Version 1.4. LME Clear DSS - BAU Version 1.4 1

Transcription

1 Version 1.4 LME Clear DSS - BAU Version 1.4 1

2 The information contained in this document is confidential and proprietary to LME Clear and should not be disclosed to any third party without the express prior written consent of LME Clear. LME Clear DSS - BAU Version 1.4 2

3 1 Abbreviations Preface Purpose Audience Scope Out of Scope Supporting Documentation Service Scope Trading and Clearing Operational Day Overview Cleared Exchange Traded Products Cleared Over the Counter Products Membership Membership Requirements Secure Payment System and Settlement Accounts Account Types Account Porting Trade Management Operational Day Trading and Clearing Trading Venues Trade Acceptance and Novation Trade Acceptance Process LME Clear Clearing System Processes Trade Data Validation Risk Validation and Pending Queue Member Notification Trade Cancellation Process Trade Cancellation Position Management New and Existing Positions Position Holding Position Adjustment Position Expiry and Settlement Option Exercise and Assignment OTC Loco London Bullion Market Forward Expiry and Settlement Monthly Average Futures Expiry Futures Expiry LME Clear DSS - BAU Version 1.4 3

4 6.5 Position Transfers Criteria for LME Clear Position Transfers Risk Management Position Transfer File Position Transfer Fees Compression Auto Compression Manual Compression File Based Compression Market Data Management LME Settlement prices LME Closing prices Closing Interest Rates Closing FX Rates Collateral Pricing Intra-day Pricing Intraday Collateral Revaluation Price Substitution Process Risk Management Real Time Risk Calculation Scheduled Intraday Margin Call End of Day Risk Process Initial Margin SPAN Parameters Variation Margin Calculation Discounted Contingent Variation Margin DCVM Cash Contingent Variation Margin CCVM Realised Variation Margin RVM Net Liquidating Value NLV Back Testing Stress Testing Default Fund calculation Additional Margin Concentration Margin Default Additional Margin Credit Additional Margin Discretionary Margin Counterparty Credit Risk Assessment and Monitoring Collateral Acceptability, Haircuts and Limits Acceptability of Cash LME Clear DSS - BAU Version 1.4 4

5 Acceptability of Financial Instruments Custody of Financial Instruments Acceptability of Warrants Acceptability of Gold Custody of Gold Collateral Haircuts Collateral Limits Treasury Management Operational Day Treasury Secure Payment System (SPS) Accounts Participating Banks SPS Mandates Overnight SPS Calls Intraday SPS Calls Applicable SWIFT Messages Clearing Member initiated collateral transfers Cash Settlements Cover Distribution Report Management Introduction Report Formats and Availability LME Clear Reports Fee Management Exchange Fees Clearing Fees Collateral Accommodation Charges and Transaction Fees Cash Collateral Interest Delivery Fees Appendix A: Parameters Appendix B: Working Definitions Appendix C Contract Specifications LME Exchange Traded Products LME Exchange Traded Forwards LME Exchange Traded Futures LME Exchange Traded American Options LME Exchange Traded Average Price Options (TAPOs) LME Monthly Average Futures OTC loco London Bullion Market Forwards LME Clear DSS - BAU Version 1.4 5

6 OTC loco London Gold Forwards OTC loco London Silver Forwards Version Date Amendments V1.1 6 August 2014 Addition of Appendix C Contract Specifications V1.2 9 March 2015 Change of LME Swaps to Monthly Average Futures V May 2015 Inclusion of Position Transfer detail. V October 2015 Updates for Compression, Warrants as Collateral, Premium Contracts. LME Clear DSS - BAU Version 1.4 6

