Clearinghouse
1 min read
A clearinghouse validates, finalizes, and settles transactions or trades between counterparties. Clearinghouses exist to mitigate risk amongst transacting parties, and do so primarily through margin requirements. Margin requirements obligate a party to maintain a specified minimum amount of cash in a margin account, called margin maintenance, as a form of assurance.
Clearinghouses transmit large quantities of money from one bank to another through the U.S. Federal Reserve System on a daily basis. Clearinghouse transmitted funds are processed, reconciled, and settled in batches.
When a trader purchases equity on margin, the clearinghouse lends cash and uses the trader’s equity as collateral. If a trader’s equity falls below the margin maintenance threshold, then the clearinghouse will issue a margin call demanding that more cash or securities be deposited into the account to satisfy margin requirements.
The clearinghouse may force the trader to sell assets if the margin maintenance threshold is not met in the specified time. Many large exchanges, including the New York Stock Exchange, require a 25% margin maintenance threshold for traders. The Financial Industry Regulatory Authority (FINRA) sets margin requirements for day traders to mitigate the risk of traders borrowing and losing clearinghouse funds on unsuccessful trades.