Difference Between Clearing and Settlement

Clearing vs Settlement
 

Clearing and settlement are two important processes that are carried out when executing transactions in financial markets where a range of financial securities can be bought and sold. Clearing and settlement allow clearing corporations to realize any rights obligations, which are created in the process of securities trading, and to make arrangements so that the funds and securities can be transferred accurately in a timely, efficient manner. The article clearly explains how each of these functions falls into the process of securities trading, explains the relationship between the two processes, and highlights the similarities and differences between clearing and settlement.

What is Clearing?

Clearing is the process of settling claims of one set of financial institutions against the claims of other financial institutions. The process of clearing occurs in between the time a trade is executed and a settlement is made. Once a trade is executed or completed in a financial market, the clearing agency will be notified, who will then carry out the process of clearing the transaction. Clearing is similar to bookkeeping, where the clearing house updates the databases by matching the buyer and seller of the transaction thereby confirming that both parties are in agreement to the terms of trade. Next the clearing house will engage in a process known as ‘netting.’

Since a large number of trades and transactions occur in financial markets in one day, the clearing house uses an automated system to set off the buy and sell orders so that only a few transactions will actually have to be settled. Once the buyers and sellers are matched and netted accurately, the clearing house will inform the parties to the transaction and make arrangements to transfer the funds to the seller and the securities to the buyer.

What is Settlement?

Settlement is the step that comes in last to the process of securities purchasing. At settlement, the buyer will complete his side of the transaction by making the necessary payments to the seller, and the seller will in turn transfer the securities purchased to the buyer. Settlement will be completed when the clearing corporation transfers ownership of the securities to the buyer and once the funds are transferred to the seller.  Stocks and bonds are settled after 3 days from the date of execution; government securities, options and mutual funds settle one day after the execution date and certificates of deposit are usually settled on the same day as the execution.

What is the difference between Clearing and Settlement?

Clearing and settlement are both processes carried out by a clearing house in the process of securities trading. It is important that a strong clearing and settlement system is set in place to maintain the smooth securities trading operations within financial markets. Clearing is the second part of the process which will come after the execution of the trade and before the settlement of the transaction. Clearing is where buyers and sellers are matched and confirmed, and transactions are netted down (set of buy with sell transactions) so that only a few transactions will actually have to be completed. Settlement is the last stage of the process where the clearing house will transfer the ownership of the securities bought to the buyer and transfer funds in payment to the seller.

The main advantage of the clearing and settlement system is the security of the transactions. Since the process is conducted by a clearing corporation, the buyers and sellers can ensure that the delivery of securities and funds will occur in a timely and accurate manner.

Summary:

Clearing vs. Settlement

• Clearing and settlement are two important processes that are carried out when executing transactions in financial markets where a range of financial securities can be bought and sold.

• It is important that a strong clearing and settlement system is set in place to maintain the smooth securities trading operations within financial markets.

• Clearing is the process of settling claims of one set of financial institutions against the claims of other financial institutions.

• Clearing is similar to bookkeeping, where the clearing house updates the databases by matching the buyer and seller of the transaction thereby confirming that both parties are in agreement to the terms of trade.

• At settlement, the buyer completes his side of the transaction by making the necessary payments to the seller and the seller, in turn, transfer the securities purchased to the buyer.

  • Wise Geek

    During settlement, what if there are no shares available in the selling party? What will happen then?