Clearing Broker: Definition, Role, Vs. Prime Broker

What Is a Clearing Broker?

A clearing broker is a member of an exchange that acts as a liaison between an investor and a clearing corporation. A clearing broker helps to ensure that the trade is settled appropriately and the transaction is successful. Clearing brokers are also responsible for maintaining the paperwork associated with the clearing and executing of a transaction.

Key Takeaways

  • Clearing brokers are liaisons between investors and clearing corporations.
  • The key job of clearing brokers is that they ensure the securities market runs smoothly and efficiently.
  • Clearing brokers handle buy and sell orders but also maintain custody of account owners' securities and other assets.
  • Aside from clearing brokers, other types of broker-dealers do not have the authority to clear transactions.
  • Clearing brokers are responsible for maintaining transaction records and reporting them to the appropriate institution.

How a Clearing Broker Works

Clearing brokers are the backbone of the securities market because their expansive knowledge ensures that the system is dependable and efficient. They must also research and confirm the information they are given and manage funds associated with the transaction.

Clearing brokers not only handle orders to buy and sell securities but also maintain custody of an account holder's securities and other assets (such as cash in the account). Because they have custody of customer assets, carrying firms must maintain higher levels of net capital than introducing firms—and they are responsible for segregating the customer funds and securities in their custody.

A clearing broker helps to make sure that trades are settled appropriately and that the transaction is successful. Once an order is executed, the clearing broker works with a clearing corporation to make sure all funds are handled and transferred properly. Many consider clearing brokers to be the “backbone” of the securities market because their services help make the system simple, reliable, and efficient. Outside of clearing trades, clearing brokers are also involved in researching to confirm the information they are given is exact, and they also manage funds associated with a transaction.

Clearing Brokers vs. Other Broker-Dealers

Aside from clearing brokers, other types of broker-dealers do not have the authority to clear transactions. Therefore, other broker-dealers will generally have one clearing broker with whom they work to clear their trades. An introducing broker, meanwhile, introduces their clients to a clearing broker. In this case, the introducing broker will send their clients’ cash and securities to a clearing broker to clear the trade, and the clearing broker will also maintain the customers’ accounts.

Introducing brokers earn commissions that are based on the volume of trades their client makes or if they are introducing trades on a delivery versus payment basis, their revenue is earned on the spread between the buy and the sell. 

Investment brokers are involved in investment banking by helping to find buyers and sellers of investment securities. They often give investment advice to their clients and earn advisory fees, which could be commission or fee-based. Investment brokers are also involved in private placements, in which they receive flat fees or commissions. Market makers, meanwhile, are a unique type of broker-dealer that assists in stabilizing the market by providing liquidity. 

What Is the Difference Between a Clearing Broker and a Prime Broker?

A prime broker is a company that employs executing brokers, carrying out trades in the name of their clients, which are usually institutional investors or hedge funds. Clearing brokers are the ones responsible for taking the trade placed through the prime brokerage and executing it on the exchange which employs the clearing broker.

How Do Clearing Brokers Make Money?

Clearing brokers themselves are employees of an exchange, and as such as paid to facilitate trading and order settlement between those requesting, or placing, the trade and the exchange.

What Does a Clearing Company Do?

A clearing broker will work for a clearing company, which ensures that a trade is settled appropriately and the transaction is successful. Clearing companies are also responsible for reporting the trades while maintaining the paperwork required.

Do Hedge Funds Use Brokers?

Hedge funds, due to the amount they trade and their importance to the exchanges, will usually have a dedicated broker who handles their trades promptly and at the best possible terms. This is an extremely important relationship and one which both the fund and the broker cultivate regularly.

How Is a Clearing Fee Calculated?

A clearing fee is a fee charged on transactions as a way to compensate the clearinghouse for completing the transaction. The fee varies on the type and size of the transaction and can be quite high for futures traders. The three largest clearing houses are CME Clearing (a unit of CME Group Inc.), ICE Clear U.S. (a unit of Intercontinental Exchange Inc.), and LCH Ltd. (a unit of London Stock Exchange Group Plc).

The Bottom Line

Clearing brokers act as an intermediary between those placing trades and the exchange from which the trade will be sourced. They report trades to the governing body, ensuring all trades are processed/settled in a legal and efficient manner.

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