Everything about Clearing Finance totally explained
In
banking and
finance,
clearing denotes all activities from the time a commitment is made for a
transaction until it's settled (see
settlement). Clearing is necessary because the speed of trades is much faster than the cycle time for completing the underlying transaction.
In its widest sense clearing involves the management of post-trading, pre-settlement credit exposures, to ensure that trades are settled in accordance with market rules, even if a buyer or seller should become insolvent prior to settlement.
Processes included in clearing are
reporting/
monitoring,
risk margining,
netting of trades to single positions,
tax handling, and
failure handling.
Central counterparty
Clearing generally involves the use of a well capitalised
financial institution known as a
central counterparty (CCP). The CCP becomes a party to every trade, acting as buyer to market participant sellers, and seller to market participant buyers. In respect of unsettled trades, market participants therefore bear the standardised
credit risk of the CCP, and not that of each other in a decentralised market. See
Central Counterparty Clearing
In the
United States, interbank clearing is done through the
Automated Clearing House (ACH). Its rules and regulations are set by
NACHA-The Electronic Payments Association, formerly the
National Automated Clearing House Association, and the
Federal Reserve. The ACH network acts as central clearing facility for all
Electronic Funds Transfer (EFT) transactions. Interbank clearing of paper
checks is done by correspondent
banks and the
Federal Reserve; they're ultimately settled between the 12 Federal Reserve Banks through the
Interdistrict Settlement Fund.
Netting
The CCP can net its daily purchases and sales in like securities since each market participant has only one counterparty to its trades. Such netting is widely identified as the key benefit offered by the use of a CCP.
Further Information
Get more info on 'Clearing Finance'.
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