What is a clearing house? - MoneyWeek Investment Tutorials

so in this video we're going to take a look at an important role in financial markets one that is a little bit hidden to the average retail investor nonetheless gets quite a lot of press comment particularly as eurozone debt problems start to emerge that is preparing house now going houses as I say or a slightly hidden role as an average retail investor you only hear about them really when things go wrong in a way or they change the rules and cause one or two of the major players in the market giving banks or panic a bit so what they do when they fit in and what causes the panic that we've seen in the last couple weeks as the eurozone bomb crisis unfolds okay so clearing houses basically fit in here now if you are a broker for example and you have a lot of clients wanting to buy shares so imagine you've got retail clients or to buy a similar share you've got institutional clients giving you buy orders what you might do as a broker is group them together it's called aggregation so you've got a nice juicy big order because you don't pay as a broker Commission's to stop market too often so you get a big juicy buy order aggregating lots of small ones together and then you go shopping you think right I need to fill this order where am I going to go and the place you go normally to do a big deal as if you like a professional a stock broker is the London Stock Exchange you don't have to for other exchanges that would be a good place to start shopping and the point about stock exchanges is that when it comes to doing a deal to buy or sell shares that's where you would typically go so stock exchanges are associated with deals being done and for anyone who's not sure about the role of an exchange I do have a separate video explaining what is a stock exchange so that could be used for background for this one I'm gonna keep it very short for this particular video okay for anyone wants the wider context still there is an introduction to potential markets available in my series as well ok so the stock exchange is a place where people deal and the something might employ people to shouts to each other and wear colorful shirts like in New York my ring bells or it might be silent electronic like it is in London but the job is the same basically the stock exchange is matching buy and sell orders and trying to get deals matched at the best possible prices BIOS trying to buy as low as possible so there's lots you trying to sell as high as possible and the stock exchange bringing them together in a big marketplace ok so that's not today's video that's not a clearinghouse what is a clearinghouse well here's a problem now anyone who's bought a property or know about this problem you got a look at a property you'll agree a price with the seller and then it can take months to get your hands on front door keys ok so the gap between doing the deal and only in the property can be months well in the stocking slop market you'll be glad to know it's not months but it is a few days and they're trying to close the gap over time so normally it takes three working days between a greater price if your buyer and paint the shares okay and that creates the risk and the risk is that it all goes wrong all right what if a buyer doesn't pay up what if a seller doesn't deliver shares or somebody suffers so enter the Clearinghouse which suggests there is a roll call theory and it's done not surprisingly by a clearinghouse now the sort of names here on these are not household names to be honest London Clearing House clear net is a good example that's - they've got together emerged alright but not something you've seen the press every day another survival role because they provide a guarantee and it's a very important guarantee and we'll see how they do it in just a moment they basically say as soon as the deal is struck at the London Stock Exchange they step in and guarantee it the other words they say although there's a gap between the deal being done that's the price of the number of shares being agreed and actual legal entitlement to them because shares our re-registered and name of buyer well there is a gap we'll make sure nothing goes wrong in other words if the seller doesn't deliver the shares they've promised here we'll deliver them if the buyer doesn't hand over - on the right day we will that's quite a big promise to make it an important one it boosts the number of deals that get done is without that guarantee people might not trust the stock exchange they might not be prepared to do anonymous deals at the London Stock Exchange so that guarantee is quite important because it enables people to trade faceless lis without revealing who they are the stock exchange quite attractive and also it encourages people to come to the stock exchange now before we talk about that in a bit more detail or plants today's video um there is a third role which I'm not going to talk about much in this video called settlement and that's where you actually get some electronically these days legal title to the shares change shares have to be leaving me registered like property so that means that the sellers names got to come off a registered somewhere the buyers name could go on to it and the cash is actually moved from the buyers bank kill the sellers bank account by The Clearing House okay and there are organizations that do that one of them is called European crest though I won't talk about that in today's video just be aware that there's a three-stage process and of course if you're wondering why you pay your broker $9.99 per trade it's because they have to pay about a bit that bit and that there probably doesn't cost them $9.99 per trade in total but nonetheless in principle that's what you've been charged for and here's the volume when do you as you know a retail investor ever see these organizations elsewhere you don't because you just ring your broker say buy me a thousand Tesco shares but the brokers then go to worry about where they get where he gets them from whether the new risk of the trade failing and also we registering legal title that kind of stuff so however clearing houses offer this central counterparty guarantee as is known how can they promise that nothing will go wrong quite a promise