A form of settlement where responsibility for payment is passed to a third party: a Clearing House or Clearing Broker

The Clearing House accepts responsibility for settling the deal.

Credit risk for the seller in the trade is reduced to almost zero

The Clearing House minimizes its Credit Risk by daily margining

Detail

An organization may trade on an Exchange either by becoming a member of the Exchange, or trading through an Exchange Broker. The clearing principles are similar in either case

In general a trading organization engages a Clearing Broker to act on its behalf

The trading organization is required to open a margin account with the Clearing Broker, which in turn maintains a margin account with the Exchange's Clearing Bank

As the organization enters into a trading position the Exchange marks the trades to market on a daily basis, and transfers cash into or out of margin accounts based on the change of the value of the trading position since the previous day. The Clearing Broker mirrors this operation to its clients' margin accounts

Every trading organization is required to maintain an amount of cash in the margin account to cover a substantial short term loss in the value of its position. If the trading organization does not maintain this margin then the Exchange closes out the position immediately, using the margin account cash to cover any losses as a result of the close out

Payments into the margin account as a result of new trades that cause an increased open position are called Initial Margin payments

Payments into the margin account as a result of the value of trades falling are called Variation Margin payments