Role of a clearing house in trade processing settlement
Answers
Clearing is the procedure by which financial trades settle - that is, the correct and timely transfer of funds to the seller and securities to the buyer. Often with clearing, a specialized organization acts as intermediary and assumes the role of tacit buyer and seller in a transaction, to reconcile orders between transacting parties. Clearing is necessary for the matching of all buy and sell orders in the market. It provides smoother and more efficient markets as parties can make transfers to the clearing corporation rather than to each individual party with whom they transact.
The Basics of Clearing
Clearing is the process of reconciling purchases and sales of various options, futures, or securities, as well as the direct transfer of funds from one financial institution to another. The process validates the availability of the appropriate funds, records the transfer, and in the case of securities ensures the delivery of the security to the buyer. Non-cleared trades can result in settlement risk, and if trades do not clear accounting errors will arise where real money can be lost. An out trade is a trade that cannot be placed because it was received by an exchange with conflicting information. The associated clearing house cannot settle the trade because the data submitted by parties on both sides of the transaction is inconsistent or contradictory.
Stock exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, have clearing firms. They assure that stock traders have enough money in their account, whether using cash or broker-provided margin, to fund the trades they are taking. The clearing division of these exchanges acts as the middle man, helping facilitate the smooth transfer of funds. When an investor sells a stock they own, they want to know that the money will be delivered to them. The clearing firms makes sure this happens. Similarly, when someone buys a stock, they need to be able to afford it. The clearing firm makes sure that the appropriate amount of funds is set aside for trade settlement when someone buys stocks.
Clearing can have a variety of meanings depending on the instrument with which it is associated. In the case of check clearing, it is the process involved in transferring the funds promised on the check to the recipient's account. Some banks place holds on funds deposited by check since the transfer is not instantaneous and may require time to process.
KEY TAKEAWAYS
Clearing is the procedure by which financial trades settle – that is, the correct and timely transfer of funds to the seller and securities to the buyer.
Often with clearing, a specialized organization acts as an intermediary known as a clearinghouse, and assumes the role of tacit buyer and seller in a transaction to reconcile orders between transacting parties.
Clearing is necessary for the matching of all buy and sell orders in the market, providing smoother and more efficient markets as parties can make transfers to the clearing corporation rather than to each individual party with whom they transact.