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How OTC to CCP clearing works: Difference between revisions
How OTC to CCP clearing works (view source)
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=={{ccp|Agent}} or {{ccp|Principal}}?== | =={{ccp|Agent}} or {{ccp|Principal}}?== | ||
[[Image:Ccp screenshot.jpg]] | |||
Under current models for clearing OTC derivatives, the capacity in which the {{ccp|clearing member}}} acts, as either {{ccp|agent}} or {{ccp|principal}}, determines the structure of the {{ccp|cleared trade}}s. | |||
'''Principal''': Where the {{ccp|clearing member}} acts as principal, the {{ccp|end user}} will face the {{ccp|clearing member}}, and the {{ccp|clearing member}} will face the {{ccp|clearinghouse}} (here, there are two identical ‘back-to-back’ transactions among the three parties). | :'''Agent''': Where the {{ccp|clearing member}} acts as agent, the {{ccp|end user}} will face the {{ccp|clearinghouse}} directly because, although the {{ccp|clearing member}} may appear to be a party to the trade, it is not the true counterparty (here, there is just one transaction, albeit involving three parties). | ||
:'''Principal''': Where the {{ccp|clearing member}} acts as principal, the {{ccp|end user}} will face the {{ccp|clearing member}}, and the {{ccp|clearing member}} will face the {{ccp|clearinghouse}} (here, there are two identical ‘back-to-back’ transactions among the three parties). | |||
The above diagram looks at the clearing process, from execution to settlement. (There are a number of different ways in which execution and clearing can be effected.) The {{ccp|end user}} (acting as a trader on its own account, or acting through a {{ccp|broker}}) enters into a trade with a market participant. That trade is then submitted by each party for clearing through its respective {{ccp|clearing member}}. When the trade is accepted for clearing, a give-up or novation of the original contract takes place through which the {{ccp|clearinghouse}} is substituted as the counterparty on both sides of the trade. | The above diagram looks at the clearing process, from execution to settlement. (There are a number of different ways in which execution and clearing can be effected.) The {{ccp|end user}} (acting as a trader on its own account, or acting through a {{ccp|broker}}) enters into a trade with a market participant. That trade is then submitted by each party for clearing through its respective {{ccp|clearing member}}. When the trade is accepted for clearing, a give-up or novation of the original contract takes place through which the {{ccp|clearinghouse}} is substituted as the counterparty on both sides of the trade. | ||
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{{ccp|end user}}s will need to examine whether a {{ccp|clearinghouse}} operates on an agency basis or a principal-to-principal basis as part of their risk analysis before choosing clearing platforms. The basic proposition is that under an agency clearing model the {{ccp|end user}} takes greater exposure to the {{ccp|clearinghouse}}, and in a principal-to-principal clearing model there is greater exposure to the {{ccp|clearing member}}. However, matters are likely to be complicated by both the {{ccp|clearinghouse}} rules and the underlying documentation between the {{ccp|clearing member}} and the {{ccp|end user}}. | {{ccp|end user}}s will need to examine whether a {{ccp|clearinghouse}} operates on an agency basis or a principal-to-principal basis as part of their risk analysis before choosing clearing platforms. The basic proposition is that under an agency clearing model the {{ccp|end user}} takes greater exposure to the {{ccp|clearinghouse}}, and in a principal-to-principal clearing model there is greater exposure to the {{ccp|clearing member}}. However, matters are likely to be complicated by both the {{ccp|clearinghouse}} rules and the underlying documentation between the {{ccp|clearing member}} and the {{ccp|end user}}. | ||
Documentation | |||
== Documentation == | |||
The structure of documentation which an {{ccp|end user}} will enter into will depend on a variety of factors including to what extent the clearing platform adopts a futures clearing approach, and indeed whether an OTC contract is ‘exchanged’ for a futures trade before being submitted for clearing, or whether the contract remains an OTC contract during the clearing process. | The structure of documentation which an {{ccp|end user}} will enter into will depend on a variety of factors including to what extent the clearing platform adopts a futures clearing approach, and indeed whether an OTC contract is ‘exchanged’ for a futures trade before being submitted for clearing, or whether the contract remains an OTC contract during the clearing process. | ||
Certain clearing platforms will require that each {{ccp|end user}} enters into a futures customer agreement with an addendum to deal with OTC derivatives. Others will require that {{ccp|end user}}s use an existing (or new) | Certain clearing platforms will require that each {{ccp|end user}} enters into a futures customer agreement with an addendum to deal with OTC derivatives. Others will require that {{ccp|end user}}s use an existing (or new) {{isdama}} with an addendum to deal with cleared transactions. Both sets of documentation will need to accommodate the {{ccp|clearinghouse}} rules, and in some cases the {{ccp|end user}} may be required to enter into an agreement directly with the {{ccp|clearinghouse}}. | ||
Parties will be able to continue to use their existing | Parties will be able to continue to use their existing {{isdama}}s for {{ccp|non-cleared trades}} (for those types of trades not be subject to mandatory clearing}} and what conditions will apply to such trades (for example to include {{ccp|collateral}} and capital requirements). | ||
