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1. Orders are routed from the investment firms (one is a buyer, the other is a seller) to their respective Executing Brokers.
2. The Executing Brokers send the orders to the appropriate Marketplace for the security being traded. The Marketplaces respond with executions ("fills").
3. The Executing Brokers send the fills to the Clearing Broker that was designated by the investment firms. Many Executing Brokers are themselves Clearing Brokers, a term which is called "self-clearing".
4. The Marketplace(s) and the Clearing Brokers compare their shares/money to make sure that they match. This is referred to as "Street-Side matching".
5. The Investment Managers inform their respective Custodians what they should expect to receive from/deliver to the Clearing Brokers, and the Custodians perform this comparison. This is referred to as "Customer-Side matching". This occurs the day of the trade (T+0).

A clearing house is a financial institution organized for bank members to exchange checks and payments. It should not be confused with a central counterparty clearing house which also provides clearing services, but very differently takes on the settlement risks of the counterparties.

Clearing houses were formed to facilitate common transactions among banks. Imagine a city with ten banks. Clients of each daily deposit checks drawn on any of the ten banks. Those drawn on the same bank as the depositor are easily processed. But checks drawn on the other banks need to be presented to each bank in order to receive payments. All ten banks might have messengers taking checks to the others, and waiting for payment. That would be long and cumbersome. Rather, the ten banks would organize a clearing house to which the checks of the other nine would be sent, sorted and presented for payment. In the US this is the role of the Clearing House Association, based in New York. Banks in the rest of the country, such as major regional banks, are clients of member banks, and banks in their regions are their clients. Thus all US banks participate in the clearing operations.

Predecessors

In England, cheques were used through the 17th century. Up until around 1770, an informal exchange of cheques took place between London banks. Clerks of each bank visited all of the other banks to exchange cheques, whilst keeping a tally of balances between them until they settled with each other. Daily cheque clearings began around 1770 when the bank clerks met at the Five Bells, a tavern in Lombard Street in the City of London, to exchange all their cheques in one place and settle the balances in cash.

London

The first organization for clearing cheques was the "Bankers' Clearing House," established in London in the early 19th century. It was founded by Lubbock's Bank on Lombard Street in a single room where clerks for London banks met each day to exchange cheques and settle accounts. In 1832 Charles Babbage, who was a friend of a founder of the Clearing House, published a book on mass production, The Economy of Machinery and Manufactures, in which Babbage described how the Clearing House operated:

"In a large room in Lombard Street, about 30 clerks from the several London bankers take their stations, in alphabetical order, at desks placed round the room; each having a small open box by his side, and the name of the firm to which he belongs in large characters on the wall above his head. From time to time other clerks from every [banking] house enter the room, and passing along, drop into the box the cheques due by that firm to the house from which this distributor is sent."

Beginning at 5 pm, a clerk for each debtor bank was called to go to a rostrum to pay in cash to the Inspector of the Clearing House the amount their bank owed to other banks on that day. After all of the debtor clerks had paid the Inspector, each clerk for the banks that were owed money went to the rostrum to collect the money owed to their bank. The total cash paid by the debtor banks equaled the total cash collected by the creditor banks. On the rare occasions when the total paid did not equal the total collected, other clerks working for the Inspector would examine the paper trail of documents so that the numerical errors could be found and corrected.

New York

The United States improved on the British check clearing system and opened a bankers' clearing house in the Bank of New York on Wall Street, New York in 1853. Instead of the slow London procedure in which each bank clerk, one at a time, stepped up to an Inspector's rostrum, in the New York procedure two bank clerks from each bank all worked simultaneously. One clerk from each bank sat inside a 70 foot long oval table, while the second clerk from each bank stood outside the table facing the other clerk from the same bank. Each of the outside clerks carried a file box. When the manager signaled, all of the outside clerks stepped one position to the left, to face the next seated clerks. If a seated clerk represented a bank to which money was owed or from which money was receivable, the net amount of cash would change hands, along with checks and paper documents.

Thus several such transactions could be conducted simultaneously, across the oval table. When the manager signaled again, this procedure was repeated, so that after about six minutes, the clerks had completed all their assigned transactions and were back to their starting locations, and holding exactly the amount of cash their papers said they should be holding. Clerks were fined if they made errors and the amount of the fine increased rapidly as time passed.