7 1 Abbreviations Acronym Abbreviation CVM Contingent Variation Margin DCVM Discounted Contingent Variation Margin GCM GTC General Clearing Member Good Till Cancelled GUI Graphic User Interface ICM Individual Clearing Member IM Initial Margin LME London Metal Exchange MASP Monthly Average Settlement Price NAP Notional Average Price NCM OIS Non Clearing Member Overnight Indexed Swap OTC Over The Counter SPAN 1 Standard Portfolio Analysis of Risk SPS Secure Payment System LMEsmart LME Broker Matching and Registration System 1 SPAN is a registered trademark of Chicago Mercantile Exchange Inc., used herein under license. Chicago Mercantile Exchange Inc. assumes no liability in connection with the use of SPAN by any person or entity. LME Clear DSS - BAU Version 1.4 7

8 LMEsword LME Physical Delivery/Warrant Management System TAPO TIM Traded Average Price Option Treasury Investment Manager VaR Value at Risk VM Variation Margin LME Clear DSS - BAU Version 1.4 8

9 2 Preface LME Clear provides clearing and settlement services, as the sole central counterparty for the London Metal Exchange (LME), the world s leading non-ferrous metals market and LBMA OTC Precious Metals contracts. Clearing through LME Clear enables Clearing Members to mitigate risk, benefit from greater capital efficiency and operational resilience provided by a bespoke service. LME Clear is ultimately a wholly owned subsidiary of HKEx and is regulated in the UK by the Bank of England. 2.1 Purpose The LME Clear Detailed Service Specification Business As Usual provides a detailed perspective of the services offered by LME Clear Limited, hereafter referred to as LME Clear, to its Members and their clients under normal operating conditions. The purpose of this document is to supply Members with sufficient information so as to allow them to understand the key business interactions and processes that LME Clear will undertake. 2.2 Audience The target audience for this document is: 1. LME Clear Members 2.3 Scope a. Business Managers and Analysts b. Operations (Business, Market, Systems) c. Risk Managers d. Collateral Managers Included within this document is information on the following: Clearing, Settlement and Delivery Cleared Products Risk Management Treasury and Collateral Operations 2.4 Out of Scope This document does not deal with the following; Business Case justification Organisation Design LME Clear DSS - BAU Version 1.4 9

10 Treasury Service Providers Non Functional Requirements Default Management LME Wire 2.5 Supporting Documentation This document should be read in conjunction with: LME Clear Member Procedures LME Clear Rule Book LME Clear DSS - BAU Version

11 3 Service Scope 3.1 Trading and Clearing Operational Day Overview LME Clear opens to receive new transactions for clearing from LMEsmart from 07:30 through to 20:15 London time, with operational support for Members from 07:00 until 22:00. As per current practice LMEsmart will close for input at 20:00 London time. Intra-day margin calls will be made in line with LME Clear Risk Management Policy through the secure payment system, and cover must be provided by Members within one hour. End of day margin calls will be made in a timely fashion following the closure of the daily clearing process at 21:15 London time, and need to be met by Members through the secure payment system by 09:00 the next working day. (All times are London times, unless stated otherwise.) 3.2 Cleared Exchange Traded Products Product Underlying Cleared Currencies Forwards Aluminium Alloy High Grade Primary Aluminium North American Special Aluminium Alloy (NASAAC) Copper Grade A Primary Nickel Standard Lead Tin Special High Grade Zinc Cobalt Molybdenum Steel Billet US Aluminium Premium Eastern Asia Aluminium Premium South-Eastern Asia Aluminium Premium Western Europe Aluminium Premium USD GBP EUR JPY LME Clear DSS - BAU Version

12 Futures Steel Scrap Steel Rebar LME Minis Copper Grade A High Grade Primary Aluminium Special High Grade Zinc USD USD LME Index LMEX USD Traded Options Aluminium Alloy High Grade Primary Aluminium North American Special Aluminium Alloy (NASAAC) Copper Grade A Primary Nickel Standard Lead Tin Special High Grade Zinc USD GBP EUR JPY Traded Average Price Options Aluminium Alloy High Grade Primary Aluminium North American Special Aluminium Alloy (NASAAC) Copper Grade A Primary Nickel Standard Lead Tin Special High Grade Zinc USD Monthly Average Futures Aluminium Alloy High Grade Primary Aluminium North American Special Aluminium Alloy (NASAAC) Copper Grade A Primary Nickel Standard Lead Tin Special High Grade Zinc USD 3.3 Cleared Over the Counter Products Product Underlying Cleared Currency Forwards Gold Silver USD LME Clear DSS - BAU Version

