Skip to main content

Central Clearing



For those of my readers not familiar with the lingo of the financial world, let me begin with a definition of clearing and then of a clearinghouse.

Clearing is the process by which transactions are reconciled, that is, money matched to the product or service it is purchasing. An institution that "clears" a transaction is also the institution that, in the first instance, runs the risk of default. Simple example: I make some large purchase with a check. The seller accepts my check in payment. In that case, in a common arrangement my bank would be the clearing party, and would bear that initial risk of default.  It is the bank, not the seller, and not in the first instance me either, who will be "out" if my check is in excess of my deposit account.

In finance, then, a clearinghouse (sometimes written in two words as 'clearing house') is an institution that provides clearing and settlement services for commodities, derivatives, or securities transactions.

The issue of whether a transaction will take place on or off a listed exchange is not the same as whether the transaction will be centrally cleared. The trend since the global financial crisis of 2007-08  has been toward ever more central clearing, even in off-exchange, aka over the counter or OTC, transactions. One of the many 'takes' on the crisis was that the absence of central clearing was to blame, and the governments of various developed countries including the US have been working to build up clearinghouses in contexts in which they were not necessarily considered desirable pre-crisis.

Craig Pirrong, finance professor at Bauer College of Business, University of Houston, lists four distinct questions raised by this trend, especially with reference to derivatives trading, thus:

1) Do we want to favor central clearing over bilateral arrangements? There are arguments in favor of the trend, but some bilateralism will surely remain, and the right balance is not at all self-evident;

2) How do different clearing mechanisms affect the allocation of risks, including non-obvious risks and indirect allocations thereof?

3) How will the rules change the scale of derivatives trading?

4) Will the rules, in Pirrong's terms, "affect risk management by end-users and what is the implication of that for the allocation of risk in the economy?"

That is a good list. Here's the link to Pirrong's discussion.





Labels:

Comments

Post a Comment

Popular posts from this blog

A Story About Coleridge

This is a quote from a memoir by Dorothy Wordsworth, reflecting on a trip she took with two famous poets, her brother, William Wordsworth, and their similarly gifted companion, Samuel Taylor Coleridge.   We sat upon a bench, placed for the sake of one of these views, whence we looked down upon the waterfall, and over the open country ... A lady and gentleman, more expeditious tourists than ourselves, came to the spot; they left us at the seat, and we found them again at another station above the Falls. Coleridge, who is always good-natured enough to enter into conversation with anybody whom he meets in his way, began to talk with the gentleman, who observed that it was a majestic waterfall. Coleridge was delighted with the accuracy of the epithet, particularly as he had been settling in his own mind the precise meaning of the words grand, majestic, sublime, etc., and had discussed the subject with William at some length the day before. “Yes, sir,” says Coleridge, “it is a maj...
9 comments
Read more

Searle: The Chinese Room

John Searle has become the object of accusations of improper conduct. These accusations even have some people in the world of academic philosophy saying that instructors in that world should try to avoid teaching Searle's views. That is an odd contention, and has given rise to heated exchanges in certain corners of the blogosphere.  At Leiter Reports, I encountered a comment from someone describing himself as "grad student drop out." GSDO said: " This is a side question (and not at all an attempt to answer the question BL posed): How important is John Searle's work? Are people still working on speech act theory or is that just another dead end in the history of 20th century philosophy? My impression is that his reputation is somewhat inflated from all of his speaking engagements and NYRoB reviews. The Chinese room argument is a classic, but is there much more to his work than that?" I took it upon myself to answer that on LR. But here I'll tak...
17 comments
Read more

Recent Controversies Involving Nassim Taleb, Part I

I've written about Nassim Taleb on earlier occasions in this blog. I'll let you do the search yourself, dear reader, for the full background. The short answer to the question "who is Taleb?" is this: he is a 57 year old man born in Lebanon, educated in France, who has been both a hedge fund manager and a derivatives trader. He retired from active participation from the financial world sometime between 2004 and 2006, and has been a full-time writer and provocateur ever since. Taleb's writings for the general public began where one might expect -- in the field where he had made his money -- and he explained certain financial issues to a broad audiences in a very dramatic non-technical way. Since then, he has widened has fields of study, writing about just about everything, applying the intellectual tools he honed in that earlier work. As you might have gather from the above, I respect Taleb, though I have sometimes been critical of him when my own writing ab...
4 comments
Read more