to make here's the answer okay what they do now I'm not going to get too techie about this you'll be glad to know what they do is they stick in between the buyer and the seller and take over the entire contract so imagine normally you'd expect divided by a thousand chairs from you this morning you'd expect it to be a simple contract whereby I pay you cash at some point you deliver shares and everybody's happy okay what we're saying is the way the markets organize things is yeah that is going to happen eventually but basically what the markets do is they say well the deal at the London Stock Exchange needs to be guaranteed by somebody so London Clearing House especially that's an example the LCH London Clearing House clear net to get its full name Brinks the contract the moment the terms are agreed at the exchange and it becomes the seller to every buyer this is what I mean by central counterparty and the buyer to every seller so the lawyers out there if that's the process breaking a contract like that is known as innovation I'm going to worry about that too much but basically they step in to create two contracts where there was one they literally divide it in two so now they're saying is actually you're dealing with us now so the seller will be delivering shares to London carrying us all right and negotiating with them if it doesn't work out or being sued by their move it doesn't work or whatever over here the buyer has a deal with own Clearinghouse alright they no longer care who that person is they'll never see that person ever meet that person they may not even know the name alright because they know the deal has been taken over automatically by LCH and if something goes wrong the contracted LTH so quite a promise they're making here this is whoever these people are and they're set up by the city falsity okay whoever they are that's quite a bit promise to make you think of the millions of shares that are transacted every day and they're stepping in and guaranteeing both sides very single contract how do they do that here's the answer is something called margin and I will be taking this on in another video doesn't just apply to share transactions it applies to bonds derivatives all kinds of other stuff here's the principle what they do is this n was to provide the guarantee okay to both sides of the contract both parties to the contract we need to deposit the moment you strike a deal with the London Stock Exchange okay to buy or sell shares we want to deposit another deposit is not the full value of the contract again we're not that suspicious that people won't deliver or one of their promises we want a proportion of the value of the trade on deposit with us until the whole thing's wrapped up in three working days tonight and then both of you can have your deposits back all plus a bit of interest right so they take it a pot it up the amount varies and I'll get into that in another video but let's call it 10 to 15% of the value of the contract so for a thousand Tesco shares has to be put up from on deposit in an account held organized by London Clearing House and as long as the buyer ends up paying the full amount of to say three working days and the seller delivers all the shares they promised then those deposits are returned all right now why would they only take a proportion of the value the contract why not the whole whack will impart it's because only certain people can join the club and become sellers and buyers that use LCH all right Oh where's the likes of Tim Bennett where we let in I don't trade often enough or big enough I'm important I don't know these okay but stockbrokers the child Stanley's this world the Goldman Sachs the Barclays for example might become a member so that they can try big volumes at the London Stock Exchange and have those big deals guaranteed by like the clearinghouse okay because it's a risk business we're talking about here so really this central party gap central kind of body guarantee only applies really to the big trades in terms of risk of non delivery of cash not delivering shares and therefore membership tends to be restricted like it is a London Stock Exchange to a list of eligible institutions they're called but that just means firms that have met the membership criteria all right so long and having hours produced a risk and fairly lengthy join they then decrease it further by taking this thing called margin up front which is refundable once both sides have honored their part of the bargain now going to finish this video the quick mention of the Italian bond market when you see these people in the newspaper the answer is days they often don't but eurozone debt woes are throwing them into the the news of the news more often that they would be normally because if London hearing house get worried so for example imagine this is a contract involving Italian government bonds for example and there's some uncertainty a bold status Italian debt at the moment then what London Clearing House can do is say well actually we're a bit nervous we're providing the center care central counterparty guarantee on every contract but actually we are a bit worried about the subject of the contract so they can boost margin requirements you'll see that comment made in the press but so today under the Clearinghouse increase the margin requirements on contracts involving Italian government bonds for example and that means they're saying well the percentage you put down upfront is no longer five frogging say it's 10 or 15 the map created a cash flow headache for the people who use on them terminals because suddenly they've got put a lot more cash up front than what they were normally expecting and the effect that that can be put people off trading the contract it can actually reduce the number of trades that go through the market on that contract that's known as reducing liquidity in the initial jargon and it's there you're most likely to come across London Clearing House Claire net in action you

Channel: MoneyWeek

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Keywords: clearing house, finance, credit, 'stock, market', investments, tutorials, money, Trading, Tutorial, Stocks, Analysis, Investment, Trade

Id: 2hp9w-gXRjM

Length: 12min 21sec (741 seconds)

Published: Fri Nov 18 2011