Novation

Indent Layer does not pass the trade along. It replaces it.

A matched trade between A and B is discharged and two new obligations are written in its place: A owes Indent Layer, and Indent Layer owes B. The original bilateral link is gone.

Why it matters

Before novation each participant has to answer a question about every counterparty it touches: can this one pay. That question is expensive, it does not scale across venues, and it is the reason bilateral markets stay small and clubby.

After novation the question is asked once, about one counterparty, and that counterparty is collateralised and continuously provable.

You are no longer trading with a stranger. You are trading with collateral.

Consequences

• Anonymity between participants becomes safe. Neither side needs to know who is on the other end, because neither side is exposed to the other.
• Venues become interchangeable. An obligation from venue X and an obligation from venue Y are the same instrument once novated, so they can net against each other.
• Risk concentrates on purpose. All exposure lands on one balance sheet. That is the point, and it is why the collateral rules and the waterfall are strict.

What has to be true for it to work

1. The clearing entity is over-collateralised at all times, not on average.
2. Position limits bind before an obligation is accepted, not after.
3. The order of loss absorption is fixed in advance and not subject to discretion.