Clearing House | B2B Finance Glossary
What is a Clearing House?
A clearing house operates as the intermediary between buyers and sellers in a financial market; namely, they facilitate the exchange of payments, derivatives, and securities. Clearing houses – whether they are designated clearing houses or internal clearing divisions – are essential components of any financial market because they are designed to verify and finalize transactions and make sure that buyers and sellers are honoring their obligations to one another. By acting as an intermediary, a clearing house brings both security and efficiency to financial markets, therefore enabling market stability and reducing risk for counterparties.
How Does a Clearing House Work?
Clearing houses are used for both payments and trades.
In trading, a clearing house comes into play after a buyer and seller execute a trade. The clearing house will “clear” or finalize the trade, settle trading accounts, collect margin payments, facilitate the physical delivery of assets, and report data on the trade itself.
The clearing house takes the opposite position of each trade to reduce both the cost and risk of settling many different transactions between multiple buyers and sellers. To reduce risk, the clearing house enforces margin requirements.
- Clearing houses for futures trading. Futures trading typically involves trading with leverage – ie, borrowing money to make an investment. This process means that a clearing house is essential since a stable intermediary is needed to facilitate the borrowing of money; in fact, the futures market is most commonly associated with clearing houses. Each futures exchange has its clearinghouse, and every exchange member must clear their trades through this intermediary.
- Clearing houses for the stock market. Major stock exchanges have clearing divisions that function as intermediaries by facilitating seamless transfers of stocks and ensuring that a stock trader has the amount of money needed in his or her account to fund the trade being placed. Clearing houses also ensure that the money is being delivered from an investor selling his or her stock shares.
- Clearing houses for payments. The Automated Clearing House (ACH) is an electronic funds-transfer system that facilitates payments among over 10,000 financial institutions in the US. This clearing house is run by NACHA, a non-profit association funded by US financial institutions. The Automated Clearing House is the intermediary for direct deposit payments and other types of electronic payments.
What are Examples of Clearing Houses?
In addition to the Automated Clearing House, the New York Stock Exchange (NYSE) is one of the most well-known clearing houses in the US. The NYSE acts as the middleman for trades across stocks, bonds, mutual funds, derivatives, and exchange-traded funds (ETFs) by allowing brokers and investors to buy and sell securities to people who match the highest bidding price to the lowest selling price.
The Options Clearing Corporation (OCC) is a clearing house that specifically assists in equity derivatives clearing, providing central counterparty (CCP) clearing and settlement services to 15 exchanges. The OCC operates as a guarantor between different parties and ensures that each side of a trade fulfills his or her contractual obligations. The OCC is responsible for moving billions of dollars a day.
The National Securities Clearing Corporation (NSC) is a part of the Depository Trust Clearing Corporation (DTCC). The NSC is located in New York, and it functions as a seller for every buyer, and a buyer for every seller in the financial industry for trades settled in US markets. It’s designed to offer settlement services to the financial industry in addition to risk management, data, and centralized clearing.
What are the Benefits of Clearing Houses?
Clearing houses are particularly beneficial to financial markets because they provide the security and efficiency essential to creating stability across different markets. Clearing houses guarantee that transactions operate smoothly and that both parties receive what they are owed in a trade.
Additionally, clearing houses ensure that the parties involved in a trade on any given exchange respect the system that’s in place and that they follow the procedures that are required to make a successful transaction. Plus, by facilitating seamless transactions, clearing houses help create liquidity in any market.
Clearing houses also ensure that the right goods are delivered to the buyer during physical delivery. Physical delivery is part of an options or futures trading contract. It usually requires the underlying physical asset (such as wheat or oil) to be delivered on the specific delivery date included in the contract before the trade itself was facilitated.
Because the clearing house ensures proper physical delivery of goods, it helps make sure that there are no disputes that ensue and that every member of the trade is fulfilling his or her obligations that were initially agreed to.