A clearing firm is a financial institution that facilitates the exchange of payments, securities, or derivatives transactions). It stands between two clearing firms, also known as member firms or participants, to reduce the risk of a member firm failing to honor its trade settlement obligations). After the execution of a trade between a buyer and a seller, the role of the clearing firm is to centralize and standardize all of the steps leading up to the payment (i.e. settlement) of the transaction, reducing the cost, settlement risk, and operational risk of clearing and settling multiple transactions among multiple parties). Clearing firms mitigate risk by ensuring both parties are financially capable of entering into such a contract and that parties will receive what they are owed, resulting in a smoother transaction and ultimately a more liquid market). Clearing firms are also referred to as clearing houses or clearing corporations.
Clearing firms can be distinguished from introducing firms, which accept orders but have an arrangement with a carrying firm to maintain custody of the securities account. Clearing firms, on the other hand, not only handle orders to buy and sell securities but also maintain custody of an account holders securities and other assets, such as cash in the account. Because they have custody of customer assets, clearing firms must maintain higher levels of net capital than introducing firms and are responsible for segregating the customer funds and securities in their custody.
Clearing firms are members of exchanges that serve as a bridge between broker-dealers and investors. They guarantee trades are properly settled and transactions prove successful, and they are tasked with maintaining the paperwork associated with the clearance and execution of transactions. Clearing firms are essentially the security markets’ supportive pillar, working in tandem with broker-dealers to ensure trades are executed and transferred exactly as they should be.
In summary, a clearing firm is a financial institution that facilitates the exchange of payments, securities, or derivatives transactions, standing between two clearing firms to reduce the risk of a member firm failing to honor its trade settlement obligations. Clearing firms centralize and standardize all of the steps leading up to the payment of the transaction, reducing the cost, settlement risk, and operational risk of clearing and settling multiple transactions among multiple parties. They are also responsible for maintaining custody of customer assets and ensuring trades are executed and transferred properly.
