Clearing house (finance)
Encyclopedia
A clearing house is a financial institution that provides clearing
and settlement
services for financial and commodities derivatives and securities transactions. These transactions may be executed on a futures exchange
or securities exchange, as well as off-exchange in the over-the-counter
(OTC) market.
A clearing house stands between two clearing firms (also known as member firms or clearing participants) and its purpose is to reduce the risk of one (or more) clearing firm failing to honor its trade settlement obligations. A clearing house reduces the settlement risks by netting
offsetting transactions between multiple counterparties, by requiring collateral
deposits (a.k.a. margin
deposits), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing firm's collateral on deposit.
Once a trade has been executed by two counterparties either on an exchange, or in the OTC markets, the trade can be handed over to a clearing house which then steps between the two original traders' clearing firms and assumes the legal counterparty risk for the trade. This process of transferring the trade title to the clearing house is called novation
. It can take fractions of seconds in highly liquid futures markets; or days, or even weeks in some OTC markets.
As the clearing house concentrates the risk of settlement failures into itself and is able to isolate the effects of a failure of a market participant, it also needs to be properly managed and well-capitalized in order to ensure its survival in the event of a significant adverse event, such as a large clearing firm defaulting or a market crash.
Many clearing house guarantee funds are capitalized with collateral from its clearing firms. In the event of a settlement failure, the clearing firm may be declared to be in default and clearing house default procedures may be utilized, which may include the orderly liquidation of the defaulting firm's positions and collateral. In the event of a significant clearing firm failure, the clearing house may draw on its guarantee fund in order to settle trades on behalf of the failed clearing firm.
The term is also used for banks like Suffolk Bank
that acted as a restraint on the over-issuance of private bank notes.
is an example of a clearing house that functions for the purpose of clearing equity options and bond derivatives, in order to ensure the proper implementation of these instruments.
, the Chicago Board of Trade
, and the New York Mercantile Exchange
, CME Group
owns and operates its own clearing operation while also offering clearing services (for a fee) to other exchanges. Its ClearPort operation also provides clearing for certain over-the-counter trades.
LCH.Clearnet
(formerly known as The London Clearing House), for example, serves major international exchanges and platforms, as well as a range of OTC markets. It clears a broad range of asset classes including: securities, exchange traded derivatives, energy, freight, interbank interest rate swaps and euro and sterling denominated bonds and repos; and works closely with market participants and exchanges to identify and develop clearing services for new asset classes.
In 2008, Intercontinental Exchange established its own Clearing House to clear ICE Europe products and migrated clearing functions from LCH.Clearnet
.
, NACHA-The Electronic Payments Association
, formerly the National Automated Clearing House Association, organizes the mechanism for the financial service institutions that participate in the Automated Clearing House
(ACH) network. These organizations use the ACH to transfer funds either as debits or credits between participating institutions. Most, but not all, U.S. banks are members of the NACHA. Typical uses of ACH transactions are for automatic payroll programs, monthly mortgage or membership payments, or among non-profit organizations, as a monthly donor/contribution program.
.
In Europe, securities clearing is offered by a variety of Central Counterparties, including EMCF
, LCH.Clearnet
, SIX x-clear and EuroCCP.
s to make their trades on an open exchange with a clearinghouse. In June 2009, Federal Reserve official Alfred Kohn mentioned that the largest credit default swap dealers were working on an exchange, and that only regulatory approval rather than legislation would be required. In March 2010, the Options Clearing Corporation
stated that it was moving forward in backing equity derivatives.
Clearing (finance)
In banking and finance, clearing denotes all activities from the time a commitment is made for a transaction until it is settled. Clearing is necessary because the speed of trades is much faster than the cycle time for completing the underlying transaction....
and settlement
Settlement (finance)
Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against payment of money, to fulfill contractual obligations, such as those arising under securities trades....
services for financial and commodities derivatives and securities transactions. These transactions may be executed on a futures exchange
Futures exchange
A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of...
or securities exchange, as well as off-exchange in the over-the-counter
Over-the-counter (finance)
Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....
(OTC) market.
