How Clearing and Settlement Work

Clearing and settlement are two different processes that involve transferring funds and securities from one person to another. The clearing house is the organization that manages these processes, which involves updating databases to match buyers and sellers. It matches the parties who agree on the terms of the trade, and then transfers the securities to the buyer. While the clearing house manages the entire process, it also acts as a middleman between the parties involved. Here's how clearing and settlement work.

Clearing involves two different processes that allow companies and investors to execute trades: one for the securities involved and another for the money. Both processes are important for the stability of the market. Ideally, clearing and settlement should be done as efficiently as possible. To ensure accuracy, the clearing process should be error-free. Any errors will prevent a trade from being settled. Fortunately, clearing and settlement are both required by law. Listed below are some of the benefits of clearing and settlement.

Deferred net settlement systems mitigate credit risk by introducing more frequent settlement windows and adding prefunding and collateral requirements. They also monitor the balances of participating financial institutions. Although deferred net settlement systems are more expensive, they do help minimize credit risk. And, as the market becomes more complex, the payment networks may use different mechanisms to settle interbank obligations. Clearing and settlement are the foundation for a market economy. The two processes complement each other.