Difference between revisions of "Clearing"

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''In order to define real time clearing, we have to describe clearing.''
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Clearing is a process where transactions of financial instruments and commodities, often called contracts, are settled, i.e. paid for and [[delivered]]. It may seem simple but includes a number of risks that need to be managed. There are also significant administrative tasks involved.
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*See also "[[Clearing organization]]"
  
The aim of clearing is to ensure that all parties meet their obligations and to minimize the risks on individual and business level as well as the [[systemic risk]] that can accumulate when a number of individuals and/or organizations are facing the same type of risk.
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Clearing is the process by which the rights and obligations arising from market transactions are formally assigned to the buyers and the sellers. Clearing is usually conducted by a distinct organization from the trading operation termed the [[clearing organization]]. The clearing organization may be affiliated with or legally separate from the venue where the trading takes place; [[CME Clearing]] and the [[OCC]], formerly known as Options Clearing Corporation, are respective examples. In derivatives exchanges, there is only one clearing organization for each contract, so the clearing venue for any exchange-traded derivative is unambiguous at the time of transaction. Accordingly, all ICE Futures US contracts are cleared at ICE Clear US, for example, and all contracts traded on options exchanges in the United States are cleared by OCC.  
Clearing also aims to facilitate payment and [[delivery]].
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See also "[Clearing organization]"
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The term clearing sometimes includes also the successful payment and or other fulfillment of contractual obligations, although settlement is a distinct concept. Settlement refers to any payments to or from the clearing organization or the transfer of ownership of commodities in conjunction with deliveries pursuant to contract terms.     
  
=====Multilateral clearing=====
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== Derivatives Clearing ==  
The process can be multilateral and include three parties, the seller, the buyer and a clearing organization (often called a clearing house). During a multilateral clearing process the clearing organization steps in between the buyer and seller in order to ensure that both parties fulfill their obligations in accordance with the deal. To safeguard against funding liquidity risk, that is the risk that liabilities cannot be met when they fall due, a clearing organization will demand collateral from their purchasing members.
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=====Bilateral clearing=====
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Clearing can also be bilateral, the parties complete the deal in direct contact with each other and the seller carries the funding liquidity risk, also known as the counterparty risk. The trading parties always carry the market risks involved. They have to make their own assessments of how they expect prices on equity and commodities, or interest and currency rates, to develop.
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There is also a hybrid between multilateral and bilateral clearing, where a clearing organization is used for the administrative post-trade efficiencies.
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=====Netting=====
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It is common practice that banks and other institutions buy and sell instruments from each other numerous times during the course of a day. When all these transactions are cleared, at the end of the day, it is practical to let them cancel each other out to make one single transfer instead of sending money back and forth. This process is called netting and is an integral part of modern clearing.
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=====Post-trade and pre-trade clearing services=====
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There are risks to manage and administrative efficiencies to consider both before and after trading.  The post-trade clearing has been described above and includes managing events, such as netting, payment and delivery, as well as risks, from trade execution to settlement.
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Pre-trade clearing is becoming increasingly important as it meets the needs to asses the risks that can develop into systemic risks such as the events of 2008 have shown.
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=====Technological benefits and challenges=====
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Modern technology has amplified the speed and sophistication of electronic trading and has sparked new business models and financial instruments, such as the infamous credit default swaps.
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It also brings with it increased risk, as the speed with which business is conducted is staggering and a trader may be involved in numerous simultaneous deals. If a trader surpasses their credit liability or is hit with a bad deal – their credit rating should be affected immediately so that other traders (and the clearing organization) have a reasonable chance to adjust their level of involvement. 
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The credit crisis has sparked ongoing debate about the need for new regulatory measures. It is becoming clear that an integral part of the response will be a requirement for enhanced and flexible clearing and risk management technology. It takes computers to keep track of the market created by computers in order to calculate the risk at each given moment. Hence the term real-time clearing.
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=Real-time clearing=
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When the clearing is done real-time all the events involved in clearing are done immediately, as opposed to at the end of the trading day. This gives the actors fast and accurate information on which to base e.g. prices, rates and credit ratings. The transparency is improved and the information is always current so that systemic market risks can be identified and managed.
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=====Position=====
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When clearing is done real-time, it is possible to see a party’s trading commitments at any given time and this information can be combined with the updated collateral requirements for the same party. The latter can be calculated by a real-time clearing system as it can take into account parameters for market risk, liquidity risk and credit risk. This gives a complete assessment of the account, i.e. its position, and can be used to make informed decisions when dealing with the party.
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The information on position can be gathered for groups of accounts based on what they are trading in, who they are or any other cluster that a clearing organization, exchange or authority wants to measure and calculate.
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Real-time clearing, simply put, provides more thorough and timely information about the positions of participants by making it possible to assess all the undertakings made by a single member or by groups of members. It can also indicate what effects many of the interlinkages and interdependencies on the financial arena can have on the economy.
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All exchange-traded derivatives must be cleared. This requirement is dictated by both tradition and law.<ref>{{cite web|url=https://www.ecfr.gov/cgi-bin/text-idx?SID=11af71af3df4a4e44bf416237e0e38a9&mc=true&node=pt17.1.38&rgn=div5#se17.1.38_1601|name=PART 38—DESIGNATED CONTRACT MARKETS §38.601 Mandatory clearing|org=CFTC|date=October 14, 2019}}</ref>
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For [[derivative]]s transactions, the clearing organization substitutes itself at the [[clearing member]] level as the counterparty for every trade on an exchange.  At the clearing organization, clearing members represent their own and their customers' trades as well as the customer trades of the brokers ([[futures commission merchants]] for [[commodity]] derivatives and [[broker-dealer]]s for [[equity option]]s) becoming the [[buyer]] to each [[seller]] of a contract or other [[derivative]], and the seller to each buyer.learing member]]s.<ref>{{cite web|url=https://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm|name= CFTC Glossary|org=CFTC|date=October 10, 2019}}</ref>
  
