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What is a Clearing House?

M. McGee
M. McGee

A clearing house is a specialized firm that acts as an intermediary between two parties engaged in a financial transaction. When people make a deal in a financial market, the money does not move instantly from one account to another. There may be assets that need liquidation and transactions that need finalization before the money moves. A clearing house takes over the sale after it is complete to oversee the movement of funds from one party to the other. If one of the parties defaults, the system moves on collateral and assures ownership is in the hands of the proper person.

The financial market has millions of sales everyday. Some of these sales are simply one person buying a financial good with actual money, so the transactions are quick and the money normally arrives in seconds. Other transactions are much more complex. In order to gather up the funds needed for the sale, the buyer may need to sell other financial goods or transfer money from non-connected accounts. This process may take days or even weeks to complete.

Man climbing a rope
Man climbing a rope

In order to offset the risk associated with sales of this type, a clearing house is often used. Once a sale is completed, the clearing house takes over the governance of the sale. The clearing house pays the seller and acts almost like a loan holder for the buyer. If the buyer has significant collateral to put up against the sale, ownership is transferred to him. If the buyer does not have collateral, the clearing house holds onto ownership of the purchased financial good.

Assuming the debt is paid, the clearing house transfers full ownership to the new owner. At that point, the owner is separated from the settlement and may do what he wants with the financial good. If the debt is unpaid, or the buyer defaults on the settlement, then steps are taken to retrieve the invested money.

The first step is determining ownership of the financial good. If the clearing house still has ownership of the good, it is free to sell it to offset its loss. If the good has transferred to the buyer, then he must try to get it back or take ownership of goods put up for collateral. In most cases, the clearing group covers the situations well enough that it doesn’t lose much or anything, even on a severe default.

Generally, a clearing house has a number of clearing firms that it uses as its monetary backbone. These firms may be separate corporations, investment houses or any other money-making investments. Each of these firms is partially or wholly owned by the clearing house, and its money is used to pay the original sellers. When a financial good goes into default, it is generally one of these firms that resells the good.

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