What is the International Clearing System
The International Clearing System is a trading system used when futures contract transactions occur on an international or an inter-country level. It is designed to promote world trade and market efficiency. Most international clearing transactions are administered by an international clearing house.
BREAKING DOWN International Clearing System
The process of clearing a trade includes all actions and events that take place between the commitment to transact and settlement. It essentially converts the promise to pay money and deliver the contract into an actual transfer of each from one account to the other.
Clearing is necessary for the matching of all buy and sell orders in the market. It confirms the specific type and quantity of the traded instrument, the transaction price, date, and the identity of the buyer and seller. Basically, it creates more efficient markets as parties interact with the clearing corporation rather than with each other.
For example, if a company wanted to purchase a futures contract for wheat from a foreign party, they would need to contact a clearing house, which will use the international clearing system to match the trade with another party. The other party, who will assume the opposite position (in this case, the one who is looking to sell the wheat contract) in the futures contract, will have also contacted a clearing house in their respective country, who will also use the international clearing system.
Individual countries have their own clearing mechanisms and requirements. Therefore, in a global world with parties trading futures outside of their home markets, a system to coordinate internationally is a must. Now serving in this role is the London Clearing House Ltd (LCH).
International Clearing House
The function of international clearing was performed by the International Commodities Clearing House (ICCH). The ICCH was an independent clearing house providing clearing or central counterparty services in several markets.
However, when the ICCH ceased to exist, the LCH took over to assume the counterparty risk when two parties trade, guaranteeing the settlement of the trade. To mitigate risk, it imposes minimum requirements on members and collects initial and variation margin or collateral for executed trades. LCH's members include most major investment banks, broker dealers and international commodity houses. Oversight is by the national securities regulator or central bank in each jurisdiction in which LCH operates.
The LCH operates an open-access model with a choice of execution venues. LCH Ltd is the group’s UK-registered clearing house. It has clearing services for rates, foreign exchange, repurchase agreements, or repos, and fixed income, commodities, cash equities, and equity derivatives.