Clearing house

Clearing house

What is a clearing house?

A clearing house is a financial institution that provides clearing and settlement services for financial transactions. This means it an intermediary between buyers and sellers, acting as a buyer to the seller and vice versa, to ensure they fulfil their legal obligations to each other.

Once a trade has been executed by two counter-parties 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 counter-party risk for the trade.

The clearing firms are the direct clients of the clearing house, for example online brokers.

The purpose of the clearing house is to reduce the risk of the clearing firms failing to honour their obligation in settling a trade.

Clearing houses need to be well-managed and possess a lot of capital to fulfill their role. The benefit of the clearing house can be seen simplified as an insurance company for trading: you pay a bit of money, but get the safety that your trades are working properly.

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. It can also take days or even weeks in some OTC markets.

Clearing houses are usually a division of an exchange, which enables the exchange to manage every step of an executed trade.

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