How Clearinghouses Make Money
Direct answer: Clearinghouses interpose themselves between buyers and sellers in financial transactions, guaranteeing settlement and reducing counterparty risk. They earn revenue through clearing fees per transaction, interest on margin and collateral deposits held from members, and membership fees.
The Role of a Clearinghouse in Financial Markets
When a buyer and seller agree on a trade in a financial market, there is a gap between when the trade is agreed upon and when it is settled (when securities and cash actually change hands). During this gap, either party could default. A clearinghouse eliminates this risk by stepping in as the central counterparty: through a legal process called novation, the original trade is replaced by two new trades, one between the buyer and the clearinghouse and one between the clearinghouse and the seller.
Now each party only has exposure to the clearinghouse, not to their original counterparty. This makes markets far safer and more efficient, because participants do not need to assess the creditworthiness of every counterparty they might trade with. The clearinghouse absorbs that counterparty risk and manages it systematically through margin requirements and default funds.
Clearing Fees: Transaction-Based Revenue
For every transaction cleared through a central counterparty clearinghouse (CCP), the clearinghouse charges a clearing fee. These fees are typically small in absolute dollar terms per transaction but add up across the enormous volumes of trades in modern markets. For equity markets, clearing fees are in cents per transaction or fractions of a cent per share. For derivatives, they are often per-contract.
The fee structures vary significantly between asset classes and clearinghouses. NSCC, the equity clearing subsidiary of DTCC, charges members fees based on their transaction volumes with various tiered rate structures. CME Clearing, which clears futures and options traded on CME Group exchanges, charges per-contract clearing fees that vary by product type and often include a component that goes to the exchange and a component that goes to the clearing function.
Interest Income on Margin and Collateral
To protect against the risk of a clearing member defaulting, clearinghouses collect initial margin (also called performance bond in futures markets) when positions are opened. They also collect or pay variation margin daily to reflect gains and losses as market prices move. The pool of margin and collateral held at any given time represents enormous sums of money.
This pool is invested in highly liquid, safe assets such as U.S. Treasury securities and money market funds. The yield on these investments minus the amount returned to the members posting the collateral is a significant source of income for clearinghouses. When short-term interest rates are higher, this income stream is more valuable. CME Group, for example, discloses this interest income in its financial results as a material contributor to its Investment & Other Revenue line.
Membership and Technology Services
Clearinghouses charge membership or access fees from the broker-dealers and banks that are direct clearing members. These fees may cover access to clearing systems, regulatory reporting tools, and the right to use the clearinghouse's netting and settlement infrastructure. Some clearinghouses also charge for trade compression services, where open derivative positions with offsetting characteristics are replaced by a smaller number of positions with the same net risk profile, reducing the gross notional outstanding and the associated margin requirements.
What does a clearinghouse do?
A clearinghouse interposes itself between the buyer and seller in a financial transaction, becoming the buyer to every seller and the seller to every buyer through a process called novation. By standing in the middle, it guarantees that the trade will settle even if one party defaults. To do this safely, it collects margin and collateral from clearing members and maintains a default fund that can absorb losses if a member fails.
How do clearinghouses earn revenue?
Clearinghouses earn revenue primarily through per-transaction clearing fees on every trade they clear, and through interest income on the margin and collateral deposited by clearing members. Membership fees paid by clearing members provide additional stable revenue. Some clearinghouses also offer trade compression services for an additional fee.
What is the DTCC and what does it clear?
The Depository Trust and Clearing Corporation (DTCC) is the dominant clearing and settlement infrastructure for U.S. equity and fixed-income markets. Its National Securities Clearing Corporation (NSCC) subsidiary clears equities and other securities. Its Depository Trust Company (DTC) subsidiary serves as the central securities depository. Together they handle the vast majority of U.S. securities transactions.
What is margin in the context of clearing?
Margin is collateral that clearing members post with the clearinghouse to cover potential losses on their open positions. Initial margin is collected when a position is opened. Variation margin is collected or paid daily to reflect gains and losses as prices move. The clearinghouse earns interest on cash margin by investing it in liquid, safe instruments, keeping the yield in excess of what it returns to members.
Is clearing the same as settlement?
Clearing and settlement are related but distinct processes. Clearing occurs after trade execution: the clearinghouse steps in as central counterparty, confirms trade details, nets offsetting positions, and calculates margin requirements. Settlement is the final transfer of securities and cash, completing the trade. In U.S. equities, settlement occurs two business days after trade date (T+2). The clearinghouse guarantees the trade between execution and settlement.