Margining/collateral maintenance procedures for OTC derivatives will be different in the clearing environment. A unilateral credit relationship will apply whereby {{ccp|clearinghouse}}s will require that collateral is posted with them to cover their exposure, but not necessarily with a parallel requirement to deliver collateral the other way. However, in practice, an {{ccp|end user}} may receive a payment from its {{ccp|clearing member}} to cover the {{ccp|end user}}’s exposure at a particular point in time. | == Margin/collateral maintenance == | ||
Margining/collateral maintenance procedures for OTC derivatives will be different in the clearing environment. A unilateral credit relationship will apply whereby {{ccp|clearinghouse}}s will require that {{ccp|collateral}} is posted with them to cover their exposure, but not necessarily with a parallel requirement to deliver collateral the other way. | |||
However, in practice, an {{ccp|end user}} may receive a payment from its {{ccp|clearing member}} to cover the {{ccp|end user}}’s exposure at a particular point in time. | |||
The robustness of a {{ccp|clearinghouse}} from a creditworthiness perspective will depend on a number of factors including how much margin it takes and how it holds it, and how much capital the {{ccp|clearinghouse}} has to fall back on. | The robustness of a {{ccp|clearinghouse}} from a creditworthiness perspective will depend on a number of factors including how much margin it takes and how it holds it, and how much capital the {{ccp|clearinghouse}} has to fall back on. | ||
A key issue being discussed at the moment concerns segregation of customer collateral. | '''Segregation of {{ccp|collateral}}''': A key issue being discussed at the moment concerns {{ccp|segregation}} of customer {{ccp|collateral}}. Lehman customers found that their collateral was unexpectedly swept up in the insolvency process. This has focused {{ccp|end user}}s’ minds on where, and how, {{ccp|collateral}} is held, and the extent to which it is ring-fenced and recoverable, should the worst happen. | ||
{{ccp|Segregation}} of collateral in a clearing context should improve the ‘{{ccp|portability}}’ of positions (i.e. the transfer of positions to a new {{ccp|clearing member}}) in the event of the failure of a {{ccp|clearing member}}, because the {{ccp|clearinghouse}} will be more capable of finding a willing transferee if the positions can be transferred with sufficient margin to support the positions. | |||
Gross and net margining | == Gross and net margining == | ||
{{ccp|end user}}s will need to examine whether they are required to margin their trades with their {{ccp|clearing member}} on a ‘gross’ or ‘net’ basis, and whether their {{ccp|clearing member}} is required to post margin to the {{ccp|clearinghouse}} on a gross or net basis. In general, gross margining should improve the portability of positions between {{ccp|clearing member}}s, although posting margin on a net basis is a more efficient use of capital because it allows offsetting risks to decrease the margin required. | {{ccp|end user}}s will need to examine whether they are required to {{ccp|margin}} their trades with their {{ccp|clearing member}} on a ‘gross’ or ‘net’ basis, and whether their {{ccp|clearing member}} is required to post {{ccp|margin}} to the {{ccp|clearinghouse}} on a gross or net basis. In general, gross margining should improve the portability of positions between {{ccp|clearing member}}s, although posting margin on a net basis is a more efficient use of capital because it allows offsetting risks to decrease the margin required. | ||
A {{ccp|clearinghouse}} may hold collateral in different pools for different groups of customers. Collateral deposited by {{ccp|clearing member}}s for their own proprietary positions should in any event be held in a separate ‘house’ account. Customers may be offered the ability to margin on a gross or net basis, or a combination of the two, with collateral being held in separate pools, one for ‘gross margining customers’ and one for ‘net margining customers’. | A {{ccp|clearinghouse}} may hold {{ccp|collateral}} in different pools for different groups of customers. Collateral deposited by {{ccp|clearing member}}s for their own proprietary positions should in any event be held in a separate ‘house’ account. Customers may be offered the ability to margin on a gross or net basis, or a combination of the two, with collateral being held in separate pools, one for ‘gross margining customers’ and one for ‘net margining customers’. | ||
Ring-fencing of accounts | == Ring-fencing of accounts == | ||
To take this analysis a step further, certain buy side participants have been pushing for a further level of segregation which would involve each buy side participant’s collateral being ring-fenced from collateral provided by other participants, to avoid exposure to a default by those other participants. In this way, customers may require segregated accounts on a ‘per fund’ basis or perhaps a ‘per manager’ basis – in the latter case a fund would accept default risk against other funds, but only those within its own ‘stable’. | To take this analysis a step further, certain buy side participants have been pushing for a further level of segregation which would involve each buy side participant’s collateral being ring-fenced from collateral provided by other participants, to avoid exposure to a default by those other participants. In this way, customers may require segregated accounts on a ‘per fund’ basis or perhaps a ‘per manager’ basis – in the latter case a fund would accept default risk against other funds, but only those within its own ‘stable’. | ||
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