A derivative that requires the out-of-the-money counterparty (the counterparty holding the out-of-the-money position) to periodically transfer an amount of variation margin equal to the cumulative change in the fair value of the underlying asset of the derivative contract to the in-the-money counterparty (the counterparty holding the in-the-money position).

Centrally-cleared derivatives are bilaterally negotiated over the counter (OTC)- i.e., between the counterparties involved in the transaction. However, these derivatives are also subject to a set of standardized terms and are traded through a central clearinghouse. The standardized terms are used to facilitate the computation of any required margin (margin requirements) by the clearinghouse.

Requirements for initial margin are determined by the clearinghouse irrespective of the quality (credit quality) of the counterparty posting the margin. Over time, variation margin undergoes daily movement, reflecting the market conditions and the state of affairs relating to the transaction.

Centrally-cleared derivatives can be structured and documented as “collateralized-to-market” (CTM derivatives) or “settled-to-market” (STM derivatives). These two types of derivatives differ depending on the mechanism used to limit or settle counterparty credit risk and the characterization of variation margin payments.