What’s the difference between a clearing firm and a custody firm?

Clearing services are a crucial part of the trading system. While there are some similarities in the respective functions of clearing and custody services, there are some crucial differences in the precise role they play and their relationship to the parties involved. 

Here we take a brief look at the services both provide and the role they play in the trading system. What are they, why are they both required and how do they differ?

What is a clearing firm?

The clearing firm is a crucial component of the trading process. They act as an intermediary between the customer and the exchange and work to guarantee that the customer fulfils their obligations under the contract. They make sure that money and stocks make it to their intended destinations.

Clearing services handle the so-called ‘back office’ details that are all important to a seamless transaction. They help to make the whole transaction as efficient as possible and reduce the risk of anyone failing to fulfil their obligations. Because they work to make sure that all funds are handled and transferred properly they are sometimes referred to as ‘the backbone of the securities market. 

Clearance and settlement services help to simplify the whole system, building in reliability and predictability  

Managing counterparty risk

In essence, the clearing firm becomes the counterparty for all the transactions that run through it. This radically reduces the overall counterparty risk and means that parties to the trade don’t have to make value judgements about the reliability of other parties to the transaction. 

As well as the important administrative duties they play, they build in the essential trust that financial markets need to operate. In reducing counterparty risk, clearing services make financial trading viable for a wider number of individuals and institutions. 

With financial markets being so dynamic and fast-moving, they play a vital role in keeping the whole process moving quickly.
 

What is a custody firm?

In financial markets, a custody firm is the company that has physical possession of your financial assets. As with the clearing firm it fulfils a role in ensuring that all parties to the transaction carry out their contractual obligations. 

Custody banking holds and maintains assets for customers. They make sure that parties to the trade have sufficient funds to complete the transaction. Unlike clearing services, the custody firm has actual custody of the securities and assets held in the account on behalf of the customer.

The custody firm will hold on to your money and investments, sending you an account statement periodically or when requested. In addition to this role, they also serve as a broker when you want to buy or sell investments. 

In an electronic, digital market-based system, the buyer and seller will never meet. This means that the custodian has the important responsibility of making sure that your money reaches the right person or institution, and vice versa.

What are the principal differences between the two?

While both custody banking and clearing services play a vital role in financial transactions, their roles in the process are different. The principal difference between the two sets of services is that custodians have custodial possession of the assets of their customers, while clearing services vouch for the ability of the parties involved to make good on their trading debts. They will also settle these trades with the central clearinghouse for the particular exchange and take care of all the necessary back-room requirements.

GIS UK provides industry-leading clearing and safe custody services

Over the past three years, Global Investment Strategy has administered 250,000 transactions with settlement values exceeding £50 billion. Here at Global Investment Strategy, our efficient post-trade, global clearing and prime services across multiple currencies allow you to focus on your key competencies.