A clearing house stands between two clearing firms (also known as member firms or clearing participants) and its purpose is to reduce the risk of one (or more) clearing firm failing to honor its trade settlement obligations. A clearing house reduces the settlement risks by netting
Netting
In general, netting means to allow a positive value and a negative value to set-off and partially or entirely cancel each other out.In the context of credit risk, there are at least three specific types of netting:...
offsetting transactions between multiple counterparties, by requiring collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
deposits (a.k.a. margin
Margin (finance)
In finance, a margin is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty...
deposits), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing firm's collateral on deposit.
Once a trade has been executed by two counterparties either on an exchange, or in the OTC markets, the trade can be handed over to a clearing house which then steps between the two original traders' clearing firms and assumes the legal counterparty risk for the trade. This process of transferring the trade title to the clearing house is called novation
Novation
In contract law and business law, novation is the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party...
. It can take fractions of seconds in highly liquid futures markets; or days, or even weeks in some OTC markets.
As the clearing house concentrates the risk of settlement failures into itself and is able to isolate the effects of a failure of a market participant, it also needs to be properly managed and well-capitalized in order to ensure its survival in the event of a significant adverse event, such as a large clearing firm defaulting or a market crash.
Many clearing house guarantee funds are capitalized with collateral from its clearing firms. In the event of a settlement failure, the clearing firm may be declared to be in default and clearing house default procedures may be utilized, which may include the orderly liquidation of the defaulting firm's positions and collateral. In the event of a significant clearing firm failure, the clearing house may draw on its guarantee fund in order to settle trades on behalf of the failed clearing firm.
The term is also used for banks like Suffolk Bank
Suffolk Bank
Suffolk Bank was a clearinghouse bank in Boston, Massachusetts, that exchanged specie or locally backed bank notes for notes from country banks to which city-dwellers could not easily travel to redeem notes. It operated from 1818 until 1858....
that acted as a restraint on the over-issuance of private bank notes.
Clearing on options exchanges
The Options Clearing CorporationOptions Clearing Corporation
Options Clearing Corporation or OCC, founded in 1973, is the world's largest equity derivatives clearing organization, providing central counterparty clearing and settlement services to 14 exchanges and platforms for options, financial and commodity futures, security futures and securities...
is an example of a clearing house that functions for the purpose of clearing equity options and bond derivatives, in order to ensure the proper implementation of these instruments.
Clearing on futures exchanges
Now a combination of the Chicago Mercantile ExchangeChicago Mercantile Exchange
The Chicago Mercantile Exchange is an American financial and commodity derivative exchange based in Chicago. The CME was founded in 1898 as the Chicago Butter and Egg Board. Originally, the exchange was a non-profit organization...
, the Chicago Board of Trade
Chicago Board of Trade
The Chicago Board of Trade , established in 1848, is the world's oldest futures and options exchange. More than 50 different options and futures contracts are traded by over 3,600 CBOT members through open outcry and eTrading. Volumes at the exchange in 2003 were a record breaking 454 million...
, and the New York Mercantile Exchange
New York Mercantile Exchange
The New York Mercantile Exchange is the world's largest physical commodity futures exchange. It is located at One North End Avenue in the World Financial Center in the Battery Park City section of Manhattan, New York City...
, CME Group
CME Group
The CME Group bases prices for US gasoline on Brent Crude rather than West Texas Intermediate Crude , which many believe is responsible for artificially high gas prices for US consumers...
owns and operates its own clearing operation while also offering clearing services (for a fee) to other exchanges. Its ClearPort operation also provides clearing for certain over-the-counter trades.
LCH.Clearnet
LCH.Clearnet
LCH.Clearnet is an independent clearing house based in Europe that serves major international exchanges and platforms, as well as a range of OTC markets...
(formerly known as The London Clearing House), for example, serves major international exchanges and platforms, as well as a range of OTC markets. It clears a broad range of asset classes including: securities, exchange traded derivatives, energy, freight, interbank interest rate swaps and euro and sterling denominated bonds and repos; and works closely with market participants and exchanges to identify and develop clearing services for new asset classes.
In 2008, Intercontinental Exchange established its own Clearing House to clear ICE Europe products and migrated clearing functions from LCH.Clearnet
LCH.Clearnet
LCH.Clearnet is an independent clearing house based in Europe that serves major international exchanges and platforms, as well as a range of OTC markets...
