Delving into stock markets: What is a clearing house?

Julie Brownlee, Fsp Invest, 03 Nov. 2014

Tags: clearing house, clearing houses, what is a clearing house, what a clearing house does, role of clearing houses,

When you buy and sell shares on the stock market, you may think it’s just the stockbrokers you’re dealing with. But every transaction has to go through a clearing house.

So what exactly is a clearing house?

Read on to find out…

The ins and outs of a clearing house

A clearing house isn’t something you hear a lot about. Clearing houses tend to go about their business with many not even realising that they exist.

In South Africa, the JSE Clearing and Settlement Division provides the role of a clearing house.

In some markets, it’s a different body or company providing the function.

But clearing houses play a crucial role in the financial system.

Let’s show what clearing houses do with the help of an example…

You decide to buy shares through your stockbroker. Your stockbroker then goes through the stock exchange to do the deal.

Usually this means the stockbroker agrees to trade in an agreed number of shares at an agreed price. It normally takes three working days for settlement of the deal.

Because of this delay, it creates a risk. The risk comes from the chance that the buyer doesn’t pay or the seller doesn’t deliver the shares.

The role of a clearing house

And this is where the clearing house comes in.

A clearing house guarantees the trade will take place by taking over the deal. So the buyer gives the cash to the clearing house and the seller gives the shares to the clearing house. And the clearing house facilitates the deal.

As well as guaranteeing the trade, it has other functions:

  • It allows parties to trade anonymously on the stock market; and
  • It boosts the liquidity of the stock market.

So the guarantee works, the buyer and seller both have to give the clearing house a margin. This is a percentage of the value of the deal. Once the deal completes, the clearing house returns the margin.

When there are times of financial crisis, the clearing house may increase its margin requirements. This is due to the clearing house having concerns about the ability of the traders to honour contracts with them

So there you have it, what a clearing house is.

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