13 4 Membership 4.1 Membership Requirements LME Clear Membership or a clearing relationship with a Clearing Member is necessary for any firm to clear products traded on the LME. Prospective LME Clear Members will have to file a formal application with LME Clear Relationship Management team irrespective of their existing LME Exchange Membership. The following are the key Membership criteria; Minimum levels of net capital Appropriate banking arrangements Staff of sufficient experience and knowledge of the market including the products being cleared Appropriate systems to manage their clearing activities; and Maintain a minimum credit rating based on the LME Clear Internal Credit Risk Assessment Framework, which is actively assessed and monitored (please refer to the Counterparty Monitoring Information section for further details). Complete and fully signed suite of Member onboarding documentation. 4.2 Secure Payment System and Settlement Accounts LME Clear operates a Secure Payment System (SPS); see Section 9, to initiate cash movements with Clearing Members for settlements and margin transfers. This is a Designated System under the Settlement Finality Directive and conforms to the IOSCO-CPSS Principles and the EMIR/ESMA Technical Standards. As such it provides clear and certain final settlement intraday in real time. All Members must have settlement accounts with an approved LME Clear Settlement Bank. A Clearing Member must have a settlement account in every currency in which they clear: USD, EUR, GBP or JPY. A Member s settlement accounts can be called for collateral at any time between 07:30 and 21:00 UK time, during which hours Members must have a USD account to cover any margin requirements. All Members must have USD and GBP accounts at a minimum. 4.3 Account Types Member account structures differ between both a General Clearing Member (GCM) and an Individual Clearing Member (ICM) relating to their role in dealing with client business. All position accounts in the clearing system have associated cash and non-cash accounts all of which will be automatically created when a new position account is added to the system. LME Clear provides a flexible account structure for Clearing Members which conforms to regulatory requirements. Cash and Collateral Accounts are available for House business, for Omnibus Clients LME Clear DSS - BAU Version

14 and for Individually Segregated Clients. A Clearing Member may have multiple client accounts of each type. Clearing Members are required under EMIR to offer their clients a choice of client accounts. LME Clear supports client porting, whereby Individually Segregated Client Accounts (ISA s) and Omnibus Client Accounts (OSA s) can be ported to another Clearing Member in the event of a default providing a back-up Clearing Member confirms the transfer and all appropriate documentation is in place. Account type House Omnibus Individually Segregated Default Fund Description Contains only LME house business for the Member. A Member s house account will be assigned as their Primary Account from which fees and any additional charges can be collected. Members will only be allowed one house account. Contains LME business for a group of Direct Clients or LME House business for an agreed group of Category 4 Members. Omnibus accounts are held net for margin purposes. Each GCM can have multiple Omnibus Accounts. Can contain LME business for a single Direct Client, LME House business for a single Category 4 Member, or LME business for a single Indirect Client or LME Business for an agreed group of Indirect Clients. Each GCM can have multiple Individually Segregated Client Accounts. Contains the Member s default fund contribution. LME Clear DSS - BAU Version

15 4.3.1 Account Porting All client accounts are portable within LME Clear. Porting will apply where all relevant documents have been received. Client accounts can be automatically ported in the event of a Clearing Member default where: o Automatic Porting Designation Document has been received by LMEC o All Clients in the account are identified o The Clearing Member Designation Documentation has been lodged at least 1 business day in advance Otherwise, porting will be available on the day of the default occurring if: o A Porting Request Notice has been received by LME Clear The above is subject to the various rules and procedures documented within the LME Clear Rulebook. Members have the option of completing a Porting Designation Documents when on-boarding new clients which will identify if a client wants their positions to be automatically ported in the event of a default of their Clearing Member and which Clearing Member they have arranged to be their back up Clearer. Positions and collateral where applicable will only be automatically ported in the event the backup Clearer agrees in the event of a default. LME Clear DSS - BAU Version

