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Most industries have a “middleman” between buyers and sellers. Clearinghouses are the “middleman” of the financial market. They facilitate transactions between two different parties.
The presence of the clearinghouse ensures that buyers and sellers who agree to a transaction on a financial marketplace follow through on their specific contractual obligations.
Below, we provide a closer look at clearinghouses, explaining their purpose and why they are important for financial market transactions.
What Is a Clearinghouse?
Clearinghouses are best defined as intermediaries between financial market sellers and buyers. This group validates transactions, ensuring they are legitimate, accurate, and executed in a timely manner.
The clearinghouse then finalizes the transaction. Buyers and sellers can move forward in full confidence with transactions agreed to on a financial marketplace knowing the clearinghouse will ensure the other party honors its contractual obligations.
Each unique financial market has a specific clearinghouse to perform this function. Aside from clearing or finalizing financial market trades and settling trades, clearinghouses also collect margin payments, regulate delivery of assets, and report trading data.
What Does a Clearinghouse Do? Functions and Purpose
Clearinghouses function as the middleman between buyers and sellers of securities/equities. The aim of clearinghouses is to enhance market efficiency, bolstering the overarching financial system’s stability.
They finalize and validate all transactions. For futures and option contracts, clearinghouses act as independent third-parties that take the opposite position of both sellers and buyers. This mitigates risk on both parties and ensures timely delivery of the equity.
Why Are Clearinghouses Important in Investing?
Clearinghouses are essential to investing as they ensure both parties fulfill their obligations in the context of buying and selling securities. The clearinghouse eliminates the fear that the transaction will not be processed due to the other party backing out or for another reason.
Examples of a Clearinghouse
You are probably familiar with one or several clearinghouses, yet you might not even know it. The little-known truth is that the NASDAQ and the New York Stock Exchange (NYSE) are the top two clearinghouses.
The NYSE makes it possible to trade stocks, mutual funds, ETFs, bonds, and derivatives. On your behalf, the NYSE serves as the middleman that ensures the lowest selling price matches the highest bid price.
Each time you trade a stock on the NYSE or NASDAQ, you rely on a clearinghouse to ensure the transaction is processed in a fair, accurate, and timely manner.
How Does a Clearinghouse Make Money?
Clearinghouses are not in business to strictly ensure fairness for buyers and sellers participating in transactions on financial marketplaces. Remember, America is nation full of capitalists. These organizations are in business to make money. Clearinghouses generate revenue through clearing fees.
This means there is a transaction fee imposed each time a trade is made. Though such fees are nominal, they add up to a meaningful sum of money based on the sheer trading volume of modern-day markets.
Are Clearinghouses Registered with the SEC?
Clearinghouses are registered with the Securities and Exchange Commission, also known as the SEC. Every clearinghouse service in the United States is an SEC-registered group.
The SEC is the regulating body that governs and holds clearinghouses accountable.
Bottom Line: What Is a Clearinghouse?
Clearinghouses are essential intermediaries between financial market buyers and sellers. These groups validate transactions, ultimately finalizing them, so buyers and sellers are satisfied.
Each financial market designates a specific clearinghouse for this important function.