A Clearing House is an intermediary between buyers and sellers of financial instruments. It is an agency or separate entity of an exchange responsible for settling trading accounts, clearing trades, and ensuring smooth executions of transactions. Clearing Houses act as third parties to all futures and options contracts— they function as a buyer for every seller and a seller for every buyer. This streamlines the process, assures efficiency, reduces risk, and promotes financial market integrity.
1. What functions do Clearing Houses serve?
Clearing Houses serve numerous functions. They centralize all buying and selling functions, maintain market integrity by assuring a smooth operational flow for exchange-related transactions, and manage risk, particularly credit risk, by acting as a buyer for every seller and a seller for every buyer.
2. How do Clearing Houses reduce risk?
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Clearing Houses reduce risk through a process known as clearing. Here, they act as an intermediary for both parties involved in a transaction, reducing the likelihood of one party defaulting on their agreement. They also require a margin deposit to further secure the transaction.
3. What is meant by margin in a Clearing House?
In Clearing Houses, margin refers to collateral that parties deposit to cover potential losses and ensure they can meet their obligations. Two types of margins are prevalent, the initial margin and the variation margin. Initial margins are made at the time of the trade, while variation margins are additional payments when the market moves against the position.
4. What is the difference between a Clearing House and a Broker?
A Clearing House acts as an intermediary and guarantees the trade, reducing the risk of default by either party. Conversely, Brokers mediate between buyers and sellers for transactions, working more directly with clients. Brokers do not guarantee trades, though they may work with Clearing Houses.
5. Are Clearing Houses regulated?
Yes, Clearing Houses are regulated by financial authorities in their respective countries. For example, in the United States, the Commodity Futures Trading Commission regulates them. These institutions ensure that Clearing Houses follow financial laws and maintain market integrity.