16 5 Trade Management 5.1 Operational Day Trading and Clearing NB On USD holidays, margin calls will be made in GBP and the period for which margin can be called intraday is reduced to GBP open times, 07:30 14:30. LME Clear may request additional margin in advance of a USD or GBP holiday and may look extending intraday calling hours as an implication of accepting other asset classes as intraday collateral. Members will be consulted in advance. 5.2 Trading Venues Transactions can only be submitted to LME Clear through LMEsmart, the LME s matching system. LME Clear receives a direct trade data feed from the trading venue via LMEsmart and using the FIX gateway. 5.3 Trade Acceptance and Novation Once a trade is matched by LMEsmart it is submitted to the clearing system where it is checked for the correct syntax. Provided this is in order the validation process begins: 1. LME Clear receives a single trade message from LMEsmart containing all relevant trade details (see ) 2. LME Clear performs Static Data Validation checks on the trade to confirm the relevant trade details are present and within the correct value ranges. Trades that fail any validation rule are either pended or rejected (see 6.3.) LME Clear acknowledges rejection or pending of the trade and sends back a status message of Rejected or Pending to LMEsmart. 3. If the trade message passes Static Data Validation, LME Clear acknowledges receipt of the valid trade and sends a status message of Acknowledged back to LMEsmart. 4. Once the trade has been verified from a static data perspective, LME Clear then performs risk validation checks on the trade. Should any trades require further analysis, or where more collateral is required, LME Clear acknowledges and sends back a status message of Pending LME Clear DSS - BAU Version

17 to LMEsmart. Where trades pass the validation LME Clear acknowledges by sending back a status message of Registered to LMEsmart 5. Trades on the pending queue are released automatically when the Member lodges more collateral. LME Clear Risk Management can re-calculate exposure after further risk reducing trades are received and if the new risk exposure is covered by current collateral levels pended trades will then be accepted. LME Clear Risk Management can decide to approve or reject the trade based on a shift in the Member s collateral holding, market prices or the addition of risk reducing trades to their portfolio in addition to this defined criteria LME Clear Risk Management can approve/reject trades at their discretion. LME Clear acknowledges rejection of the trade and sends a status message of Rejected back to LMEsmart. Section details the LME Clear pending queue methodology. 6. Trades that have successfully completed the validation checks are registered for clearing. LME Clear acknowledges registration of the trade by sending back a status message of Registered to LMEsmart. At the point of being registered, the trades are novated. 5.4 Trade Acceptance Process LME Clear DSS - BAU Version

18 5.5 LME Clear Clearing System Processes Trade Data Validation All trades are subject to basic trade detail checks upon entering the clearing system. This data is taken directly from a feed from LMEsmart and should feature no inconsistencies. LME Clear has the facility to accept, pend and amend or pend and reject trades based on the validity of their trade data. Fault Reason in LME Clear GUI Ops Response Invalid Member Mnemonic Member does not exist Reject trade. Incorrect Account ID Account ID does not exist Reject trade. Incorrect Client ID Invalid Metal Invalid Currency Invalid Prompt Date Invalid Trade Price Invalid Number of Lots Invalid Strike Price Client ID not matching that held on the intended position account None trade rejected by FIX server None trade rejected by FIX server None trade rejected by FIX server None trade rejected by FIX server None trade rejected by FIX server None trade rejected by FIX server Client ID validation is not currently applicable. If implemented, amendments will be possible whilst the trade is pending and at the Member s request. N/A N/A N/A N/A N/A N/A Risk Validation and Pending Queue As each trade is submitted to the clearing system, the risk on the affected Member s portfolio will be calculated in real time. A variation margin check is performed, calculating the variation margin for both sides of the trade. Where the variation margin is above a pre-defined threshold the trade will be temporarily placed on the pending queue. If the variation margin is below the pre-defined threshold the trade will be automatically registered for clearing. Each time a trade enters the pending queue, a revaluation of the portfolio will take place in real time using the current system prices. The Member s portfolio will include: The new trade, Any new trades accepted on the same business day, LME Clear DSS - BAU Version

