Clearing

Clearing, in payments and financial markets, is the process of transmitting, validating and reconciling the details of transactions between the institutions involved, and calculating the resulting obligations, so that the transactions can be settled. In a payment, clearing is the stage after a payer's bank has accepted an instruction and before money actually moves between banks. In securities and derivatives, clearing covers confirming trades and calculating what each party must deliver or pay, often through a central counterparty.

Clearing is usually discussed together with settlement, the final transfer of funds or assets that discharges the obligations. The two can happen almost at once, as in real-time systems, or be separated by hours or days, as in many batch systems. Clearing is carried out by banks themselves for transfers between their own customers, or by shared infrastructure such as a clearing house, an automated clearing house or a card network.

• Exchange of information. Participants send payment or trade messages to each other or to a central system.
• Validation. Messages are checked for format, completeness, valid account and bank identifiers, duplicates and compliance with system rules.
• Matching and reconciliation. Trades are matched between buyer and seller, and payment records are reconciled so that every party agrees on what was sent.
• Calculation of obligations. The system works out what each participant owes or is owed, either transaction by transaction or as a net figure after offsetting.
• Preparing settlement. The resulting positions are passed to the settlement system, often a central bank's real-time gross settlement system.

In retail payment systems, such as ACH in the United States or Bacs in the UK, banks submit batches of payments that the operator sorts by receiving bank. At the end of each clearing cycle, it calculates each bank's net position and sends it for settlement, a model known as deferred net settlement. Instant payment systems clear each payment individually in seconds, settling either in real time or against prefunded positions. High-value systems, such as real-time gross settlement systems, combine clearing and settlement for each payment.

In card payments, clearing is the step after authorisation. Merchants capture approved transactions and their acquirers submit them to the card networks in clearing files. The network validates each record, applies interchange and fees, and passes the details to issuers, which post the transactions to cardholder accounts. Each record is carried in a clearing message that contains the final amount, which may differ from the authorised amount, along with identifiers used later for refunds and disputes. The network then calculates the net amounts due between issuers and acquirers for settlement through settlement banks.

In capital markets, clearing begins once a trade is executed. Trade details are confirmed and matched, and in many markets a central counterparty (CCP) steps in between buyer and seller, becoming the buyer to every seller and the seller to every buyer. The CCP nets positions, collects margin and manages the default of any clearing member, which greatly reduces counterparty risk. Regulators made central clearing mandatory for many standardised over-the-counter derivatives after the 2008 financial crisis. Securities then settle through central securities depositories, usually on a delivery-versus-payment basis.

Many clearing systems use netting: instead of settling each transaction separately, they offset what participants owe each other and settle only the difference, an approach described under net settlement. Netting reduces the amount of money or securities that must move and the liquidity banks need. However, it creates a period during which participants are exposed to each other: if one fails before settlement, others may not receive what they expected. Systems manage this risk with limits, collateral, loss-sharing rules and, in some cases, guarantees. Legal rules, such as those on settlement finality, ensure that netted positions cannot be unwound if a participant becomes insolvent.

Because clearing systems sit at the heart of the financial system, central banks and market regulators oversee them. Internationally, the Principles for Financial Market Infrastructures issued by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions set standards for governance, risk management, operational resilience and transparency. Systems judged systemically important face the strictest oversight.

• Committee on Payments and Market Infrastructures