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Clearing organizations are accessible only to their clearing members, which usually are legal entities. Retail customers, local traders, proprietary trading and brokerages gain access by having accounts with clearing member firms.<ref>{{cite web|url=http://thismatter.com/money/stocks/settlement-and-clearing.htm|name=Execution, clearing and Settlement|org=Thismatter|date=April 19, 2017}}</ref>
  
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===  Regulations ===
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Clearing organizations for derivatives are regulated by the same governmental bodies that regulate derivatives trading. In the United States, futures clearing organizations are regulated by the CFTC and stock options clearing organizations are regulated by the SEC. In the European Union, clearing organizations are regulated by ESMA with backstopping by "competent authorities" in individual countries. In the United Kingdom, clearing is regulated by the Financial Conduct Authority. Regulation of clearing in China is carried out by the China Securities Regulatory Commission.
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Clearing is conducted pursuant to processes and procedures taking the form of clearing organization rules once they are approved by the clearing organization's highest authority, such as its board of directors. The clearing rules are usually approvable or at least reviewable by the regulator before they are put into effect.
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Clearing organization rules include membership requirements. The rules usually are incorporated by reference into the contractual relationships between the clearing organizations and their clearing members.
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=== Guarantees ===
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Clearing organizations effectively guarantee financial performance on all open positions by substituting themselves for the original counterparty clearing member in each trade. All clearing members look only to the clearing organization to pay obligations due them on a timely basis.
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Clearing organizations usually, if not always, create, manage and control a guarantee fund that is available to them to pay clearing members in the event other clearing members' losses exceed available funds. Guarantee funds are composed of mandatory deposits at levels of value stipulated by the clearing organizations from clearing members.       
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=== Risk management ===
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The three pillars of risk management are managing exposures to counterparties by dealing only with clearing members which are vetted for operational and financial capability, paying and collecting variation margin based on daily marking of positions to market, and collection and maintenance of performance bonds for open positions, also known as initial or variation margin. The guarantee fund, contributions from exchanges, retained earnings of the clearing house, and third party insurance are also commonly used risk management tools. 
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=== Account management ===
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Clearing organizations receive trading information directly from exchanges. Except for the accounts for clearing members' own trades, the clearing organization is unaware of the ultimate owners of the contracts on its books.
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== References ==
 