19 The brought forward position from the previous day, The total margin required is then compared to the Member s available collateral including any intraday credit tolerance allowed to the Member by LME Clear. If there is sufficient collateral in place then any pending trade will be released and registered. If there is insufficient collateral then a request will be made to the Clearing Member s Settlement bank for additional collateral. Once the confirmation is received that this collateral is in place with LME Clear the pending trade will be released and registered. There will be a 15 minute window where a call generated by a trade breaching the collateral threshold can be cancelled by the LME Clear Risk team prior to its release. This can occur if LME Clear are informed of an incoming risk reducing trade or impending collateral lodgement, as well as other mitigating actions by the Member. Where possible all ad hoc intraday margin calls will be accompanied by a notification to Members from the LME Clear Operations team. If a risk reducing trade is received by LME Clear then actions can be taken by LME Clear to release the pending trade straight away. Intra Day Risk Management Accept Trade LMESmart New trade Trade and Position Management Manually accept trades in pending queue Request what if on trades in pending queue Receive new trade Pend new trade Accept new trade and all trades in pending queue Yes No Market Risk Management Calculate portfolio risk (incl new trade, pending tades and existing position) Compare risk with available collateral Pending threshold reached Collateral threshold reached No End Market Data Management Manage ITD Prices Yes Treasury Collateral received Value collateral Request Collateral Trades can leave the Pending Queue in the following circumstances: Sufficient collateral is lodged to cover the portfolio margin requirement Sufficient risk reducing trades are sent for clearing The trade is cancelled, If there is a shift in market price that alters a Member s margin requirement sufficiently to take them below the level of available collateral The trade is manually accepted for clearing by LME Clear Risk Management, The trade is manually rejected by LME Clear Risk Management, LME Clear DSS - BAU Version

20 5.5.3 Member Notification Member users with the appropriate GUI access will be able to view their liabilities, against their lodged collateral, at any time. The colour coding system as described in section 8.1 is in place to allow Members to proactively monitor their margin requirement against lodged collateral and therefore lodge additional collateral in advance of a request from LME Clear. Members will be able to track the status of a trade at all times within the GUI, as well as via the corresponding FIX messages. 5.6 Trade Cancellation Process Trade Cancellation Trade cancellation can occur in four possible ways: Exchange Cancellation Any Exchange trade cancellations are handled separately between LME System Operations and LME Clear Operations. Any Exchange cancellations will be directed from LME Compliance. In the instance of extenuating market circumstances, for example if there is a pricing error that leads to the market trading away from fair value, then the exchange may bust or cancel any trades outside certain parameters, though this is very rare. Member Cancellation o Segregated Cross Trades In instances where a trade is executed between a Member s House account and their Segregated Client account, a cancellation request can be submitted in LMEsmart if it is on the same day as the original trade. This will see the trade go from a status of Matched Trade to Cancelled Trade in both LMEsmart and the LME Clear GUI. If the trade is not for the current day then a Reversal trade must be entered into LMEsmart. o Member to Member Trades A Reversal trade must be submitted in LMEsmart. Internal Cancellation in exceptional circumstances, LME Clear can cancel a trade. There is no FIX messaging in this instance, consequently LME Clear Operations will inform LME System Operations of the internal cancellation to ensure they are aware of the fact. In the case LME Clear DSS - BAU Version

