Clearing house can be defined as entity which is different from the exchange, although it works closely with the exchange so that day to day operations of the exchange can run smoothly. Clearing house is integral part of the derivatives market.
Here are some of the important functions performed by the clearing house –
1. As clearing house give guarantee for all the transactions and acts as counterparty for all the transactions it will never have open positions in the market.
2. It ensures that all parties adhere to the system and procedures so that various parties in the market can do trading smoothly which in turn leads to more confidence of the players on the markets and hence it increases liquidity in the market.
3. It ensures a proper risk management system in place by stipulating that margin is maintained which is of two types – initial and maintenance margin and hence accounting is done for all the gains and losses on daily basis and hence chances of default are reduced considerably.
4. It ensures that delivery of the underlying asset is consistent in terms of quality, quantity, size etc… so that there is no confusion among parties, in other words all contracts are standardized.
Hence from the above one can see that clearing house is the backbone of the derivatives market and is very important for smooth running of the derivatives markets.