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`Clearinghouse Definition
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`INVESTING
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`INVESTING ESSENTIALS
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`Clearinghouse
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`AKHILESH GANTI
`By
`Updated December 31, 2021
`Reviewed by JULIUS MANSA
`Fact checked by PETE RATHBURN
`The Clearinghouse: An Overview
`
`A clearinghouse is a designated intermediary between a buyer and seller in a financial market.
`The clearinghouse validates and finalizes the transaction, ensuring that both the buyer and
`the seller honor their contractual obligations.
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`Clearinghouse Definition
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`INVESTING
`
`INVESTING ESSENTIALS
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`Clearinghouse
`
`AKHILESH GANTI
`By
`Updated December 31, 2021
`Reviewed by JULIUS MANSA
`Fact checked by PETE RATHBURN
`The Clearinghouse: An Overview
`
`A clearinghouse is a designated intermediary between a buyer and seller in a financial market.
`The clearinghouse validates and finalizes the transaction, ensuring that both the buyer and
`the seller honor their contractual obligations.
`
`Advertisement
`
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`Clearinghouse Definition
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`Every financial market has a designated clearinghouse or an internal clearing division to
`handle this function.
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`Understanding the Clearinghouse
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`Clearinghouse Definition
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`The responsibilities of a clearinghouse include "clearing" or finalizing trades, settling trading
`accounts, collecting margin payments, regulating delivery of the assets to their new owners,
`and reporting trading data.
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`Clearinghouses act as third parties for futures and options contracts, as buyers to every
`clearing member seller, and as sellers to every clearing member buyer.
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`Clearing House
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`Clearinghouse Definition
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`The clearinghouse enters the picture after a buyer and a seller execute a trade. Its role is to
`accomplish the steps that finalize, and therefore validate, the transaction. In acting as a
`middleman, the clearinghouse provides the security and efficiency that is integral to stability
`in a financial market.
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`In order to act efficiently, a clearinghouse takes the opposite position of each trade, which
`greatly reduces the cost and risk of settling multiple transactions among multiple parties.
`While their mandate is to reduce risk, the fact that they have to act as both buyer and seller at
`the inception of a trade means that they are subject to default risk from both parties. To
`mitigate this, clearinghouses impose margin requirements.
`
`The Clearinghouse in the Futures Market
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`The futures market is highly dependent on the clearinghouse since its financial products are
`leveraged. That is, they typically involve borrowing in order to invest, a process that requires a
`stable intermediary.
`
`Each(cid:96)exchange has its own clearinghouse. All members of an exchange are required to clear
`their trades through the clearinghouse at the end of each trading session and to deposit with
`the clearinghouse a sum of money, based on the clearinghouse's margin requirements, that is
`sufficient to cover the member's debit balance.
`
`KEY TAKEAWAYS
`
`A clearinghouse or clearing division is an intermediary between a buyer and a seller
`in a financial market.
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`Clearinghouse Definition
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`In acting as the middleman, the clearinghouse provides the security and efficiency
`that is integral for financial market stability.
`
`To mitigate default risk in futures trading, clearinghouses impose margin
`requirements.
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`Futures Clearing House Example
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`Assume that a trader buys a futures contract. At this point, the clearinghouse has already set
`the initial and maintenance margin requirements.
`
`The initial margin can be viewed as a good faith assurance that the trader can afford to hold
`the trade until it is closed. These funds are held by the clearing firm but within the trader's
`account, and can't be used for other trades. The intention is to offset any losses the trader
`may experience in the transaction.
`
`The maintenance margin, usually a fraction of the initial margin requirement, is the amount
`that must be available in a trader's account to keep the trade open. If the trader's account
`equity drops below this threshold, the account holder will receive a margin call demanding
`that the account be replenished to the level that satisfies the initial margin requirements.
`
`If the trader fails to meet the margin call, the trade will be closed since the(cid:96)account cannot
`reasonably withstand further losses.
`
`In this example, the clearinghouse has ensured that there is sufficient money in the account to
`cover any losses that the account holder may suffer in the trade. Once the trade is closed, the
`remaining margin funds are released to the trader.(cid:96)
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`The process has helped reduce default risk. In its absence, one party could back out of
`the(cid:96)agreement or fail to produce money owed at the end of the transaction.
`
`In general, this is termed transactional risk and is obviated by the involvement of a
`clearinghouse.
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`Stock Market Clearinghouses
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`Clearinghouse Definition
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`Stock exchanges such as the New York Stock Exchange (NYSE) have clearing divisions that
`ensure that a stock trader has enough money in an account to fund the trades being
`placed. The clearing division acts as the middle man, helping facilitate the smooth transfer
`of the stock shares and the money.
`
`An investor who sells stock shares needs to know that the money will be delivered. The
`clearing divisions make sure this happens.
`
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`Related Terms
`
`International Clearing System Definition
`
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`Clearinghouse Definition
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`The International Clearing System is a trade clearing system for financial products or assets when parties
`are in different countries. more
`
`Clearing
`Clearing is when an organization acts as an intermediary to reconcile orders between transacting parties.
`A clearing bank approves checks for payments. more
`
`COMEX Definition
`COMEX is the primary futures and options market for trading metals such as gold, silver, copper, and
`aluminum. more
`
`Euroclear
`Euroclear is one of two principal clearing houses for securities traded in the Euromarket and specializes in
`verifying information supplied by brokers involved in a securities transaction and the settlement of
`securities. more
`
`Stock Market | Investopedia
`The stock market consists of exchanges or OTC markets in which shares and other financial securities of
`publicly held companies are issued and traded. more
`
`What Is Pay/Collect?
`Pay/collect refers to the payment or collection of funds related to futures positions that have been
`marked to market. more
`
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`Clearinghouse Definition
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