21 of internal cancellations completed by LME Clear, LME Clear will inform all necessary Members accordingly. 6 Position Management The LME Clear EOD process sees that all cleared trades in the system are aggregated into positions. Members are able to view their positions in real time through the LME Clear GUI. Positions are maintained and margined by LME Clear from the point of trade novation until final settlement is confirmed. 6.1 New and Existing Positions Where a position already exists, the volume of the new trade will be combined with the volume of the current position. A new position is always created if it is the first trade within the Member account for that instrument, in that currency and direction. The following table displays the attributes of a position, and to which instrument they apply: Identifier Exchange and OTC Traded Forwards, Futures and Monthly Average Futures Exchange Traded Options and TAPOs Instrument Y Y Underlying Y Y Prompt Date Y Y Call/Put N Y Strike Price N Y Currency Y Y Direction (Long or Short) Y Y Trade Date Y Y Trade Price Y Y All positions can be viewed in retrospect by using the Position History Search function. Position data will be held in the system for 90 days following the expiry of that position. 6.2 Position Holding Positions are either maintained gross or net depending on the underlying product. Positions held gross display the total longs and shorts whereas net positions will be displayed as a total amount combining both longs and shorts. Prices on the underlying trades that form the positions will not be shown at the position level, but the position can be drilled down into to see the component trades. Products held gross: LME Clear DSS - BAU Version

22 Exchange Traded Forwards Exchange Traded Monthly Average Futures OTC Loco London Bullion Market Forwards Once a position in any of the above instruments is created in the clearing system, a User can view its constituent trades at any point up until the position expires. Products held net: Exchange Traded Futures (Minis & LME Index) Exchange Traded American Options Exchange Traded Average Price Options (TAPOS) Within the clearing system, the following attributes will be displayed for all positions: Attribute Description Account ID Tradable Instrument Long Short Net MTM Prompt Date Current Price Last Closing Price Currency Underlying The ID of the position account where the position is being held e.g. AAA_H_1 The instrument that the position is in e.g. CAD The total number of bought lots that make up the position. The total number of sold lots that make up the position. The net of bought and sold lots that make up the position. The mark to market (DCVM, CVM, CCVM or NLV dependent on instrument) on the position. This will be updated basis the market price up until the publication of the Closing Prices when the figure will remain unchanged until the clearing system opens on the next business day. The prompt date of the position s underlying instrument where relevant. The current market price of the position s underlying instrument. For Options and TAPOs this will be the premium. The Closing Price of the position s underlying instrument from the previous night. The currency of the underlying instrument upon which the position is based e.g. USD The underlying commodity upon which the position is based e.g. AH 6.3 Position Adjustment In addition to a new trade, a Member s position is subject to the following variables: Event Position Description The expiry of a position due to the prompt date of the underlying instrument. This will LME Clear DSS - BAU Version

23 Expiry Position Delivery Position Close Out Position Transfer initiate a cash settlement, a physical settlement or the creation of forwards position(s) basis the original strike price. The point at which a position that requires physical settlement reaches maturity and instigates the physical delivery process. When a Member closes their position by flattening their net holding of lots for a given instrument. This does not apply to forwards where a Member will always be obliged to meet their buying and selling obligation at expiry. The transferring of a position either between Members or between accounts within a Member. All of the above events will be managed and displayed via the GUI. 6.4 Position Expiry and Settlement Positions will expire and require settlement dependent on the contract. Expiry will only occur on the prompt or expiry date of the underlying instrument with the exclusion of Exchange Traded American Options. This section will detail the methods of settlement that each product requires, either Cash settlement, Physical Settlement or, in the case of Traded Options, the creation of a forward position. The LME Clear GUI acts as the interface for monitoring positions across all cleared instruments. Members have access to a range of perspectives through which they can view their positions in expiring instruments and manage the exercise process for Exchange Traded Options Option Exercise and Assignment Expiry Process for Exchange Traded American Options Exchange Traded Options can be early exercised between 07:30 and 11:15hrs on any business day once they are novated. This remains the case up until the first Wednesday of their expiration month whereby positions that are flagged for auto-exercise or auto-abandon displayed in the GUI, in the first instance will be exercised or abandoned as appropriate. User variable can be applied to these classifications, please find details below. The system identifies Options as In-the-Money, At-the-Money and Out-of-the- Money according to the following business rules: Definition In-the-Money (highlighted green on expiry day) At-the-Money (highlighted yellow on expiry day) Rule For Call Options, this will be any Option with a strike price that is two or more strike gradations lower than the At-the-Money strike. For Put Options, this will be any Option with a strike price that is two or more strike gradations higher than the At-the-Money strike. For Call Options, this will be any Option that is at the strike nearest to the previous night s closing price for the underlying third Wednesday forward, and the first strike below this. For Put Options, this will be any Option that is at the strike nearest to the previous night s closing price for the underlying third Wednesday forward, and the first strike above this. LME Clear DSS - BAU Version

