3
The role of
the clearing house
In the derivatives industry we find different terminology being used
around the world. This is true with the description used to identify
the organisation appointed by or incorporated into the exchange to
manage the clearing, settlement and risk of the exchange and its
members.
Clearing house is commonly used but equally we might come across
clearing corporation, clearing organisation as well as ‘clearer’, clearing
firm or clearing member but the latter three refer to members rather
than the exchange clearing entity.
For simplicity we will use the term ‘clearing house’.
In general terms the role of the clearing house is to act as a coun-
terparty to both sides of the trade thereby breaking the direct coun-
terparty relationship between the two trading counterparties. It is
fundamental to the integrity and credibility of the market for which it
operates, as its purpose is to guarantee the performance of each and
every transaction.
By assuming the legal responsibility for the trade, the clearing
house removes any risk on each other that the two original counter-
parties might have had.
In addition the clearing house also acts as risk manager, and
provides the settlement routing and data to members, and statistical
and other data to the exchange and external parties often including
regulators.
There are two main types of clearing house; those that are a divi-
sion of the exchange itself and indistinguishable from the exchange
who own them, and those that are independent of the exchange with
their own financial backing. In most cases, for these independent
clearing houses, shareholders, the members of the markets and the
clearing house, or a combination of these three provide the necessary
financial backing.
The London Clearing House (now LCH.Clearnet) and the Options
Clearing Corporation (OCC) in Chicago are examples amongst clearing
houses of ones that clear business for more than one exchange.
This can be advantageous for the broker as clearing members of,
for instance, Euronext.liffe, London Metal Exchange (LME) and IPE
because it means only one point of settlement for all of their trading
in these markets as LCH.Clearnet is the clearing house for these
exchanges.
Clearing houses must be financially robust in order to sustain a
default in the market(s) for which they operate. The financial standing
of the clearing house is a very important consideration for brokers
when they are contemplating becoming clearing members of an
exchange. It is also an important issue for companies researching the
potential of trading in the market, as they need to know that their
trades will be efficiently settled and that their positions will be secure
in the event of another unrelated party causing a default in the market.
In the United Kingdom the FSA have designated LCH.Clearnet as a
Recognised Clearing House and regulate it. This gives the members
and users of the market comfort that it is a properly organised and
approved clearing house. Of course the members of LCH.Clearnet
must also adhere to the rules and regulations laid down by the clear-
ing house. Any failure to do so would almost certainly be deemed to
put a firm in breach of these rules and regulations and in turn it
would constitute a default. That would result in the firm concerned
being banned from acting as a clearing house member not only in the
market concerned but in all probability would result in curtailment
or suspension of the status in relation to other markets.
The LCH.Clearnet also has registration as a Designated Clearing
Organisation (DCO) granted by the US regulator The Commodity
Futures Trading Commission (CFTC).
When did the first clearing house come into existence?
One of the oldest clearing houses is that established by the Chicago
Board of Trade as the following statement illustrates:
The Chicago Board adopted a motion suggesting that it establish
a modern clearinghouse. Probably no more progressive and far-
reaching step was ever taken to insure prices accurately reflecting
supply and demand. I believe it will be effective.
36 Clearing and settlement of derivatives
Secretary of Agriculture William Jardine in a Report to President
Calvin Coolidge, 1925
Source: The Clearing Corporation.
Originally formed as the ‘Board of Trade Clearing Corporation’ it is
today called The Clearing Corporation (CCorp) and provides services
to the Eurex US electronic derivatives market. Its importance in the
history and development of the clearing of derivatives exchanges can
be seen by the following extract taken from their website:
In the history of the world’s financial markets, perhaps no single
entity has had a greater impact on the safety and soundness of the
clearing process than The Clearing Corporation (CCorp). Based on
a tradition of independence, integrity, and innovation, The Clearing
Corporation has established itself as the model for the majority of
the world’s clearinghouses.
September 3, 1925 is among the most important dates in the his-
tory of the futures industry. It was on that day, more than 75 years
ago, that the Board of Trade Clearing Corporation, now named The
Clearing Corporation, was founded by the Chicago Board of Trade
(CBOT
®
) membership.
The Clearing Corporation is one of the oldest independent clearing-
houses in the world. It has not only survived, but flourished,
through the Great Depression and periods of recession, war, and
rapid technological and economic change. Its world-class standing
has been and will continue to be built upon three fundamental
concepts: Independence, Integrity, and Innovation.
The importance of its independence as a corporate entity cannot be
overestimated. This quality has allowed The Clearing Corporation
to make objective decisions during periods of substantial stress
with one goal in mind–financial integrity for the clearing and
settlement process.
Integrity goes hand-in-hand with independence. Clearing members
know that The Clearing Corporation makes decisions based on
safety and soundness for the marketplace and nothing else.
The financial integrity of the marketplace also has been aided
through The Clearing Corporation’s commitment to innovation
since its founding. This commitment is evidenced by its history as
an industry leader–from its first use of computers in 1963 to the
The role of the clearing house 37
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