In addition to the clearing of city and country checks, principally the former, and the settlement of balances, which may be called the primary clearing house functions, there are others not quite so much in general use but which nevertheless are of great importance. Many clearing house associations exercise a close supervision over their members, through the medium of the clearing house system of examination under the direct supervision of a clearing house examiner. The clearing house examiner supplements the work of Federal and State examiners. The National and State officers are limited in their powers of criticism to actual infringements on the law, and before they can take steps to correct such infringements capital has often become impaired and failure is threatened. Most bank failures are due to the gradual acquirement of undesirable assets over a period of years, and if some authority exists with power to make recommendations of a remedial character, with the further power to enforce such recommendations, if necessary, there is little doubt that many bank failures would be averted. The examinations include, besides a verification of the assets and liability of each bank, so far as is possible, an investigation into the workings of every department and are made as thorough as is practicable. After each examination the examiner prepares a detailed report in duplicate, describing the bank’s loans, bonds, investments, and other assets, mentioning specially all loans, either direct or indirect, to officers, directors, or employees, or to corporations in which they may be interested. The report also contains a description of conditions found in every department. One of these reports is filed in the vaults of the Clearing House, in the custody of the examiner, and the other is handed to the examined bank’s president for the use of its directors. The individual directors are then notified that the examination has been made and that a copy of the examiner’s report has been handed to the president for their use. In this way every director is given an opportunity to see the report, and the examiner, in every instance, insists upon receiving acknowledgment of the receipt of these notices.
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The detailed report retained by the examiner is not submitted to the Clearing House committee, under whose direct supervision he operates, unless the discovery of unusual conditions makes it necessary. A special report in brief form is prepared in every case and read to the Clearing House committee at meetings called for that purpose. The report is made in letter form, and describes in general terms the character of the examined bank’s assets, points out all loans, direct or indirect, to officers, directors, or employees, or to corporations in which they may have an interest. It further describes all excessive and important loans, calls attention to any unwarranted conditions, gross irregularities, or dangerous tendencies, should any such exist, and expresses, in a general way, the examiner’s opinion of each bank as he finds it. The examiners enter into an agreement not to enter the employ of any member or non-member of the association, or any other bank, banking institution, firm, or individual engaged in the business of banking, within a radius of miles, for a period of years after the expiration of services with the association. The Clearing House examiner is a very valuable man to the small bank or new institution. The officers of these banks very often do not have the facilities or experience necessary to pass upon paper which is submitted to them for sale or discount. They are apt to become loaded up with credits which have been rejected by their larger or better informed neighbors and must pay dearly for their lack of knowledge. The bank examiner is in a position to make valuable suggestions which often save failures and liquidations. Towns which are too small to be able to afford the services of a skilled examiner can combine with two or more other cities and thus secure a proper official. A great many associations have rules for the conduct of their members. These rules provide for uniform exchange charges on out-of-town checks, uniform maximum interest rates on balances, regulations regarding hours for business, advertising, etc. Most associations publish a weekly statement of condition of the members, and cooperate in every possible way for the general good of the members of the association and the community in which it is located. There are not enough clearing house associations in America today. Nearly every town and city having three or more banks could probably form one to advantage and the Clearing House Section of the American Bankers Association will be glad to furnish all information desired.
Clearing House Services Benefits
Some of the key drivers that result in the IATA Clearing House benefits are:
1. Netting
Through multi-lateral, multi-currency netting of Members’ & Associates’ receivables a ‘netting ratio’ of more than 80% is achieved. This translates into an 80% reduction in the credit risk exposure of Members & Associates, significant acceleration in collection of outstanding credit and reduction in the foreign exchange risk exposure.
2. Simplification & ‘one window’ operation
Through a single net receipt from the Clearing House or payment to the Clearing House each month, Members & Associates settle their accounts with all other participants. Cross-remittances, follow-up for credit collection and delays are eliminated. Members & Associates receive full accounting and reconciliation statements.
