Cleared vs. Bilateral Swap Structures
advancedPublished: 2026-01-01
Cleared vs. Bilateral Swap Structures
Cleared swaps use a central counterparty (CCP) to guarantee performance, while bilateral swaps remain direct obligations between the original counterparties. The choice between structures affects margin requirements, counterparty risk, operational complexity, and regulatory capital treatment.
Definition and Key Concepts
Structural Comparison
| Aspect | Cleared | Bilateral |
|---|---|---|
| Counterparty | CCP (via clearing member) | Original dealer/counterparty |
| Credit risk | CCP guarantee | Direct counterparty risk |
| Margin | IM + VM daily | VM (+ IM for covered entities) |
| Netting | Multilateral across CCP | Bilateral per counterparty |
| Default management | CCP waterfall | ISDA close-out |
| Documentation | CCP rulebook | ISDA Master + CSA |
Clearing Mandate
Products subject to mandatory clearing (US):
- USD, EUR, GBP, JPY interest rate swaps (standard tenors)
- CDX and iTraxx credit indices
Exempt from clearing:
- End-users hedging commercial risk
- Small financial entities below thresholds
- Non-standard/bespoke products
Major CCPs
| CCP | Location | Products |
|---|---|---|
| LCH SwapClear | UK/US | Interest rate swaps |
| CME Clearing | US | Rates, credit, FX |
| ICE Clear Credit | US | CDS, credit indices |
| Eurex Clearing | Germany | Euro rates, equity derivatives |
| JSCC | Japan | Yen rates, CDS |
How It Works in Practice
Cleared Swap Workflow
Trade execution to clearing:
| Step | Timing | Activity |
|---|---|---|
| 1 | T+0 | Trade executed on SEF or bilaterally |
| 2 | T+0 | Trade submitted to CCP via clearing broker |
| 3 | T+0 | CCP validates and accepts trade |
| 4 | T+0 | Trade novated: CCP becomes counterparty to both sides |
| 5 | T+0 | Initial margin calculated and called |
| 6 | T+1 | Initial margin posted |
| 7 | Daily | Variation margin exchanged |
Novation effect: Original trade (A ↔ B) becomes two trades:
- A ↔ CCP
- CCP ↔ B
Bilateral Swap Workflow
| Step | Timing | Activity |
|---|---|---|
| 1 | T+0 | Trade negotiated and agreed |
| 2 | T+0 | Confirmation exchanged |
| 3 | T+0 | Trade reported to SDR |
| 4 | T+1 | Portfolio reconciliation |
| 5 | Daily | Variation margin exchanged (under CSA) |
| 6 | Periodic | Initial margin exchanged (if covered) |
Margin Comparison
Cleared margin (example: $100M 5Y IRS):
| Component | Amount | Timing |
|---|---|---|
| Initial margin | $2.0 million | T+1, held at CCP |
| Variation margin | MTM-based | Daily, cash |
| Default fund contribution | $0.5 million | Ongoing |
Bilateral margin (same trade, covered entities):
| Component | Amount | Timing |
|---|---|---|
| Initial margin (SIMM) | $2.5 million | Each party posts, segregated |
| Variation margin | MTM-based | Daily, cash |
Key difference: Cleared IM is held at CCP; bilateral IM requires third-party segregation.
