What Is A Clearinghouse?

Most investing brokers, including investment apps, use clearinghouses to ensure that financial transactions settle correctly.

While most stock and ETF sales settle in a matter of seconds, these behind-the-scenes players play an important role in keeping the financial markets safe and secure.

If you use investment apps like Robinhood, Stash, or others, the app enlists the help of a clearinghouse to ensure all transactions take place. Here’s what you need to know about these independent companies that are involved in all your securities sales.

What Is A Clearinghouse?

A clearinghouse (also called a clearing firm) is an independent company that matches buyers to sellers in a securities transaction. By law, all clearing firms must be members of SIPC (Securities Investor Protection Corporation) so that they can offer financial protection to brokers.

These clearing firms protect buying and selling brokerages if one party is illegally trading or if the brokerage goes bankrupt. They also take care of the administrative tasks associated with most financial transactions. Clearinghouses are essential to keep securities markets running smoothly.

Whenever someone wants to buy or sell a financial product, a clearinghouse is responsible for everything related to ensuring that a securities transaction happens. Without clearinghouses, brokers would need to call one another on the phone and email stock certificates to one another (after checks settled at the banks). But thanks to clearing firms, buying and selling stocks takes mere seconds.

Clearinghouses take on the risk of stock transactions while they are in the transaction. Often, they'll only be responsible for a matter of seconds. However, in difficult or complex transactions, the firm may take on more responsibility.

Self-Clearing vs. Independent Clearing

There are two basic types of clearinghouses. The first type are independent clearinghouse which with many broker firms. Apex Financial is an example of an independent clearinghouse. This company is the clearinghouse for apps like:

• M1 Finance
• Betterment
• Wealth Simple
• And many other small companies

Because Apex Financial is an independent clearing company, it charges clients to settle transactions on their behalf (it also requires firms that they work with to maintain enough capital/money to handle the transaction they process). The companies that use Apex Financial typically pass on costs to their clients through management fees, transaction fees, or other types of fees. However, as an investor, you’ll never see a fee directly charged from Apex financial.

The other type of clearinghouse is a self-clearing firm. Many major discount brokers have their own private clearinghouses. These companies have enough trading volume to justify owning an independent clearing firm to settle their transactions. Examples include:

• TD Ameritrade
• Fidelity
• Vanguard
• Robinhood
• And many other large brokers

Self-clearing can mean lower trading costs or lower management fees for clients, but that isn’t always the case. The exact price you pay for your investments depends on the fee structure at a firm.

How Do Clearing Firms Work For Investment Apps?

For an investment app to function properly, it needs to partner with a clearinghouse. You can find out the exact company that services your app by searching “Your Firm, clearing corporation”. These are some of our favorite investment apps and their associated clearing firm.

Should You Choose An Investment App Based On Its Clearinghouse?

Typical investors, even those buying individual stocks, are unlikely to care much about which clearinghouse a company uses. Most trades are executed within a matter of seconds regardless of which clearing firm is doing the work behind the scenes.

However, high-frequency traders, especially those that use margin accounts need to consider clearing firms as well as brokers. A clearinghouse’s rules influence rules related to margin including the assets required to be a margin client.

Clearinghouses are also important if you tend to buy stocks with very low trade volume. Since shares of these stocks can be harder to buy and sell, the clearinghouse becomes more important in the matching process.

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