As per Dodd-Frank regulation, some trades are required to be cleared by the Central Clearing Counterparties (CCPs) in order to mitigate credit risk. For clearing through CCP, it has to be routed through a registered broker at the clearing house or CCP, also known as Clearing Broker.
Most of the investment banks are already registered with the Clearing houses and act as clearing brokers to other parties. As clearing broker, they help clients to clear their trades. A financial institution can become a member of a clearing house or CCP by completing a pre-qualification process and depositing required securities or cash with that clearing house as collateral. This is considered as security deposit towards the clearing fund maintained by a clearinghouse.
For an example, Client A approaches Clearing Broker CB to clear a trade at Clearing House CH on its behalf. In this case, there will be two trades
- A trade between Client A and Clearing Broker CB
- Another trade between Clearing Broker CB and Clearing House CH
- Client A will deposit the required fund or collateral to Clearing Broker CB to clear the trade on its behalf
- CB will use its member security deposit or additional fund to clear the trade at Clearing House CH
- In this process, credit risk can be mitigated completely
Note: All Investment banks are mostly member of all the important Clearing Houses across different regions and they can clear their trade easily without approaching a Clearing Broker.