Last editedJan 20222 min read
When engaging in any financial transaction, it’s important to minimize risk while meeting obligations. Clearing houses offer a way to manage the transactional process and ensure all parties are following the rules. What is a clearing house, exactly? We’ll discuss the clearing house definition below, along with the situations when you’re likely to encounter one.
Understanding clearing houses
A clearing house is an independent third party that acts as a mediator between two parties involved in a financial transaction. The primary goal of a clearing house is to ensure that both the buyer and seller uphold their ends of the bargain. The seller receives the correct amount of compensation, and the buyer receives the correct tradable goods. Clearing houses can take many forms, whether they’re agencies, individuals, or separate corporations associated with a stock exchange.
This goal is achieved by following what’s known as the clearing process. During the clearing process, the clearing house performs a series of checks as a prerequisite for any legal transaction. These checks include things like ensuring that the buyer has adequate funds to pay for the tradable goods. The clearing firm also ensures that all parties involved follow required procedures for a smoother transaction.
The role of a stock clearing house
One of the areas where you’re most likely to use a clearing house is in stock market trading. Exchanges like the New York Stock Exchange (NYSE) and NASDAQ hold clearing houses to facilitate trading of derivatives, stocks, bonds, and mutual funds. All financial markets, like these stock exchanges, have their own specific clearing house to facilitate transactions. When investors agree to a transaction’s specific terms, the clearing house acts as an impartial middleman to represent both parties. It ensures that trading regulations are followed and that the contract proceeds as agreed upon.
Within the futures market, a stock clearing house collects deposits from every investor to cover all balances. At the end of each trading session, exchange members must clear trades via the clearing house. This helps to build trust and stability in the market, instead of allowing for a free-for-all.
What is automated clearing house (ACH)?
Another context in which you’ll see the term clearing house used is in electronic banking. You might be wondering, what is an automated clearing house and how does it differ from a stock clearing house? Automated clearing house, or ACH, is a network operated by the National Automated Clearing House Association (NACHA). It works as a self-regulating institution that enables electronic fund transfers between domestic banks.
What is the automated clearing house ACH system?
If you’ve ever set up automatic payroll, direct deposit, or online tax payments, you’ve probably done so using the automated clearing house system. This electronic banking system applies the clearing process to domestic bank transactions, representing over 10,000 financial institutions within the United States. As with a stock clearing house, the ACH network facilitates the organized transfer of funds between bank accounts, including B2B transactions, consumer payments, and government transfers.
Payments are set up at the originating bank as a debit or credit ACH transaction. These are batched together and processed using the ACH system at regular intervals throughout the day. By batching transactions, the clearing house can manage them more efficiently for reduced processing times.
The bottom line
Whether used in the context of banking or future trading, clearing houses perform similar functions. They ensure that all parties involved follow appropriate procedure during the clearing process. From verifying account balances to assisting with price negotiations, clearing houses make sure that both a buyer and seller – or sender and recipient in the case of banking – adhere to all regulations.
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