To summarise the exchange and clearing process environment we
can say that:
1. Trades take place between exchange members.
2. Trades are made via the trading mechanism applicable to the
exchange.
3. Trades are matched either via the dealing system or through a
matching process.
4. The status of trades is often available in real time through a
trade processing/registration system or at a minimum by peri-
odic reports from the exchange.
5. Unmatched/alleged trades need to be resolved and repaired
within a set time frame or a member will incur fines.
6. Once matched both the buy and the sell elements of the trade
passes to the clearing system.
7. The clearing system allows clearing members to see the updated
positions and settlement obligations they have with the clearing
house.
8. The obligations are settled automatically at a predetermined
time via a secured payment system with a designated bank.
9. A failure to meet obligations to the clearing house would result
in the member facing ‘being put into default’.
10. The clearing member reconciles the positions and settlement
obligations shown by the clearing house to their own records.
Use of futures
Futures contracts are used for a variety of reasons such as specula-
tion or hedging, as well as strategies like asset allocation in fund
management and also for arbitrage opportunities.
If we consider that futures contracts are synthetic versions of the
underlying on which they are based we can easily see how they are
used by speculators and hedgers alike.
Take the case of a fund manager who is worried about the direction of
the equity market. Let us suppose that the equity exposure of the fund
is mainly in FTSE 100 stocks with a current value of £15 000 000. If
the index falls, the fund’s current good performance will be affected. The
fund manager believes that the UK equity market will fall gradually over
the next three months but then will recover to its current level.
The manager could sell the equity portfolio at the current level and
then repurchase the shares at the lower level. There are two problems
here. First, costs to the fund in terms of the broker’s commission for
selling and buying the shares. Secondly, what if the index does not fall?
52 Clearing and settlement of derivatives

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