Clearing house (finance)
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.
Clearing on options exchanges
The Options Clearing Corporation 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 Exchange, 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.
Clearing of payments
In the United States, 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.
Clearing of securities
In the United States, U.S. securities clearing is done by The Depository Trust Company or Fedwire.
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 swaps 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.
- Australian Clearing House and Electronic Sub-register System
- Clearing House Interbank Payments System (CHIPS)
- Options Clearing Corporation
- Bankers' clearing house - historical origins
- ^ Primer: Derivative Instruments. Financial Policy Forum Derivatives Study Center.
- ^ Rolnick, Arthur J., Bruce D. Smith, and Warren E. Weber. "The Suffolk Bank and the Panic of 1837" Federal Reserve Bank of Minneapolis Quarterly Review. Vol. 24, No. 2, Spring 2000, pp. 3–13 
- ^ Reuters. Kohn: OTC clearinghouse could concentrate risk.
- ^ Retuers. OCC says pushing ahead on over-the-counter plan.
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