Clearance and Settlement

A trade is cleared when the two sides of the trade are compared to make sure they match. In many transactions, a clearinghouse will become the other party on a transaction. This reduces the risk for the broker-dealer because the broker-dealer doesn’t have to worry that the other party won’t pay for or deliver the security. In this way, the clearinghouse takes on the counterparty risk.

A clearinghouse, also called a clearing facility or a clearing corporation, is the entity that clears trades for an exchange, and becomes the counterparty to the transaction. The National Securities Clearing Corporation (NSCC) is the largest clearinghouse and clears all trades executed on the two largest exchanges in the U.S.: the NASDAQ and the New York Stock Exchange (NYSE). It also clears over-the-counter trades for NASDAQ and NYSE members. After trades are executed on an exchange, trade confirmations are automatically sent to the NSCC for clearing. The clearing broker-dealers assist the clearinghouses and executing broker-dealers by providing the back office operations necessary to clear the trades and by retaining the appropriate records. Clearing broker-dealers are usually members of the clearinghouse.

After comparing the trade, the clearinghouse (in most cases the NSCC) will net the trades for the executing broker-dealer. “Net,” in this case, means subtract the buy orders from the sell orders. For example, if, at the end of the day, a broker-dealer has accumulated seven buy orders totaling 12,500 shares of Microsoft and six sell orders totaling 10,000 shares of Microsoft, the broker-dealer will owe the clearing agency the cost of 2,500 shares of Microsoft (12,500 shares bought – 10,000 shares sold). This is often referred to as continuous net settlement. Continuous net settlement is a type of clearing practice where buy and sell orders are not s