Clearing Overview - Practising Law...

© 2016 CME Group. All rights reserved.

Clearing Overview

Jason Silverstein, Executive Director & Associate General Counsel

October 25, 2016


Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of

a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders

should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one

trade because they cannot expect to profit on every trade. All references to options refer to options on futures.

Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the

meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s

value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use

funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because

they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago

Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New

York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity

Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other

trademarks are the property of their respective owners.

The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for

any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should

not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be

consulted in all cases concerning contract specifications.

Copyright © 2015 CME Group. All rights reserved.

Disclaimer

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Clearing Overview


• CME was deemed systemically important

in 2012

• SIFMUs are subject to oversight of the

Board of Governors of the Federal

Reserve System, in addition to their

supervisory agency

The Financial Stability Oversight Council has

declared eight domestic market utilities and

two domestic CCPs to be “systemically

important” Financial Market Utilities (“FMUs”)

under Title VIII of Dodd-Frank

• DCOs are regulated by the CFTC

• Title VIII of Dodd-Frank includes rules

regulating the swaps marketplace and

requiring swaps to be cleared by DCOs

A DCO is a clearinghouse, clearing

association, clearing corporation, or similar

entity

• Any clearinghouse that seeks to provide clearing services with respect to futures

contracts, options on futures contracts, or swaps must register with the Commodity

Futures Trading Commission (“CFTC”) as a DCO before it can begin providing such

services.

• A DCO provides clearing services to clearing members and, clearing members provide

clearing services to customers.

Clearing Overview: DCO Introduction

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Clearing Overview: DCO Introduction • A DCO must comply with the below Core Principles of the Commodity Exchange Act

and CFTC Regulations promulgated thereunder:

o Compliance

o Financial Resources

o Participant and product eligibility

o Risk management

o Settlement procedures

o Treatment of funds

Default rules and procedures

o Rule enforcement

o System safeguards

o Reporting

o Recordkeeping

o Public information

o Information-sharing

o Antitrust considerations

o Governance fitness standards

o Conflicts of interest

o Composition of governing boards

o Legal risk

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CME Clearing mitigates risk by providing a central clearing counterparty for its members

Clearing Overview: Comparison of Market Environments

CME FIRM

B

FIRM

D

CUSTOMER

E CUSTOMER

C CUSTOMER

A

CME

Centrally Cleared Environment

CME Clearing mitigates the risks between Firms B,

D, F and G as well as customers A, C, and E

FIRM

A

FIRM

B

FIRM

D

FIRM

F

FIRM

G

FIRM

C

Market Without

Centrally Cleared Environment

Firm A has risk to

Firms B, C, D, E, F, G

FIRM

C

Clearing members and customers further benefit from central clearing through

netting and compression

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FIRM

F FIRM

G


Clearing Overview: Basic Cleared Market Structure

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Risk Management


Actively Manage Crisis

Situations

Build on Experience to Improve Risk Management

Process

Provide Industry

Leadership

System of Prudent

Protections and

Resources

Maximize Early

Detection

CME Risk

Management

RISK MANAGEMENT FUNCTIONS

• Risk monitoring: 24 hours a day, 6 days a week

• Monitors clearing members and their customers exposures and profits/losses with real-time market observations

• Portfolio margining

• Performance Bond Review & Maintenance

• Clearing member trend analysis & monitoring

• Stress testing

• Financial safeguards

• Default management drills

• Clearing member Risk Reviews

• Acceptable collateral management

CME Clearing uses a proactive risk

management approach

Risk Management Philosophy

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Performance Bond

• Good faith deposits to guaranty

performance of open positions

• Performance bond requirements provide

coverage for 99% of market volatility for a

given historical time period

• Requirements are recalculated twice daily

for most products, and at least once daily

for all products

• FCMs collect performance bond from

their customers and CME collects

performance bond from the FCMs

Daily Mark-to-Market • Prevents the accumulation of exposures

on positions

• Clearing member positions are marked-

to-market at each clearing cycle, resulting

in the movement of cash for gains and

losses on clearing member and customer

portfolios

• Requirements are recalculated twice daily

for most products, once daily for select

cleared only products

Performance Bond (Margin) Daily Mark-to-Market Settlement Variation

Risk management is key for DCOs to be able to enhance market stability and counterparty

protections. CME Clearing supports a series of risk management processes to ensure proper

management for its clients.

Clearinghouse Risk Management: Fundamental Risk

Safeguards

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Firm A

CME Clearing facilitates daily mark-to-market (“MTM’) money movements between

clearing members and settles all outstanding market exposure from the prior

settlement cycle

Firm

B

-$25

-$200

MTM Losses

+$100

+$120

MTM Gains

Clearing Overview: Risk Mitigation – Variation

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Customer

House

-$75

House

Firm C

Firm

D

Customer

Customer

House

+$80


Default Management


Upon the default of a clearing member CME Clearing

would seek to concurrently:

• Liquidate “House/Proprietary” positions of defaulting

Clearing Member

• Port non-defaulting customers to other clearing

Default Management:

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Default Management: CME Clearing Financial

Safeguards

1CME Rulebook Chapter 8, Rule 802.G, Up to 550% for multiple defaults 2Equal to the greater of $50 million and (y) 5% of the CDS Guaranty Fund,

maximum of $100 million

All Financial Safeguards numbers are as of 06/30/2016

IRS Financial Safeguards

Defaulting Clearing Member

IRS Fund Performance Bonds


IRS Guaranty Fund Contribution

$150M CME Capital

for IRS Guaranty Fund

Non-Defaulting Clearing Members

IRS Guaranty Fund Contributions

Assessment Powers

3rd and 4th largest CM shortfalls

Base Financial Safeguards


Base Fund Performance Bonds


Base Guaranty Fund Contribution

$100M CME Capital

for Base Guaranty Fund


Base Guaranty Fund Contributions

Assessment Powers

275% of Member GF Contributions1

CDS Financial Safeguards


CDS Fund Performance Bonds


CDS Guaranty Fund Contribution

$50M

CME Capital

for CDS Guaranty Fund2


CDS Guaranty Fund Contributions

Assessment Powers

3rd and 4th largest CM shortfalls

IRS Financial Safeguards Product Coverage

• Interest Rate Swaps

• Portfolio-margined interest rate futures

$4.914 Billion $12.384 Billion $848 Million

Base Financial Safeguards Product Coverage

• Futures and options

• OTC FX

• Other non-IRS and non-CDS OTC products

• Cross-margined products

CDS Financial Safeguards Product Coverage

• Credit Default Swaps

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• Each clearing member is required to contribute to the respective guaranty fund related

to their clearing membership that can be used in the event of a clearing member

default to CME.

• In the event of a default by a clearing member, CME would first liquidate the

performance bond deposits and the guaranty fund contribution of the defaulted clearing

member to satisfy any losses.

• In the event those resources aren’t sufficient to cover the loss, CME contributes a pre-

determined amount of capital to satisfy the loss from the defaulted firm.

• Should CME’s contribution not be sufficient, the guaranty fund contributions of the non-

defaulting clearing members would be used (mutualization).

• In the event there is still a loss remaining, CME has the right to assess non-defaulting

clearing members for additional pre-determined amounts.

Default Management: CME Clearing Financial

Safeguards

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• “End of Waterfall”

• Recovery Tools needed for continuity of clearing:

• Allocate uncovered losses

• Reestablish of Matched Book

• Tools:

• Voluntary actions

• Gains Haircuts

– No IM haircuts

• Tear-ups

Default Management: Recovery

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Thank you

Clearing Overview - Practising Law...

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