In finance, clearinghouse is the institution which safeguard the parties of future contract from the risk of default. For this, clearinghouse get commission from both parties. This organisation provides the insurance to seller and buyer of the future contract, if any will default, this organisation will pay.

Now, understand Clearinghouse with following simple example

Suppose, I am Vinod Kumar, I have made cement lenter. Before this, I was steel shed. I want to sell it. Its current market price is Rs. 1000. So, I want to sell it at current market price. I have seen the trend of market price of steel which is increasing and end of month, I estimated, same steel shed's price will be Rs. 1500. So, I went to my friend whose name is Mahinder. I told same. Still, he has no money. He told me, he is interested to buy at the end of month by paying only current price Rs. 1000. I am also ready for this. So, we did future contract. Now, there is two risks of Default this Future Contract

1st Risk of Default : Defaulting by Seller 

You know, Vinod Kumar is honest person. But I am also human being. As seller, I can become defaulter due to greed. For example, If at the end of the month my steel shed's price will go to RS.2500. I can stop to sell because I will huge profit. Why should I sell it on Rs. 1000? Due to this, contract will break. So, this is the big risk of default to buyer. So, he should think this.

2nd Risk of Default : Defaulting by Buyer 

Mahinder may not buy at the end of the month if at the end of price will be Rs. 500 of same steel shed. He can say me easily, I need not your because its price is Rs. 500. So, it is big risk for seller of this asset.

Existence of Clearinghouse

Now, I (seller) and Mahinder (buyer) went to the organisation ABC who take above both risks on some commission. We have done one new contract with this organisation. So, this organisation is for use a clearinghouse. If seller will defaulter, this organisation will give same asset to buyer. If buyer will defaulter, clearinghouse will give the price money to seller. For his service, it will take some commission. We can also say it as clearing house (finance). If this organisation works at company level. We will say it clearing corporation. This organisation also helps to complete the options and swap contracts.

Related : Forward Contracts






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Accounting Education: Clearinghouse
Accounting Education
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