Clearing House provides the robust, cost-effective infrastructure for Members & Associates to settle accounts with other airlines, travel partners and service providers – to enable Members & Associates to focus on providing integrated, quality services to their customers.
3. Clearance calendar
The calendar of ICH clearances is notified to Members & Associates up to one year in advance. Members & Associates can plan their billing, receivables and cash management activities in advance. Clearing House notifies each Member & Associate of its net accounts with all other participants and the net payable or receivable amount, in advance. Settlement is assured on the designated ICH dates. Members & Associates are able to plan and optimize the usage of their financial resources.
4. Currency Exchange and Bank Transfers
Multi-currency transactions are translated into the clearance currencies at the Clearing House Rates of Exchange. After netting, settlement of the net balance is effected by/to the Members & Associates concerned through a single payment in the settlement. Members & Associates avoid commissions/brokerage on multiple foreign exchange transactions, international bank transfer charges and float losses.
5. Protection on Devaluation of a Debtor’s Currency
For miscellaneous transactions, use of the Clearing House ensures that in the event of a devaluation of a debtor’s currency the creditor is wholly protected, and any loss of exchange falls on the debtor. The debtor’s loss will be restricted, however, to the exchange loss on the balance after offset of miscellaneous charges.
6. Credit Control
Although membership of the Clearing House implies no credit status whatsoever, Clearing House monitors the payment history of each participant. Where necessary, security deposits are taken to cover future transactions. In the event of a default in settlement by a member or associate of the Clearing House, all other members & associates are notified concurrently and at an early date. To ensure continued wide interlining capabilities and efficient customer service, Members & Associates tend to pay their Clearing House balance on priority over other bilateral arrangements.
The enhanced security and efficiency of settling transactions through the Clearing House enables Members & Associates to generate more credit than would otherwise be available to them – thereby substantially improving their working capital management.
7. Exchange Controls
A number of airlines are subject to stringent exchange control regulations and central bank approval requirements in their country of residence on remittance of hard currency funds. This leads to delays in settlement to interline and travel partners or service providers, resulting in business constraints.
Membership of Clearing House greatly reduces the requirements and delays: by reducing the need to only one exchange control application to settle a net balance instead of numerous applications for greater individual sums – and on account of the established reputation of the IATA Clearing House for settlement of interline dues. In certain instances, need for exchange control approval is entirely eliminated due to consistent net settlement balances in that Member’s favor.
8. Inter-clearance with ACH
The IATA Clearing House has an inter-clearance agreement with the Airlines Clearing House (ACH) of the US, enabling Members & Associates of both clearing houses to settle their respective claims by and against each other.
For more than 300 Members & Associates of the IATA Clearing House (ICH) and just under 100 members of the ACH, this means that each participant can settle with more than 400 other parties through these Services.
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Institutional Differences
Existing derivatives exchanges, SROs and governmental regulatory agencies all have rules intended to achieve the three basic regulatory goals. There are many similarities in the rules of different exchanges, regulatory organizations and agencies across different jurisdictions, but there are also many differences. These differences reflect, in part, differences in the way the markets are organized and operated. One such difference, for example, concerns the relationship between the exchange for equity derivatives and the equity exchange. In some instances, the two exchanges are part of the same organization. In others, the equity derivatives exchange and the equity exchange are entirely separate entities.. Another difference concerns the structure of the clearing house. In some cases, the clearing house is part of the exchange. In others, it is not. And some clearing houses clear for only one exchange while some provide clearing services for more than one exchange. Another fundamental institutional difference lies in the trading method itself. Most derivatives exchanges use open-outcry, but some use electronic trading systems.
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These differences appear to be so fundamental that there is a natural inclination to believe that a successful market or successful regulation of a market can only be achieved if the proper choice is made in each of these areas. In other words, the differences in organization and trading method appear to be so profound that some believe that a market or its regulators can only be successful if the best organization and trading method is used. Let us look at each of these issues more carefully.