.
Clearing of payments
In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, NACHA-The Electronic Payments Association
NACHA-The Electronic Payments Association
NACHA – The Electronic Payments Association manages the development, administration, and governance of the ACH Network, the backbone for the electronic movement of money and data in the United States. It is funded by the financial institutions it governs...
, formerly the National Automated Clearing House Association, organizes the mechanism for the financial service institutions that participate in the Automated Clearing House
Automated Clearing House
Automated Clearing House is an electronic network for financial transactions in the United States. ACH processes large volumes of credit and debit transactions in batches. ACH credit transfers include direct deposit payroll and vendor payments. ACH direct debit transfers include consumer payments...
(ACH) network. These organizations use the ACH to transfer funds either as debits or credits between participating institutions. Most, but not all, U.S. banks are members of the NACHA. Typical uses of ACH transactions are for automatic payroll programs, monthly mortgage or membership payments, or among non-profit organizations, as a monthly donor/contribution program.
Clearing of securities
In the United States, U.S. securities clearing is done by The Depository Trust Company or FedwireFedwire
Formally known as the Federal Reserve Wire Network, Fedwire is a Real Time Gross Settlement Funds Transfer system operated by the Federal Reserve Banks that enables financial institutions to electronically transfer funds between its more than 9,289 participants...
.
In Europe, securities clearing is offered by a variety of Central Counterparties, including EMCF
European Multilateral Clearing Facility N.V.
The European Multilateral Clearing Facility is a clearing house based in the Netherlands for equity trades done on stock exchanges or multilateral trading facility throughout Europe....
, LCH.Clearnet
LCH.Clearnet
LCH.Clearnet is an independent clearing house based in Europe that serves major international exchanges and platforms, as well as a range of OTC markets...
, SIX x-clear and EuroCCP.
Clearing of derivatives
In the wake of the financial crisis of 2007-2010 and as part of the Obama financial regulatory reform plan of 2009, pressure has been placed on traders of derivatives such as credit default swapCredit default swap
A credit default swap is similar to a traditional insurance policy, in as much as it obliges the seller of the CDS to compensate the buyer in the event of loan default...
s to make their trades on an open exchange with a clearinghouse. In June 2009, Federal Reserve official Alfred Kohn mentioned that the largest credit default swap dealers were working on an exchange, and that only regulatory approval rather than legislation would be required. In March 2010, the Options Clearing Corporation
Options Clearing Corporation
Options Clearing Corporation or OCC, founded in 1973, is the world's largest equity derivatives clearing organization, providing central counterparty clearing and settlement services to 14 exchanges and platforms for options, financial and commodity futures, security futures and securities...
stated that it was moving forward in backing equity derivatives.
See also
- Australian Clearing House and Electronic Sub-register SystemAustralian Clearing House and Electronic Sub-register SystemThe Australian Clearing House Electronic Subregister System is an electronic book-entry register of holdings of approved securities that facilitates the transfer and settlement of market transactions between the Australian Securities Exchange and the ASX Settlement and Transfer Corporation Pty...
- Central securities depositoryCentral Securities DepositoryA Central Securities Depository is an organization holding securities either in certificated or uncertificated form, to enable book entry transfer of securities. In some cases these organizations also carry out centralized comparison, and transaction processing such as clearing and settlement of...
- Clearing House Interbank Payments SystemClearing House Interbank Payments SystemThe Clearing House Interbank Payments System is the main privately held clearing house for large-value transactions in the United States, settling well over US$1 trillion a day in around 250,000 interbank payments. Together with the Fedwire Funds Service , CHIPS forms the primary U.S...
(CHIPS) - Options Clearing CorporationOptions Clearing CorporationOptions Clearing Corporation or OCC, founded in 1973, is the world's largest equity derivatives clearing organization, providing central counterparty clearing and settlement services to 14 exchanges and platforms for options, financial and commodity futures, security futures and securities...
- Bankers' clearing houseBankers' clearing houseA bankers' clearing house is an organization that transfers money between member banks, originally to clear checks. For more than a century, this service has been expanded to include several other banking services now done electronically.- Predecessors :...
- historical origins