Reviewed by Oct 05, 2020| Updated on
Clearing is a process by which financial transactions are settled. That is the accurate and timely transfer of funds to a seller and a buyer's securities.
A specialised organisation often acts as an intermediary in clearing and assumes the role of tacit buyer and seller in a transaction to communicate orders between the transacting parties. The clearing is important for all buying and selling orders on the market to suit.
The clearing is the method of reconciling purchases and selling of different options, futures, or shares as well as the transfer of funds directly from one financial institution to another. The process reinforces the availability of the appropriate funds, records the transfer, and ensures that in the case of securities, the security is delivered to the buyer.
Non-cleared trades can lead to settlement risk, and where trades do not make it easy to identify mistakes can occur, and real money can be lost. An out trade is a transaction that cannot be imposed since an exchange with contradictory details obtained it. The related clearing house cannot settle the trade because the data on both sides of the transaction provided by the parties is inconsistent or contradictory.
Clearing can be of a variety of meanings depending on the instrument it is associated with. In the event of cheque clearing, it is the mechanism involved in the transfer to the receiver's account of the funds promised on the cheque. Some banks keep funds deposited by cheque because the transfer is not immediate and can take time to process.
With respect to futures and options, a clearing house acts as an intermediary for the trade, serving as the tacit counterparty for both the future or option buyer and seller. It applies to the capital market, whereby until the settlement, the stock exchange validates the capital trade.
Clearing houses charge a fee for their services, called a clearing fee. When an investor pays the broker a commission, this clearing fee is also already part of the commission sum. This fee encourages transaction centralisation and reconciliation, which promotes the effective distribution of purchased investments.