Exchange Structure
This issue is of particular interest with respect to equity derivatives. There is widespread concern that the existence of a derivatives markets for which equities are the underlying product can lead to increased volatility in the equities market and that this volatility can be function of whether the derivatives exchange is a part of the equities exchange.
In this regard , it should be remembered that the fundamental reason for the existence of a derivatives market is price volatility in the underlying market. In a well-functioning derivatives market, price volatility will be the result of changes in the demand for, or supply of, the underlying product. If both markets are working properly, prices in the two markets will move together and the futures and cash prices will converge as the futures contract expires. Large changes in supply or demand conditions, therefore, should cause volatility in both markets – regardless of whether the derivatives exchange is part of the exchange on which the underlying instrument is traded. A poorly designed derivatives contract can cause volatility to be higher than it would otherwise be – regardless of structural considerations. The key, therefore, to preventing derivatives from increasing volatility lies primarily in ensuring proper contract design and in having adequate protections against manipulation rather than in separating – or combining – the derivatives and cash markets.
Clearing House Structure
There are two issues here. One is whether the clearing house should be a part of the exchange or a separate entity. This distinction itself is not very important. The critical issue is that the clearing house have the authority and commitment to impose and enforce prudential margining and collection standards for all market participants. Experience has shown that both types of structure can function very well. Moreover, it has not revealed that one type is more likely to function better than another.
The other structural issue concerns whether a separate clearing house for each exchange (regardless of whether the clearing house is part of the exchange) or a common clearing house for the derivatives and equity exchanges is more likely to be efficient and to promote financial integrity. There are advantages to both arrangements. A common clearing house reduces costs to its members, makes more information about financial risk readily available, and makes it easier for regulators to monitor the entire portfolio of a member. A possible advantage of separate clearing houses (or disadvantage of common clearing) is that the consequences of inadequate margining or other mistakes would have more widespread consequences. There may also be operational disadvantages to common clearing. Margining arrangements for equity and derivatives markets are different as are requirements for marking to market. There is no generally accepted view as to which arrangement is better at ensuring financial integrity, but there would seem to be little reason for regulators to require common clearing, although they certainly might permit it. The more critical issue is whether the appropriate rules for establishing financial integrity are in place and the proper procedures for monitoring and enforcing compliance with these rules are regularly carried out.
Trading Method
Most existing derivatives exchanges use the open outcry method in which a trade is executed only when the parties to the trade personally agree to its terms. A few use electronic or screen-based systems in which trades are executed by a computer based upon orders entered by the parties. This difference in trading methods raises the question of whether one system is superior with respect to achieving market and financial integrity and to providing fair treatment of customers. From a regulatory perspective, however, the difference between the two types of trading systems may not be as great as some believe.
All modern exchanges, whether screen-based or open outcry, rely on electronics to a large and growing extent. An open outcry system can use electronic technology for such purposes as transmitting orders, recording trades, constructing audit trails, and monitoring compliance. This means that today’s open outcry exchanges are able to construct and maintain much more accurate records than was the case previously. As a result, both SROs and governmental regulators can be more effective in monitoring trading activity and in detecting and deterring rule violations.
The question of the type of trading system to use is fundamentally a business or economic issue rather than a regulatory issue. Both open outcry and electronic systems can achieve acceptable levels of integrity and fairness. Neither type of system is foolproof. No matter what type of trading method is used, problems can and will occur on occasion. Some people will violate the rules. Unforeseen circumstances will arise. When this happens SROs and other regulators must be prepared to discipline those who violate the rules and to modify systems and rules if necessary.
From a regulatory perspective, the most important issue is not the type of trading system. It is to ensure that the exchange has rules which are appropriate for the trading technology used and systems for monitoring and enforcing compliance with the rules. In today’s world these systems will necessarily rely heavily upon electronic technology even though the trading system itself may well rely upon open outcry.
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