Clearing house memberships are mostly held by corporations, who assume responsibility for all transactions executed under their membership. They must meet financial requirements and take on a degree of risk, but are insured and can write off losses for tax purposes.
Direct members are individuals or corporations that hold a certain membership class in a clearing house. The vast majority of clearing house memberships are held by corporations, due to the requirements most clearing house organizations have in place for membership. The privileges extended to the clearing member include the possibility of buying and selling the underlying securities in compliance with current regulations.
Along with the privileges associated with client trades, the clearing member also assumes responsibility for all transactions executed under the terms of the membership. In the case of a firm that is a clearing member, the firm will be responsible for incurring all obligations associated with executing orders on behalf of its clients. The clearing member generally makes arrangements with the client to ensure that obligations to the clearing house are met in a timely manner.
The clearing member will need to meet a number of requirements based on cash flow and a generally strong tax position. Since a clearing member can accept trades executed on an exchange basis, this condition of verifiable financial strength is understandable. A strong cash base helps ensure that the clearing house can place a fair degree of confidence in the member. At the same time, the clearing member’s clients can be assured that they are executing orders through a reliable and stable entity.
A clearing member also takes on a certain degree of risk. In the event that a client of the clearing member is unable to meet its obligations for any reason, the clearing member is still liable to the clearing house for debt settlement. Once the matter with the clearing house is closed, the clearing member is free to use an appropriate legal remedy to remunerate the defaulting client. However, the clearing member may not be able to collect the remaining balance from the customer. When this is the case, the loss may be partially covered by insurance or written off as a bad debt or loss for tax purposes.
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