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As I understand it a trade works as follows. A buys from B on an exchange. Instead of a direct exchange, A and B report the trade to their clearing brokers. The clearing brokers then submit the trades to a clearing house and if they match then the clearing house processes the trade. In case that A or B default, the clearing house guarantees the trade.

I have also heard, however, that both the exchange and clearing brokers also guarantee the trade. How is the risk shared? More specifically:

  1. Is the exchange's role in guaranteeing trades just to require participants to have a clearing broker? If so, what's the point of exchange margin requirements if the clearing broker guarantees the trades?
  2. My guess is that the clearing house losses are split among the constituent clearing brokers so they all share the risk together. Is this true?
  3. How is the risk distributed across clearing brokers in a clearing house? Do they have to put in more collaterals / pay more fees if they bring in bad trades?
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  • Questions of personal finance/investing are considered off topic on Economics.SE see our help center for topics that are on/off topic. This is likely to be on topic on personal finance and money stack so I am moving it there. Possibly you could also try quantitative finance stack. – 1muflon1 Jan 31 at 10:37
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To a degree that can not be answered because it depends on jurisdiction and often even exchange - it works different for futures than for stocks.

This is one reason why GME stocks where limited for RobinHood, btw. - RobinHood could not handle the desired payments to guarantee the clearing risk, which had to come OUT OF IT'S CAPITAL - not out of customer funds. Because GME was such a big outstanding issue, they would have to deposit 10% of the net price as guarantee. Again, out of THEIR funds - customer funds can then only be used for payments. Hence the trading limitation.

Generally a lot of parties give a lot of guarantees and back them up with financial guarantees. The details seriously depend, also on circumstances. In case of stocks, the brokers all use in the USA ONE clearing system, and have generally to deposit 2% to 3% of the outstanding balance as guarantee. So, for stock X you get 1000 units, deliver 2000 units, that is an outstanding balance of 1000 units. Here is the issue, though - if that balance gets bigger (because your clients trade asymmetric) that percentage goes up. Example: GME recently in RobinHood - everyone went long, so nothing to offset and the clearing side suddenly demands 10%. Ups. And this guarantee is the BROKER's guarantee- so it does not come out of client segregated funds.

Stocks in the USA clear T+2 (up to 2 days after trade). Futures otoh clear between FCM (Futures Comission Merchants) END OF DAY - there is no outstanding balance, everything is squared in the evening.

Other countries have other regulations. Actually the T+2 setup in the USA is "historic" -there is no reason really today to take 2 days to clear stocks.

You literally need to define a lot more parameters and then start reading up. There is no "one answer fits all".

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  • So answer to 2 and 3 is that the collateral is marked to the amount of risk the brokerage brings in (asymmetric trades and volatile stocks). How about 1? Do exchange's guarantee anything beyond requiring each side have a clearing broker? – curiousgeorge Jan 31 at 22:59

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