24 Out-of-the-Money (highlighted white on expiry day) For Call Options, this will be any Option that is at a strike price higher than the At-the-Money strike price. For Put Options, this will be any Option that is at a strike price lower than the At-the-Money strike price. During the Option expiry window on the first Wednesday of the month, there are several variables a Member User can alter in order to change the way their Option positions are flagged. These variables are: User Reference Price a User entered reference price which will supersede the previous night s Closing Price with regards to the highlighting of the ITM/ATM/OTM Options positions. This price is applied by the Member User to specific positions with the User being prompted to change any uneconomical declarations basis their new reference price by their exercise quantities being highlighted in red. Indicative Option Exercise Price (IOEP) A reference price calculated by the Exchange at around 10:30hrs on expiry day. LME Clear, in turn, will apply the price to expiring Option positions in the GUI. Members then have the choice of using the price to adjust the flagging of their positions, or disregarding it. o IOEP Calculation Methodology The IOEP is established on LMEselect using a calculated trade weighted average price over a 15 minute pricing period between 10:15 and 10:30 on the first Wednesday of the month. The following example shows how this calculation works: Lots Price (USD) Tonnes per lot Contract Value (USD) 10 3, , , , , , , , , ,560, , , Total 52 5,072, IOEP 3, Here, the IOEP is calculated as the total contract value divided by lot size and total number of lots. User ATM Strike Management A variable whereby a Member User can designate how many strikes will be deemed ATM for any given position. The default setting is two ATM strikes (as described in the table above) but a User can also select to have a single ATM strike, or none whatsoever in which case all positions will either be in or out of the money basis the reference price. The below table displays the Traded Options strike gradations for all underlying commodities across all commodities: Currency USD Definition For all metals: LME Clear DSS - BAU Version

25 $25 for strikes from $25 to $9,975 $50 for strikes from $10,000 to $19,950 $100 for all strikes over $20,000 EUR GBP JPY For all metals: 25 for strikes from 25 to 9, for strikes from 10,000 to 19, for all strikes over 20,000 For AH, AA, NA and CA: 25 For PB and ZS: 20 For NI and SN: 50 For AH, AA, NA, CA and ZS: 5,000 for all strikes from 245,000 10,000 for all strikes over 250,000 For NI and SN: 10,000 for strikes from 10,000 to 390,000 20,000 for all strikes over 400,000 For PB: 20,000 for all strikes over 20, Expiry Process for Exchange Traded Average Price Options (TAPOs) Once a TAPO trade is novated it cannot be early-exercised. The GUI will flag for exercise any positions that are USD0.01 or greater in the money on expiry day which is the last business day of the month. Exercising a TAPO creates two open forward positions for a Prompt Date two business days after the expiry day. These forward positions are equal and opposite in all respects other than price, with one of them created at the Monthly Average Settlement Price (MASP) and the other created at the original strike price of the option on the second business day of the following month. The cash difference between these positions is the settlement amount and will be realised upon the settlement of the two forward positions. The following table displays the Option Exercise and Assignment Rules for each product: Option Product Expiry Date Last Trading Time Exchange Traded American Options Exchange Traded Average Price Options (TAPOs) 07:30 11:15hrs daily 11:15hrs on the 1 st Wednesday of the month. 15:00hrs on the last day of the month. 18:00hrs on Expiry Day :00hrs on Expiry Date - 1 LME Clear DSS - BAU Version

