In the field of trading operations, clearing of transactions is a very important process. Clearing is often considered guaranteeing the settlement of a contract between two parties, like a form of insurance. Nevertheless, it concerns much more than that. Clearing denotes various activities from the time a commitment is made to the settlement of a contract. Amongst others, netting is a subset of clearing. In case of exchange-trading, multilateral netting is the actual process of balancing all executed transactions of all exchange members at the end of a trading day and summing the position of an individual member with its position at the start of the trading day, to establish the firm’s new position.
Generally speaking, clearing incorporates all activities from the time a contract is entered into until it is has actually been settled. (For an option, which is not exercised, this may mean until the contract has expired). Even more, clearing involves the management of open contracts. Hence, clearing concerns managing post-trading, pre-settlement credit exposures. This way, it is ensured that all trades are settled in accordance with contract specifications and relevant market rules, even if one of the parties to the contract fails to meet its obligations, for instance, because this party has become insolvent prior to settlement.
Activities covered in the clearing process are position reporting, price reporting, monitoring, margining to cover open exposures, netting of trades to single positions, tax handling and failure handling.
Settlement of commodity contracts usually involves delivery-versus-payment. This is why clearing of delivery has to be arranged for, as well as clearing of payment. After all, counterparty risk consists of delivery risk for the buyer and credit risk for the seller.
- Clearing of delivery is necessary to turn the promise of supply into actual movement of the commodity from the seller to the buyer.
- Clearing of payment is necessary to turn the promise of payment into actual movement of money from one bank (account) to another.