== References ==
 
<references />
 
<references />
 
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Latest revision as of 17:22, 15 October 2019

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Clearing is the process by which the rights and obligations arising from market transactions are formally assigned to the buyers and the sellers. Clearing is usually conducted by a distinct organization from the trading operation termed the clearing organization. The clearing organization may be affiliated with or legally separate from the venue where the trading takes place; CME Clearing and the OCC, formerly known as Options Clearing Corporation, are respective examples. In derivatives exchanges, there is only one clearing organization for each contract, so the clearing venue for any exchange-traded derivative is unambiguous at the time of transaction. Accordingly, all ICE Futures US contracts are cleared at ICE Clear US, for example, and all contracts traded on options exchanges in the United States are cleared by OCC.

The term clearing sometimes includes also the successful payment and or other fulfillment of contractual obligations, although settlement is a distinct concept. Settlement refers to any payments to or from the clearing organization or the transfer of ownership of commodities in conjunction with deliveries pursuant to contract terms.

Derivatives Clearing

All exchange-traded derivatives must be cleared. This requirement is dictated by both tradition and law.[1]

For derivatives transactions, the clearing organization substitutes itself at the clearing member level as the counterparty for every trade on an exchange. At the clearing organization, clearing members represent their own and their customers' trades as well as the customer trades of the brokers (futures commission merchants for commodity derivatives and broker-dealers for equity options) becoming the buyer to each seller of a contract or other derivative, and the seller to each buyer.learing member]]s.[2]

Clearing organizations are accessible only to their clearing members, which usually are legal entities. Retail customers, local traders, proprietary trading and brokerages gain access by having accounts with clearing member firms.[3]

Regulations

Clearing organizations for derivatives are regulated by the same governmental bodies that regulate derivatives trading. In the United States, futures clearing organizations are regulated by the CFTC and stock options clearing organizations are regulated by the SEC. In the European Union, clearing organizations are regulated by ESMA with backstopping by "competent authorities" in individual countries. In the United Kingdom, clearing is regulated by the Financial Conduct Authority. Regulation of clearing in China is carried out by the China Securities Regulatory Commission.

Clearing is conducted pursuant to processes and procedures taking the form of clearing organization rules once they are approved by the clearing organization's highest authority, such as its board of directors. The clearing rules are usually approvable or at least reviewable by the regulator before they are put into effect.

Clearing organization rules include membership requirements. The rules usually are incorporated by reference into the contractual relationships between the clearing organizations and their clearing members.

Guarantees

Clearing organizations effectively guarantee financial performance on all open positions by substituting themselves for the original counterparty clearing member in each trade. All clearing members look only to the clearing organization to pay obligations due them on a timely basis.

Clearing organizations usually, if not always, create, manage and control a guarantee fund that is available to them to pay clearing members in the event other clearing members' losses exceed available funds. Guarantee funds are composed of mandatory deposits at levels of value stipulated by the clearing organizations from clearing members.

Risk management

The three pillars of risk management are managing exposures to counterparties by dealing only with clearing members which are vetted for operational and financial capability, paying and collecting variation margin based on daily marking of positions to market, and collection and maintenance of performance bonds for open positions, also known as initial or variation margin. The guarantee fund, contributions from exchanges, retained earnings of the clearing house, and third party insurance are also commonly used risk management tools.

Account management

Clearing organizations receive trading information directly from exchanges. Except for the accounts for clearing members' own trades, the clearing organization is unaware of the ultimate owners of the contracts on its books.


References

  1. PART 38—DESIGNATED CONTRACT MARKETS §38.601 Mandatory clearing. CFTC.
  2. CFTC Glossary. CFTC.
  3. Execution, clearing and Settlement. Thismatter.