Clearing Broker: Definition, Role, Vs. Prime Broker

What Is a Clearing Broker?

A clearing broker is a member of an exchange that acts as a liaison between an investor and a clearing corporation. A clearing broker helps to ensure that the trade is settled appropriately and the transaction is successful. Clearing brokers are also responsible for maintaining the paperwork associated with the clearing and executing of a transaction.

How a Clearing Broker Works

Clearing brokers are the backbone of the securities market because their expansive knowledge ensures that the system is dependable and efficient. They must also research and confirm the information they are given and manage funds associated with the transaction.

Clearing brokers not only handle orders to buy and sell securities but also maintain custody of an account holder's securities and other assets (such as cash in the account). Because they have custody of customer assets, carrying firms must maintain higher levels of net capital than introducing firms—and they are responsible for segregating the customer funds and securities in their custody.

A clearing broker helps to make sure that trades are settled appropriately and that the transaction is successful. Once an order is executed, the clearing broker works with a clearing corporation to make sure all funds are handled and transferred properly. Many consider clearing brokers to be the “backbone” of the securities market because their services help make the system simple, reliable, and efficient. Outside of clearing trades, clearing brokers are also involved in researching to confirm the information they are given is exact, and they also manage funds associated with a transaction.

Types of Clearing Brokers

There's three main types of clearing brokers. First, general clearing members act as intermediaries between trading parties and central clearinghouses. They facilitate trade settlement by matching buy and sell orders, ensuring compliance with clearinghouse rules, and assuming responsibility for risk management.

Second, executing brokers focus primarily on executing trades on behalf of clients. These clients are typically retail or institutional investors. Executing brokers place buy and sell orders at the best available prices in the market and often rely on third-party clearing brokers or general clearing members for post-trade processing.

Last, self-clearing firms handle all aspects of the clearing process internally, from trade execution to settlement. They maintain direct relationships with central clearinghouses, assuming full responsibility for clearing and settlement functions. Despite requiring significant infrastructure and resources, self-clearing firms enjoy greater control and flexibility over the clearing process.

Types of Clearing Broker Fees

Another way to consider clearing brokers is by looking at the types of fees they can collect. There's three main types of fees.

Clearing Fees

Clearing fees are charges levied by clearing brokers to cover the costs associated with processing and clearing trades through the central clearinghouse. Clearing fees are typically calculated on a per-transaction basis, with the exact amount depending on things like the type of asset being traded, the volume of trades executed, and any additional services provided by the clearing broker.

Settlement Fees

Clearing brokers may also collect settlement fees. Settlement fees are charges imposed to cover the costs associated with settling trades and transferring securities and funds between trading parties. Like clearing fees, settlement fees are typically calculated on a per-transaction basis.

Custody Fees

Finally, custody fees are charges for holding and safeguarding clients' securities and other assets. These fees cover the costs of maintaining custody accounts, providing secure storage facilities, and administering asset transfers. Custody fees are more often calculated on a periodic basis, such as monthly or annually. They may also be calculated as a percentage of the total value of assets under custody.

Clearing Brokers vs. Other Broker-Dealers

Aside from clearing brokers, other types of broker-dealers do not have the authority to clear transactions. Therefore, other broker-dealers will generally have one clearing broker with whom they work to clear their trades. An introducing broker, meanwhile, introduces their clients to a clearing broker. In this case, the introducing broker will send their clients’ cash and securities to a clearing broker to clear the trade, and the clearing broker will also maintain the customers’ accounts.

Introducing brokers earn commissions that are based on the volume of trades their client makes or if they are introducing trades on a delivery versus payment basis, their revenue is earned on the spread between the buy and the sell. 

Investment brokers are involved in investment banking by helping to find buyers and sellers of investment securities. They often give investment advice to their clients and earn advisory fees, which could be commission or fee-based. Investment brokers are also involved in private placements, in which they receive flat fees or commissions. Market makers, meanwhile, are a unique type of broker-dealer that assists in stabilizing the market by providing liquidity. 

The Bottom Line

Clearing brokers act as an intermediary between those placing trades and the exchange from which the trade will be sourced. They report trades to the governing body, ensuring all trades are processed/settled in a legal and efficient manner.