Novation
The legal substitution by which a clearing corporation replaces the original trade with two new contracts, becoming counterparty to both sides.
How it is identified
Test: one bilateral contract is replaced by two contracts, each with the clearing corporation as the opposite party
Unit
qualitative
In depth
Novation is the mechanism behind the settlement guarantee: after it, the buyer's contract is with the clearing corporation and so is the seller's, and the two original parties have no relationship at all. This is what allows anonymous trading — you can transact with a stranger of unknown creditworthiness without taking any credit risk on them. It also concentrates risk in the clearing corporation, which is why its margin regime and default fund are so heavily regulated. Novation is often confused with netting; netting reduces the number of transfers, novation changes who owes whom.
Worked example
A buys from B. After novation there are two contracts: A with the clearing corporation, and the clearing corporation with B. If B defaults, the corporation still delivers to A and pursues B separately. A never had a claim on B at all.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Novation” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.