Modern-day clearing services are incredibly flexible!

In simple terms, clearing services relate to the process of reconciling purchases and sales across a range of different investment assets. Ultimately, this will lead to the exchange of funds and stock to settle a transaction. It all sounds straightforward in theory, but in practice, it can be a little more complex. However, the modern-day system is highly flexible!

 

Why are clearing services so important?

 

Investment clearing services are carried out in conjunction with a clearinghouse which adds a significant degree of trust to the market. The clearing process is guaranteed using an array of financial safeguards meaning those members using the clearinghouse are in a position to settle their trade. This helps to maintain market integrity and encourages enhancedliquidity.

 

If a clearinghouse member was to go out of business, unable to clear outstanding trades, the combined power of the clearinghouse members is used to safeguard these transactions. Due to this safety mechanism, clients dealing through clearinghouse members will always see their trades honoured.

 

What happened before clearing houses?

 

It is important to say that clearing services in the shape of clearinghouses have been around for more than a hundred years. While clearinghouses were very different in the earlydays, it quickly became apparent that when buyers and sellers were dealing directly, there were no guarantees. For example,if a buyer was to acquire an option to purchase 10 tons of grain at a fixed price in 12 months, this was done on trust; there were no guarantees.

 

Failed trades and disagreements prompted the introduction of third parties bringing buyers and sellers together to "clear transactions". This started the clearing services industry we know today, which is integral to all investment markets. We have seen significant developments since then, with electronic clearing and safe custody services working hand-in-hand.

 

Back-to-back clearing services for traders

 

As a short-term/day trader, you will likely open and close numerous positions on the same day or trade over a number of days. Back-to-back clearing services ensure that settlement dates for the purchase and sale of any assets can be matched. For example, you might buy a stock on Monday for settlement on Wednesday. This may be funded by the sale of another investment on Tuesday. Using the same settlement period, the sale will be settled on Thursday, leaving a 24 hour unfunded position. 

 

Using back-to-back clearing services, the settlement date for the sale could be adjusted to Wednesday. In effect, this creates a position where the purchase and sale are settled on the same day and "netted off". This ensures that your funds are available to reinvest/withdraw as soon as possible.

 

Prime broker back-to-back clearing services

 

Many traders/investors have a prime broker, their principal financial adviser, who often holds their investment assets in safe custody. While it is relatively simple to deal in any stock market worldwide today, it is often easier to use specialist brokers in a particular field. This ensures that you obtain the best price for your transaction and settlement is completed in an orderly manner. So, where do back-to-back clearing services come in?

 

As your prime broker usually holds your investment assets in safe custody, keeping your new investment under the same umbrella makes sense. So, the third-party broker will settle your transaction and then deliver the stock to your prime broker. This transaction involves the receipt and delivery of stock and is therefore deemed a back-to-back transaction.

 

Clearing services dictate trust

 

As traders, we often take clearing services for granted when they are critical. They ensure that funds and stock are available on settlement date and support market integrity. If investors have no confidence that every transaction will be settled on time, this won't encourage high-volume trading. In turn, this would reduce liquidity and may impact the ability to deal in size at the “correct” price. There are many knock-on effects to a lack of trust!

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