Professional Clearing Member

Trading and clearing are two different businesses that happen to sit next to each other.

Trading is finding the order and executing it. Clearing is standing behind the settlement: computing the obligations, posting the collateral, and being the party the clearing corporation holds responsible if the money does not arrive. The second business needs a large balance sheet and a custody operation. The first does not.

A Professional Clearing Member does only the second. It clears the trades of its associate trading members and of institutional clients, and it is not a trading member of the exchange at all — it places no orders of its own. Typically it is a bank or a custodian, which is exactly the kind of institution that already has the capital and the settlement machinery.

That lets a broker with a good trading franchise and a small balance sheet stay in business: he executes, a PCM clears for him.

The workbook sets out four membership categories, and the examinable skill is telling them apart:

The two rows that clear for others — TCM and PCM — are both required to bring in additional security deposits in respect of every trading member whose trades they undertake to clear and settle. That is the price of taking on somebody else's settlement risk.

A PCM's duties are the clearing member's duties: computing the obligations of all his trading members, performing the actual settlement, and running risk management — setting position limits against upfront deposits and margins for each trading member, and monitoring positions continuously.

Note where the client sits. A participant is a client of a trading member, and clients may trade through several trading members but settle through a single clearing member.

A custodian bank registers as a Professional Clearing Member and takes on the clearing of four trading members.

Its entry cost with the clearing corporation:

Net worth requirement                          Rs 300 lakh  (Rs 3 crore)
Deposit with the clearing corporation          Rs  50 lakh
Additional deposit, 4 TMs × Rs 10 lakh         Rs  40 lakh
                                               ───────────
Total deposit with the clearing corporation    Rs  90 lakh

It has also placed additional security deposits in respect of each of those four trading members, and it will place more for the fifth.

What it has bought. Suppose those four trading members and their institutional clients carry, between them, 6,000 long and 2,000 short Nifty contracts at the end of a day. The PCM is the party the clearing corporation looks to for the margin on all 8,000, and for the mark-to-market on all of them every morning — despite having placed not one order.

Now contrast the economics. A self-clearing member with the same Rs 100 lakh net worth clears only what he himself trades, and can clear nothing for anybody else. A trading-cum-clearing member does both jobs. The PCM is the only one of the four that clears for others while executing nothing, which is precisely why a bank can do it and a broker cannot.

Chapter 6, section 6.1, lists the entities involved in trading futures and options — trading member, trading-cum-clearing member, professional clearing member, self-clearing member, participants and authorised persons. Chapter 7, section 7.1, repeats the three clearing-member types and attaches the eligibility norms. This is pure recall, and it is asked as a "which of these is not a trading member of the exchange?" or "who can clear trades of other trading members?" question. The answer to the first is the PCM; to the second, the PCM and the trading-cum-clearing member.

• A PCM is not a trading member. This is its defining feature and the single most examined point. It clears; it does not trade.
• A self-clearing member cannot clear for other trading members — only his own proprietary and client trades. Do not confuse SCM with PCM; both are clearing members, and only one of them serves others.
• A trading-cum-clearing member does everything a PCM does, plus trades. So "clears for other TMs" alone does not identify a PCM.
• Additional security deposits are required per trading member cleared, for both the TCM and the PCM.
• A client may trade through several trading members but settles through one clearing member. The reverse phrasing is a common distractor.
• Banks and custodians become PCMs because of capital and settlement infrastructure, not because of any regulatory reservation of the role to them.