Clearing Overview. Jason Silverstein, Executive Director & Associate General Counsel October 25, CME Group. All rights reserved.

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1 Clearing Overview Jason Silverstein, Executive Director & Associate General Counsel October 25, 2016

2 Disclaimer 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. 2

3 Clearing Overview

4 Clearing Overview: DCO Introduction 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. A DCO is a clearinghouse, clearing association, clearing corporation, or similar entity 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 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 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 4

5 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 5

6 Clearing Overview: Comparison of Market Environments CME Clearing mitigates risk by providing a central clearing counterparty for its members Market Without Centrally Cleared Environment CME Centrally Cleared Environment B G B CME D C A C CUSTOMER A CUSTOMER C CUSTOMER E D F G F Firm A has risk to Firms B, C, D, E, F, G CME Clearing mitigates the risks between Firms B, D, F and G as well as customers A, C, and E Clearing members and customers further benefit from central clearing through netting and compression 6

7 Clearing Overview: Basic Cleared Market Structure 7

8 Risk Management

9 Risk Management Philosophy CME Clearing uses a proactive risk management approach System of Prudent Protections and Resources Maximize Early Detection CME Risk Management Provide Industry Leadership Actively Manage Crisis Situations Build on Experience to Improve Risk Management Process 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 9

10 Clearinghouse Risk Management: Fundamental Risk Safeguards 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. Performance Bond Performance Bond (Margin) Daily Mark-to-Market Daily Mark-to-Market Settlement Variation 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 Prevents the accumulation of exposures on positions Clearing member positions are markedto-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 10

11 Clearing Overview: Risk Mitigation Variation 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 A MTM Losses MTM Gains Firm C House -$25 +$100 Customer -$75 Customer Customer +$80 House -$200 +$120 House Firm B Firm D 11

12 Default Management

13 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 13

14 Default Management: CME Clearing Financial Safeguards IRS Financial Safeguards Base Financial Safeguards CDS Financial Safeguards $4.914 Billion $ Billion $848 Million Defaulting Clearing Member IRS Fund Performance Bonds Defaulting Clearing Member Base Fund Performance Bonds Defaulting Clearing Member CDS Fund Performance Bonds Defaulting Clearing Member IRS Guaranty Fund Contribution Defaulting Clearing Member Base Guaranty Fund Contribution Defaulting Clearing Member CDS Guaranty Fund Contribution $150M CME Capital for IRS Guaranty Fund $100M CME Capital for Base Guaranty Fund $50M CME Capital for CDS Guaranty Fund 2 Non-Defaulting Clearing Members IRS Guaranty Fund Contributions Non-Defaulting Clearing Members Base Guaranty Fund Contributions Non-Defaulting Clearing Members CDS Guaranty Fund Contributions Assessment Powers 3 rd and 4 th largest CM shortfalls Assessment Powers 275% of Member GF Contributions 1 Assessment Powers 3 rd and 4 th largest CM shortfalls IRS Financial Safeguards Product Coverage Interest Rate Swaps Portfolio-margined interest rate futures 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 All Financial Safeguards numbers are as of 06/30/ CME Rulebook Chapter 8, Rule 802.G, Up to 550% for multiple defaults 2 Equal to the greater of $50 million and (y) 5% of the CDS Guaranty Fund, maximum of $100 million 14

15 Default Management: CME Clearing Financial Safeguards 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 predetermined amount of capital to satisfy the loss from the defaulted firm. Should CME s contribution not be sufficient, the guaranty fund contributions of the nondefaulting 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. 15

16 Default Management: Recovery 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 16

17 Thank you

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