A clearing house is defined as an intermediary between two parties, a buyer and seller, which helps facilitate the overall process from trade inception to settlement.
Clearing houses streamline the exchange of payments, securities, or derivatives transactions.
The clearing house is situated between two clearing firms who also helps reduce the risk of either member firm failing to honor their respective trade settlement obligations.
Buyers and sellers enter into legally binding agreements for the execution of trades.
Consequently, as a third party, the role of the clearing house is to centralize and standardize all of the steps leading up to the settlement of any transaction.
Clearing houses are integral in helping reduce the cost, settlement or operational risk of clearing as well as settling multiple transactions across multiple entities.
Role of Clearing Houses Across Exchanges
Financial exchanges such as commodities and stock exchanges have relied on clearing houses for over a century.
Today, the futures market is often associated with a clearing house, as its financial products are leveraged and necessitate a stable intermediary.
Every reputable exchange possesses its own clearing house. This requires all members of an exchange to effectively clear their trades via a clearing house at the terminus of each trading session.
Additionally, exchange members are obligated to reconcile clearing house's margin requirements, sufficient to cover the member's debit balance.
This is a crucial stopgap to help prevent risk to individual traders. For example, if a trader doesn't meet a margin call, any and all trades will be closed.
This is to prevent against any additional losses.
This process helps reduce the risk to individual traders, ensuring sufficient funds in the account to cover any losses which may occur.