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What is a clearing house?

November 11, 2011

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

clearing house

Q: Our mutual fund investments at Chase were just transferred to the JP Morgan Chase clearing house. What does clearing house mean? The title scares me a bit.

A: The name "clearing house" should not worry you. It is a fairly common term in the finance business.

The concept of a clearing house has to do with the settlement of security trades. By owning a mutual fund, you essentially own part of a company that invests in a variety of securities. This is very different from bank savings accounts or money market accounts. In those cases, the bank is simply required to honor your deposit amount and any interest earned, while you are effectively insulated from whatever investments the bank makes with your deposit.

With a mutual fund, there is a specific portfolio of securities that the fund owns. The nature of these securities depends on the objectives of the fund, as spelled out in its prospectus. Whatever the make-up of that portfolio of securities, every investor in the mutual fund owns a representative slice of those securities, in proportion with how many shares of the fund they own.

The use of a clearing house relates to settling trades in that mutual fund. A clearing house is a type of organization set up by banks and brokerage firms to efficiently settle trades. As you can imagine, there is quite a bit of activity within a mutual fund, with people buying and selling shares of the fund all the time. Processing these requires adjustments to the underlying portfolio of securities, which itself is being managed to adjust to changing market conditions. Multiply this over the dozens of mutual funds that large banks and brokerage firms offer, and you can understand the need for an operation that aggregates and processes those trades in an orderly manner. That's what a clearing house does.

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