Clearing overview - CCP

Cash margin: Note that it is legally impossible to separate possession and ownership of cash. Any person holding cash is, against all other persons in the world, its outright owner: a payee can therefore assume a payer has good title to any cash it pays. This guarantees commercial certainty for cash and preserves its status as an abstract token of value and not an asset.

• Payment by client directly to broker: (described as “money as banker”, or “title transfer”). Client pays margin in cash directly to the broker. There is no purported client money regime or any insolvency protection: The broker’s obligation to return initial margin at the end of the transaction is a debt claim in the client’s hands.
  • Client risk to broker? Yes.
    • The broker is indebted to the client for the return of initial margin.
    • If the broker fails, the client is an unsecured creditor.
  • Client risk to bank where broker deposits margin? No.
    • If the bank fails the broker remains liable for the return of initial margin.
    • There is a second order risk if the bank’s failure causes the broker’s failure, but this is properly characterised as client risk to broker – see above.
  • broker risk to bank where broker deposits margin? Yes.
    • This is the broker’s own bank account.
    • The broker is fully exposed to the credit risk of this bank.
    • This bank is in scope for the broker’s LER calculations
  • Client risk to intermediaries: depends on limited recourse – see below.
• Payment by client to broker’s client money bank: (likely to be protected by local client money regulations – CASS, SGP, HGK, Australia, US). Here the broker establishes a bank account with a third party bank in the broker’s name but acting as fiduciary for the client. The broker will be obliged to deposit all margin it receives from the client into this bank account. The broker will never hold client cash directly. The broker may direct this bank to pay margin to other intermediaries. Money paid to intermediaries ceases to be client money, but is instead a debt claim owed to the clients. Any return of margin from those intermediaries must be paid back into this account and not to the broker directly. The intermediaries who receive money from this client money bank may be required to acknowledge that in operating this account the broker is not acting on its own behalf but as a fiduciary for its clients.
  • Client risk to broker? No.
    • broker never holds client money.
    • If broker fails, the client money bank (and intermediaries who have received money from the client money bank) have acknowledged broker’s fiduciary status.
    • Amounts due from them will be segregated from the broker’s insolvency estate
    • Each Client should receive its total claim on the bank (less amounts it owes to the broker wrt its positions) in full.
  • Client risk to bank? Yes.
    • The clients are direct beneficiaries of the client money bank.
    • If client money bank fails clients are unsecured creditors.
    • Client claims against client money bank will be pro-rated according to its insolvency recovery rate.
  • Broker risk to bank? No.
    • The broker acts only as an fiduciary for its clients.
    • broker does not underwrite the performance of the client money bank.
    • Clients have full credit risk to the client money bank.
    • A client money bank is not in scope for the broker’s LER calculations.
  • Client risk to intermediaries: [TO CHECK WITH SS – wouldn’t the client money regime deliver limited recourse because it becomes the client’s secondary pooling event?][Depends on limited recourse – see below.] [SS: Yesthis would be a secondary pooling event under UK CASS rules, but TBD how this is treated under non-UK client money rules.]

Non-cash/Securities margin: securities are not an abstract token of value but a representation of a financial right to or over something. It is possible to hold a security without being its owner, and deliver a security to another person without. This means that, unlike cash, one can hold a non-cash asset as a fiduciary on behalf of another person.

• Title transfer: client delivers asset by outright title transfer to broker. There is no purported custody arrangement: The broker’s obligation, to return an equivalent asset at the end of the transaction, is a debt claim in the client’s hands. As it owns them outright, there are no restrictions in what the broker can do with the assets (it can, but need not, post them to intermediaries). Note – there is a minor risk to loss of assets in the hands of the custodian.
  • Client risk to broker? Yes.
    • broker is indebted to the client for the redelivery of the asset.
    • broker is not required to return the exact asset delivered to it, but to an identical, “fungible” asset (same issuer, series, ISIN, notional etc)
  • Client risk to broker’s custodian? No.
    • If the bank fails the broker remains liable for the redelivery of the (equivalent) asset.
    • Note there is no significant second order risk as the assets should not form part of the custodian’s insolvency estate– see below.
  • broker risk to custodian? No.
    • If the broker holds its own asset with a custodian, the asset will not (unless the custodian is negligent) form part of the custodian’s insolvency estate (this is a key difference between cash and custody assets).
  • Client risk to intermediaries: depends on limited recourse – see below.
• Pledge: client pledges assets to broker as margin – it may do this by physically delivering them directly to the broker (or a third party custodian or escrow agent) who will hold the assets as custodian for the client, but subject to security interests in favour of the broker. broker may be entitled to onward-deliver assets to intermediaries, either by (i) “re-pledge”, where the intermediary takes possession of the asset subject to the client’s existing interests (i.e., the broker delegates the custody role to the intermediary) or (ii) “rehypothecation”, where the broker takes title to the assets and delivers them outright against a personal liability to return equivalent assets (that is, rehypothecation effectively converts a pledge to title transfer).
  • Client risk to broker? No, unless rehypothecated, in which case Yes.
    • If the broker fails, the assets should not form part of its insolvency estate because it is acting as custodian. But amounts owing to the broker by the client can be taken out of the assets, returning the balance. If broker has rehypothecated the assets, then its obligation to return them is an unsecured claim on the insolvency estate.
  • Client risk to broker’s custodian? No.
    • If the broker’s custodian fails, the assets should not form part of its insolvency estate because it is acting as custodian.
    • Note there is no significant second order risk as the assets should not form part of the custodian’s insolvency estate– see below.
  • broker risk to custodian? No.
    • If the broker’s custodian fails, the assets should not form part of its insolvency estate because it is acting as custodian.
  • Client risk to intermediaries: Depends on way which assets are transferred to intermediary in question.
    • If re-pledged: No. if the intermediary fails the assets do not form part of its insolvency estate. But amounts owing to the intermediary wrt the client’s contracts can be taken out of the assets, returning the balance.
    • If re-hypothecated: Depends on comprehensive limited recourse in client documentation.
      • If there is limited recourse language then Yes, because the broker does not have to pass on amounts it does not receive from the intermediary.
      • If there is no limited recourse language, then No, because the right to redelivery of the assets is a debt obligation of the broker irrespective of the performance of the intermediary.

intermediaries

• Client risk to intermediaries: Depends on comprehensive limited recourse in client documentation. It must be more than force majeure: must make the broker’s obligation to pay amounts to client conditional on the broker receiving those amounts from the intermediary.
• broker risk to intermediaries: Depends on comprehensive limited recourse in client documentation. If the client has it, the broker won’t have it!

Margin Type	Transfer Type	Client Risk (Broker)	Client Risk (Bank/Custodian)	Client Risk (Intermediary)	Broker Risk (Bank/Custodian)	Broker Risk (Intermediary)
Cash	Outright transfer	Yes	No - it's the Broker's bank.	Depends on limited recourse	Yes	Depends on limited recourse
Cash	Client money	No	Yes – it is client’s bank	Generally Yes but limited recourse language will help	No	Generally Yes but limited recourse language will help
Securities	Outright transfer	Yes	No - it's a custody asset.	Yes, if limited recourse	No	No
Securities	Pledge	No, unless a right of rehypothecation, in which case Yes.	No	If re-pledged: No. If rehypothecated: Depends on limited recourse.	No	Depends on limited recourse.

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