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Clearing houses – guardian angels of the financial markets

13 Oct 2020

Clearing houses – guardian angels of the financial markets

200 years of stock trading in Frankfurt: It all began with the share of the Austrian National Bank. Since then, countless companies have financed themselves via the stock exchange – and investors have invested in precisely those companies. With our series “Evolution of exchange trading!” we look back on the origins and milestones of exchange trading from various perspectives.

Ever since people started trading in shares, derivatives and other financial instruments, there has been a need to minimise and hedge the risks inherent in these transactions. This is why clearing houses were invented.

So, they’ve been around for quite some time and, although they are used for different types of transactions, practically all clearing houses fulfil certain basic functions. By centralising and standardising certain classes of financial transactions, they reduce the costs and risks involved in trading between several market participants. In many cases, they also act as guarantors for transactions – as so-called counterparties – and thus help to reduce the credit and liquidity risks of market participants.

In 1853 financial stability was greatly advanced

Commercial banks in New York City foundet the first major clearing house, the New York Clearing House, in 1853 to streamline the clearing and settlement of checks. Before the New York clearing house was founded, employees of 60 banks worked on the clearing and settlement process, rushing through the city to present checks to each other. A time-consuming process that led to disputes and inevitable errors. The establishment of the clearing house improved the situation almost immediately. There were significant savings in time, effort and financial costs, so by the end of the 19th century, many check clearing houses were already in existence throughout the United States. In Europe, as late as 1899, the London Stock Exchange was the only exchange with a clearing house.

The equity and derivatives markets needed a little more time as their control functions were much more complex. In 1892, the New York Stock Exchange (NYSE) took the first steps to improve clearing and settlement by creating a clearing house for some types of brokerage transactions. As trading volumes and the associated clearing costs grew, the NYSE established the Stock Clearing Corporation in 1920. The new clearing house reduced the number of checks required for processing by up to 90 percent and the volume of funds and loans required by 70 percent and more.

A study published in the Journal of Political Economy in 2019 concluded that the establishment of the NYSE clearing house in 1892 “significantly reduced the volatility of NYSE yields caused by settlement risk and increased the value of assets”, suggesting that “a clearing house would enhance market stability and can improve the value of the market by reducing network contagion and counterparty risk”.

Learning from every crisis

In 1907, prices on the NYSE in the U.S. fell by almost half of their 1906 peak, and on the fourth day of the crisis the New York clearing house publicly announced that member banks had been audited and rated as solvent, reassuring depositors. It then offered these banks loans, which were eventually converted into Clearing House loan certificates, one of the benefits of Clearing House membership.

Black Monday in 1987 raised the question of the security of the clearing houses. This led the financial sector to work towards strengthening them.

After the 2008 financial crisis, the G20 countries met in Pittsburgh. The meeting enhanced the importance of clearing houses and, as a result of the agreements reached, clearing houses are now seen as a fundamental part of seeking to avoid financial crises.

Since the 2008 financial crisis, clearing houses have been obligatory for some transactions as “central counterparties” (CCP) between buyers and sellers. If one of the two parties is unable to meet its obligations, the clearing house steps in. This reduces risk and increases transparency and security in derivatives markets. The clearing houses or CCPs are the central, neutral intermediaries for financial transactions. 

Eurex Clearing – we ensure secure markets

Eurex Clearing AG is a subsidiary of Eurex Frankfurt AG and settles all transactions at Eurex. It was founded in 1998, alongside the establishment of Eurex. As one of the world's leading central counterparties, Eurex Clearing serves some 200 clearing members in 19 countries, manages a collateral pool of €49 bn and settles transactions valued at €11 tn each month.

Further information

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Evolution of exchange trading

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Read more about the origins and milestones of exchange trading: from “derivatives” in ancient times to the first share in Frankfurt and the development of trading systems.


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