A typical contract between two financial-market participants involves one agreeing to sell and later deliver a product (say, shares) and another agreeing to pay for it. The seller and buyer can agree terms privately (or ‘over the counter’).
But there are at least two problems. First, what if a big seller wants to remain anonymous so that word doesn’t spread that they are trying to dump assets? And what if one party fails to honour their side of the bargain by not paying (buyer) or delivering (seller) on the agreed date?
Enter a clearing house. When share deals are arranged anonymously via, say, the London Stock Exchange, they are immediately adopted by the clearing house LCH.Clearnet. It guarantees the buyer will pay and the seller will deliver, typically three working days later, for shares.
• Watch Tim Bennett’s video tutorial: What is a clearing house?