When some online brokers including Robinhood Markets Inc. and Webull Financial LLC moved this week to restrict trading in GameStop Corp. , AMC Entertainment Holdings Inc. and other stocks, fueled by Reddit’s WallStreetBets forum, they did so in part because of obligations with clearinghouses that help ensure trading across the market isn’t disrupted by defaults. Here’s how it works.
What is a clearinghouse?
Consider the basics of trading: Buyers and sellers must agree on a price. The buyer then must pay the seller, and ownership must be formally transferred.
Enter clearinghouses. The clearinghouse collects and distributes payments and transfers ownership. So traders are free to focus just on price, and to take the best price in the market regardless of who is offering it. Neither side has to worry about the other’s ability to pay.
For stocks in the U.S., the main clearinghouse is National Securities Clearing Corp., which is part of a larger clearing organization that operates in other markets, called Depository Trust & Clearing Corp.
How do they work?
Clearinghouses serve to mutualize risk. Members keep cash or collateral such as Treasury securities at the clearinghouse to cover their own activities and the obligations of other members should they fail. The clearinghouse might ask the members to post more of this money, often known as margin, if they are making riskier trades. The aim is to ensure that no individual member’s failure causes the whole system to collapse.
This content was originally published here.