the clearing members.

Unwinding (or settlement unwind): a procedure followed in certain payment and settlement systems in which transfers of securities or funds are settled on a net basis, at the end of the processing cycle, with all transfers provisional until all participants have discharged their settlement obligations. If a participant fails to settle, some or all of the provisional transfers involving that participant are deleted from the system and the settlement obligations from the remaining transfers are then recalculated.

Value at risk: an estimate of the upper bound on losses an institution would expect to incur during a given period (for example, one day) for a given confidence level (for example, 95%).

Variation margin: funds that are paid to (or received from) a counterparty (clearing house or clearing member) to settle any losses (gains) that are implied by marking open positions to market. In some markets the term is also used to describe the transfer of collateral to (from) a counterparty to cover an initial margin deficit (surplus) in a non-cash clearing or options-style margining system.

Zero-hour rule: a provision in the insolvency law of some countries whereby the transactions of a closed institution that have taken place after 00:00 on the date the institution is ordered closed may be retroactively rendered ineffective