File:CanadianChequeSamplePAR.png

Cheque sample for a fictional bank in Canada showing the MICR encoding used during clearing to route the cheque to the appropriate bank

Cheque clearing (or check clearing in American English) or bank clearance is the process of moving a cheque from the bank in which it was deposited to the bank on which it was drawn, and the movement of the money in the opposite direction. This process is called the clearing cycle and normally results in a credit to the account at the bank of deposit, and an equivalent debit to the account at the bank on which it was drawn.

The process would take a number of days as cheques would have to be physically taken back to the issuing bank until the development of cheque truncation in the 1990s. In many countries this would be via a central clearing house operated by the banks to make the process more efficient. If there was not enough funds in the account when the cheque arrived at the issuing bank, the cheque would be returned as a dishonoured cheque marked as non-sufficient funds.

History

With the development of cheques in England in the 1600s it was customary to return the cheque to the issuing bank for payment. However as cheque usage grew some customers would deposit a cheque with their own bank who would arrange for it to be returned to the issuing bank for payment. Until about 1770, an informal exchange of cheques took place between London banks. Clerks of each bank visited all the other banks to exchange cheques, whilst keeping a tally of balances between them until they settled with each other. Daily cheque clearing began around 1770 when the bank clerks met at the Five Bells, a tavern in Lombard Street in the City of London, to exchange all their cheques in one place and settle the balances in cash.

By the 1800s a dedicated space was established, known as a bankers' clearing house. The London clearing house used a method where each bank paid cash to and then was paid cash by an inspector at the end of each day. This method spread to a number of other countries and by 1853, the New York clearing house used a large oval table and two clerks from each bank. An outer ring of clerks would rotate at set intervals, settling payments in cash with each bank on a pairwise basis.

The Federal Reserve System was established in the United States in 1913 to act as a central, well-capitalized clearinghouse. This prevented occasional panics where banks would refuse to deposit cheques due to uncertainty about the solvency of the drawing bank. The Federal Reserve can physically accept and transport cheques.

As volume grew, more efficient sorting methods were needed. Approaching the 1940s, two popular methods were Sort-A-Matic and Top Tab Key. Sort-A-Matic involved a set of metal or leather dividers numbered 00 through 99. Checks would be sorted by hand according to the first two digits. The cheques would be removed, and each stack sorted into the same dividers by the third and fourth digits. The process was iterated until the cheques were completely sorted. Top Tab Key used a physical mechanism: holes were punched in the top of each cheque representing the values of various digits, and metal keys used to physically move them until sorted.

Magnetic ink character recognition (MICR) was developed and commercialized in the 1950s. It enabled computers to reliably read routing and account numbers and made sorting of paper checks automated.

Electronic clearance

See also: Substitute check in United States

Cheque truncation was introduced in various countries, starting the 1990s, to allow electronic images to be made of physical cheques, for electronic clearance.

These changes made it possible for businesses and consumers to deposit cheques without delivering them to their own banks. In the procedure known as remote deposit, a depositor would make an image of the physical cheque with a smartphone or other device, and attach the image to a deposit. The depositing bank would use the cheque image in the normal electronic clearance process, though in this case MICR data is not available.

See also

• Clearing house (finance)
• Automated Clearing House (ACH)
• Electronic funds transfer (EFT)
• Electronic payments
• Substitute check

See also

• Clearing house (finance)
• Automated Clearing House (ACH)
• Electronic funds transfer (EFT)
• Direct Deposit
• The Electronic Check Council (ECC)
• Fedwire
• Electronic Benefit Transfer
• Electronic payments

History

Clearing or the settlement of mutual claims by payment of differences is most common in banking. Banks have long used clearing houses to settle accounts for payment of or to "clear" cheques (American English "checks"). A common clearing center existed for London bankers on Lombard Street in that city from 1775. In the U.S., the Suffolk Bank opened the first clearing house in 1818 in Boston, and one was incorporated in New York in 1850. A clearing house for bankers was opened in Philadelphia in 1858.

Clearing of payments

In the United States, NACHA-The Electronic Payments Association, formerly the National Automated Clearing House Association, organizes the mechanism for the financial service institutions that participate in the Automated Clearing House (ACH) network. These organizations use the ACH to transfer funds either as debits or credits between participating institutions. Most, but not all, U.S. banks are members of the NACHA. Typical uses of ACH transactions are for automatic payroll programs, monthly mortgage or membership payments, or among non-profit organizations, as a monthly donor/contribution program.