What it means
Executing a trade and settling it are two separate jobs, and they are charged for separately. The exchange takes an execution fee for matching the order, while the clearing house takes a clearing fee for standing behind the trade and moving the cash and securities.
Clearing fees are typically quoted per contract for derivatives and per share, per trade or as a fraction of value for cash equities. A futures clearing fee might be a few tens of cents per contract per side, which sounds negligible until a market maker trades hundreds of thousands of contracts a month.
Brokers pass these costs on in different ways. Some show the clearing fee as a separate line on the confirmation, while others bundle everything into one commission and keep the difference between what they charge the client and what the clearing house charges them.
Volume discounts and membership status complicate any comparison. A firm that is a direct clearing member pays the clearing house rate, whereas a firm clearing through someone else pays that member's marked-up rate on top of the underlying fee.
The practical point for a business is that clearing fees are a variable cost of trading rather than a fixed overhead. Any strategy whose edge per trade is measured in fractions of a cent has to survive the clearing fee before it earns anything at all.
In practice
Real-world examples.
Example
A proprietary trading firm running a high frequency strategy earns an average of $0.90 per round turn before costs. Clearing fees of $0.80 leave $0.10 per contract, so the firm applies for direct clearing membership to cut the fee and protect the strategy.
Example
A pension fund reviews its equity dealing costs and finds that clearing and settlement charges add roughly 0.4 basis points to every trade. Over $3,000,000,000 of annual turnover that is about $120,000, enough to justify consolidating its business with fewer brokers to earn a volume rate.
Example
A small futures broker discovers it has been absorbing an exchange fee increase for eight months rather than passing it on. It renegotiates its client schedule, adding $0.15 per contract, and recovers roughly $90,000 a year on 600,000 contracts of annual volume.
Formula
Calculation
Total clearing cost = number of contracts x fee per side x number of sides
Net trading margin = commission revenue - total clearing cost
A futures broker charges a client $2.50 per contract for a round turn, meaning both the opening and the closing side. Its clearing house charges $0.40 per side, so $0.80 per round turn. The client trades 5,000 contracts in a month.
Commission revenue is 5,000 x $2.50 = $12,500 and the clearing cost is 5,000 x $0.80 = $4,000, leaving a net trading margin of $12,500 - $4,000 = $8,500. As a proportion of what was billed, that is $8,500 / $12,500 = 68%.
If the clearing house raised its charge to $0.50 per side, the clearing cost would rise to 5,000 x $1.00 = $5,000 and the margin would fall to $12,500 - $5,000 = $7,500, or 60% of revenue. The broker would need to trade 5,000 x ($4,000 / $5,000) more volume, or roughly 6,667 contracts, to earn the same $8,500 without repricing the client.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Ledgemoor Futures, an invented introducing broker, cleared its client business through a larger member firm and paid a bundled $1.10 per contract per side, of which the underlying clearing house fee was $0.42 and the rest was the clearing member's mark-up. Ledgemoor billed its clients $3.00 per round turn and cleared 1,800,000 contracts a year.
The arithmetic looked comfortable at first glance: revenue of 900,000 round turns x $3.00 = $2,700,000 against clearing costs of 1,800,000 sides x $1.10 = $1,980,000, leaving $720,000. When Ledgemoor modelled becoming a direct clearing member, the fee fell to $0.42 a side, or 1,800,000 x $0.42 = $756,000, but membership required $8,000,000 of regulatory capital and a $1,400,000 default fund contribution.
In this fictional case the saving of $1,980,000 - $756,000 = $1,224,000 a year was real, but the capital and the added obligation to stand behind other members' defaults were not costs the firm's owners were willing to accept. Ledgemoor stayed an introducing broker and instead negotiated the mark-up down to $0.75 a side, worth 1,800,000 x $0.35 = $630,000 a year for no capital at all.
Watch out
Common mistakes.
- Reading a headline commission rate as the full cost of trading and ignoring clearing, exchange and regulatory fees layered underneath it.
- Assuming clearing fees are charged once per trade, when derivatives are usually billed per side, so an open and a close are two charges.
- Treating the fee as fixed and non-negotiable, when volume tiers and membership status can change it substantially.
Questions
People also ask.
Who actually receives the clearing fee?
The clearing house or clearing member that guarantees and settles the trade, not the exchange that matched it.
Do buy and hold investors pay clearing fees?
Yes, but only on the rare occasions they trade, so the amount is usually a few cents and is buried in the commission.
Why are clearing fees higher for some products?
Because riskier or less liquid instruments cost more to margin, monitor and unwind if a member defaults, and the fee reflects that work.
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