What is a Clearing House?

Published by Thomas Herold in Accounting, Banking, Investments, Trading

'Clearing House' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A Clearing House refers to a financial intermediary that exists between sellers and buyers of financial instruments such as stocks, bonds, futures, options, and mutual funds. At the same time, it is also an agency which operates in tandem with a futures exchange. In this capacity, they handle clearing trades, settling trading accounts, collecting and maintaining monies for margin accounts, reporting trades, and regulating delivery of the relevant financial instruments. These clearing houses serve as third parties for all options and futures contracts. They are also simultaneously buyers for each seller who is a clearing member and sellers for every buyer who is a clearing member.

Another way of looking at this is that the clearing houses take on the opposite side of every trade transacted. As two investors consent to a financial transaction and its terms, the clearing house will work in the critical capacity as middle man for the two participating third parties. This involves selling and buying securities. The ultimate reason of existence for clearing houses lies in boosting the efficiency of markets and increasing the financial stability of the relevant markets.

Futures markets are most closely connected to clearing houses. The reason for this is that their financial instruments prove to be exceedingly complex. They must therefore have a stable financial intermediary backing them up. Every futures exchange maintains its own proprietary clearing house. This forces every exchange member to clear its trades via the clearing house by no later than the end of every trading session. They will have to deposit a given amount of margin money with the clearing house based on the maintained margin requirements so that they can cover any deficit member balance.

It always helps to consider a real world clear example to illuminate a challenging concept such as this one. If Godfrey’s Futures, a member broker, alerts the clearing house of the commodity and futures exchange at trading day end that it net bought 30,000 bushels of May soybeans for its customer accounts, then it will subsequently be required to deposit the margin cover of six cents or each individual net bushel position. This would amount to $1,800 in total deposit to be on hand with the clearing house in question. Since every member will have to clear out all trades via the house and so has to keep enough funds to cover their debit balances, it is ultimately the clearing house that carries the responsibility to all member broker dealers to fulfill the contracts according to the appropriate terms.

Within the United States today, there exist two separate most important clearing houses. These are the NASDAQ and the NYSE New York Stock Exchange. At the NYSE, they facilitate all mutual funds, bonds, exchange traded funds, stocks, and derivatives trading and contracts. They serve as the middle man on every side of an auction trade which allows for investors and brokers to purchase and sell off securities to other third parties and customers. They do this by matching up the highest bid price with the lowest ask price.

The NYSE actually maintains an expansive physical trading floor in pursuit of this important mission and purpose. On the other hand, the NASDAQ also has to do the same functions, yet it does not have the advantage of a physical trading floor on which to do it. All NASDAQ trades they match up entirely electronically for their various broker dealers and investor customers.

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The term 'Clearing House' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.