Worked Example
Trade details:
- Product: 10-year USD interest rate swap
- Notional: $200 million
- Party A: Hedge fund (receives fixed)
- Party B: Bank (pays fixed)
Cleared Execution
Clearing path:
- Trade executed at 4.50% fixed
- Submitted to LCH SwapClear
- Both parties post IM (~$8 million each)
- Daily VM based on rate moves
After 3 months (rates rise 50 bps):
- MTM: Party A gains ~$8.5 million
- VM: Party B (via clearing broker) posts $8.5 million to LCH
- LCH passes VM to Party A (via their clearing broker)
Counterparty risk: Party A's exposure is to LCH, not Party B. LCH guarantee backed by:
- Party B's margin
- Party B's clearing broker guarantee
- CCP default fund
- CCP capital
Bilateral Execution
Documentation:
- ISDA Master Agreement between A and B
- Credit Support Annex (IM and VM)
- IM segregation at custodian
After 3 months (same scenario):
- MTM: Party A gains $8.5 million
- VM: Party B posts $8.5 million directly to Party A
- IM: Both parties maintain segregated IM at custodian
Counterparty risk: Party A has direct exposure to Party B. Protection from:
- IM held at custodian
- VM held directly
- Netting across ISDA relationship
Cost Comparison
| Cost Element | Cleared | Bilateral |
|---|---|---|
| Clearing fees | 0.5 bps on notional | None |
| FCM fees | 2-5 bps annual | None |
| IM funding cost | ~4.5% on $8M | ~4.5% on $5M (SIMM) |
| Custodian fees | CCP holds | 5-15 bps on IM |
| Operational cost | Lower (standardized) | Higher (bespoke) |
Annual cost estimate ($200M notional):
| Component | Cleared | Bilateral |
|---|---|---|
| Clearing/FCM | $30,000 | $0 |
| IM funding | $360,000 | $225,000 |
| Custody | $0 | $7,500 |
| Total | $390,000 | $232,500 |
Bilateral appears cheaper but ignores counterparty risk cost.
Risks, Limitations, and Tradeoffs
Counterparty Risk
| Scenario | Cleared Impact | Bilateral Impact |
|---|---|---|
| Counterparty default | CCP manages; minimal loss | Close-out; potential loss |
| CCP default | Rare but systemic | N/A |
| Clearing broker default | Porting to new broker | N/A |
Netting Efficiency
Cleared:
- Multilateral netting across all participants
- Reduces gross exposure significantly
- Compression services available
Bilateral:
- Netting only within each ISDA relationship
- Multiple counterparties = multiple exposures
- Portfolio compression harder to achieve
Regulatory Capital
| Treatment | Cleared | Bilateral |
|---|---|---|
| Risk weight (bank) | 2% (qualifying CCP) | 20-150% (depending on counterparty) |
| Exposure calculation | Simpler (CCP guarantee) | Full SA-CCR calculation |
| Capital efficiency | Higher | Lower |
Banks strongly prefer cleared swaps for capital efficiency.
Flexibility vs. Standardization
| Factor | Cleared | Bilateral |
|---|---|---|
| Product customization | Limited to CCP-eligible | Fully bespoke |
| Tenor flexibility | Standard tenors | Any tenor |
| Embedded features | Not supported | Any feature |
| Amendment | Requires novation | Bilateral agreement |
Common Pitfalls
| Pitfall | Description | Prevention |
|---|---|---|
| Clearing rejection | Trade fails CCP validation | Pre-validate terms before execution |
| Margin call timing | Missed intraday calls | Maintain excess margin buffer |
| Porting failure | Cannot move positions if FCM defaults | Maintain backup FCM relationships |
| Documentation gaps | Missing clearing addendum | Complete documentation before trading |
Decision Framework
When to clear:
- Product is clearing-eligible and liquid
- Counterparty credit is a concern
- Regulatory capital optimization needed
- Netting benefits available
When to stay bilateral:
- Bespoke/non-standard product
- End-user exemption available
- Limited clearing infrastructure
- Relationship and flexibility valued
Checklist and Next Steps
Clearing setup checklist:
- Establish FCM relationship
- Execute clearing documentation
- Fund initial margin accounts
- Test connectivity to CCP
- Configure trade submission workflow
- Verify margin call procedures
- Establish backup FCM arrangement
Bilateral setup checklist:
- Execute ISDA Master Agreement
- Negotiate CSA (VM and IM if applicable)
- Establish custodian for IM segregation
- Implement portfolio reconciliation
- Configure margin call workflow
- Document credit limits
Related articles:
- For SEF execution, see Swap Execution Facilities (SEFs)
- For portfolio optimization, see Compression and Portfolio Tear-Ups