Clearing

The process that turns an agreed trade into a set of obligations that can be settled safely. It confirms that both sides recorded the same terms, calculates who owes what once offsetting trades are netted, and on a cleared market interposes a clearing house between the original parties. That substitution is called novation: the clearing house becomes the buyer to every seller and the seller to every buyer, so neither original party carries the other's credit risk.

A clearing house protects itself with margin. It collects an initial margin when a position opens and calls or pays variation margin as the position is marked to market, usually daily and sometimes intraday, backed by a default fund contributed by its members. This machinery is why an exchange traded future can be held without knowing who took the other side of it.

Contracts dealt over the counter are frequently not cleared at all, and a retail contract for difference is one of them: the broker remains the counterparty for the entire life of the contract, so the firm's own standing and its client money arrangements do the work a clearing house would otherwise do. The common confusion is with the neighbouring steps. Execution is agreeing a price, clearing is establishing and guaranteeing who owes what, and settlement is the money and title actually moving. Three different moments, frequently used as if they were one.