Question
What is a ‘Clearing House’? What are the different functions of Clearing House? Explain the
settlement process of Trading through Custodian and Clearing Corporation Houses.
Answer :
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Skip in 10
A Clearing House is an intermediary institution that facilitates the settlement of trades executed on a stock exchange. It acts as the central counterparty between buyers and sellers, ensuring that transactions are completed smoothly, securely, and efficiently. After a trade is executed, the clearing house assumes the responsibility of guaranteeing the completion of the transaction by becoming the buyer to every seller and the seller to every buyer. This mechanism eliminates counterparty risk and enhances confidence in the securities market. In modern financial markets, clearing houses are generally operated by clearing corporations associated with stock exchanges and are regulated by the relevant securities market authority. The major functions of a Clearing House include: Trade Confirmation and Matching: The clearing house receives trade information from the stock exchange and verifies the details submitted by the buying and selling brokers. It ensures that all transactions are accurately matched before settlement. Novation: One of the most important functions is novation, where the clearing house replaces the original contract between buyer and seller with two separate contracts. It becomes the legal counterparty to both sides, thereby guaranteeing settlement. Risk Management: The clearing house manages settlement risk by collecting margins from trading members, monitoring their financial exposure, conducting mark-to-market settlements, and maintaining guarantee funds. These measures reduce the possibility of default. Settlement of Securities and Funds: It coordinates the transfer of securities from sellers to buyers and the transfer of funds from buyers to sellers. It ensures that deliveries and payments occur simultaneously according to the prescribed settlement cycle. Margin Collection: Clearing houses collect initial margin, exposure margin, variation margin, and other applicable margins from market participants to safeguard against potential losses arising from price fluctuations. Default Management: If any trading member fails to fulfill settlement obligations, the clearing house uses margins, guarantee funds, or other resources to
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