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THREAD:
I’m going to explain what a clearinghouse does and why it matters for exchanges, using only gifs from my favorite movie, the Big Short.
Clearing changed your life “more than Michael Jordan, the iPod, and YouTube put together”.
Let’s dive in 
pic.twitter.com/k7nlJH52XY
In 2005 Michael Burry discovers a bubble in the housing market. In the movie, Burry meets with Goldman Sachs to find a way to short the market, through credit default swaps on subprime mortgage backed securities.pic.twitter.com/Fv3zhrrZhj
During the meeting Burry asks a key question: “I want to be certain of payment in case of solvency issues with your bank”, to which Goldman responds “um, excuse me?” This is called “default risk” – the risk that a counterparty can’t pay up in the event of unforeseen lossespic.twitter.com/IjH89uPbbw
This is a serious risk in OTC markets, because there’s no one to guarantee payment if a trader blows up. Mark Baum (played by Steve Carrell) faces this problem later in the movie – the risk that Morgan Stanley can’t pay when the market crashes and his swaps balloon in value:pic.twitter.com/nGxmG6dUOl
This is where a clearinghouse comes in. The clearinghouse puts systems in place (like position margin, trade reporting and guarantee funds) to eliminate default risk. If you send your trade through a clearinghouse, you’re effectively guaranteed payment when the trade goes thru.pic.twitter.com/IzE6lNFcdH
Why does this matter? Clearinghouses help lower costs and improve trust in the system. These lower costs show up in the products we consume – companies can hedge the prices of commodities, interest rates and even stocks more efficiently with the help of clearinghouses.pic.twitter.com/xMEG0PgsrD
Some real world clearinghouses in operation today: OCC – options DTCC – equities LCH – various CME Clearing - futures Eurex Clearing – various ICE Clear US & Europe – futures ICE Clear Credit – credit default swaps Give them a high five!pic.twitter.com/IrfrcdWgUX
Thank you for reading – hopefully this thread taught you something. Be like Ben Rickert and mask up!pic.twitter.com/lYPf6nAXtl
Would also mention: 1) For futures exchanges, the concept of the vertical silo; 2) The benefit of cross margin and lower capital requirements; 3) The default waterfall.
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