26 Exchange Traded Forward Expiry and Settlement Any open positions in Exchange Traded and OTC Loco London Bullion Market Forwards at the time of expiry will require physical settlement. The settlement process for forward expirations is as follows: Delivery Day -2 o o LME publishes Settlement Prices for the forward traded LME metals. JPY delivery positions expire. Long positions will generate a cash instruction that will be called for in the next overnight process, short positions will create a pending cash instruction that will remain as such until the overall position across all currencies is known. Delivery Day -1 (relevant to positions at 13:30hrs) o o o o LME Clear publishes a delivery file (LMIA.TXT) for import into LMEsword at approximately 16:00. This generates the Cleared Transfers for Members. Once this file has been loaded into LMEsword, Members are able to nominate their warrants for delivery. If there are any delivery transfers between Members after the file has been published, LME Clear will publish an updated version of the file. Any additional Cleared Transfers generated by a new LMIA file will automatically reflect any increase in a Member s position. Any reductions will be handled manually in LMEsword by the giver. If Members require a delivery transfer request, they must submit this via to LME Clear Operations. LME Clear GUI calculates the amount of money required from buyers. Delivery Day o LME Clear GUI collects the cash from buyers at the start of day via SPS.Members are able to nominate their warrants in LMEsword up until the deadline of 11:00. LME Clear DSS - BAU Version

27 o o o o o o o o At 11:00, the first warrant collection job is performed in LMEsword by LME Clear Operations followed by the first allocation run. LME Clear Ops have the ability to edit the allocations. Any amendments will need to be authorised. Once the allocation run has completed successfully, the warrant delivery process will be run by LME Clear. Once deliveries have been completed, LME Clear Operations will release the payments to sellers. At 15:00, LME Clear Operations authorises the final settlement/warrant delivery job. If there are any late deliveries, the final job can be delayed up until 16:00. LME Clear Operations authorise the production of the Rent and Weight adjustments file in LMEsword. The Rent and Weight Adjustment file is loaded into LME Clear GUI. LME Clear Operations obtain a delivery report from LMEsword and carry out settlement rollovers for non/partial deliveries. During LME Clear Cover Distribution, the Rent and Weight file adjustment file will be used to reimburse buyers/sellers accordingly LME Warrant Netting Forward positions that go to delivery will be stated in the LMIA delivery file that is sent to LMEsword adhering to the following rules: House Accounts House accounts will be represented by two lines in the LMIA file, one that nets all long positions and one that nets all short positions. When it comes to delivery, these long and short lines will net off against each other to give either a net long or short position at the value of the settlement price. Client Accounts ISA and Omnibus accounts will also be represented by two lines in the LMIA file, one for long positions and one for short positions. These positions will not be netted off when it comes to warrant allocation in LMEsword. On the settlement day, sold lots for the same product, in USD, GBP, JPY or EUR are netted against bought lots in other currencies. The settlement value for the netted lots is credited or debited to the appropriate cover account for the currency. Remaining sold lots are delivered under normal procedures Rent, Weight and FOT Differences Allowances for accrued rent, any difference between warrant weight and contract tonnage weight, and Fees on Truck are detailed on the Warrant Collection Adjustment Invoice and Warrant Allocation Adjustment Invoice produced by LMEsword. The rent, weight and Fee on Truck values, calculated in US Dollars, are netted against each other to create an overall debit or credit amount. This amount is posted to the Clearing Member s US Dollar cover account on the delivery day for value and settlement on the next business day. When rent and weight adjustments are received by LME Clear at approximately 14:00 they will appear within the risk calculations as unsettled transactions and included in the overall margin requirement Process for Partial/Non-Deliveries In the instance of there being partial or non-deliveries, there are a number of options available: If a Member has both a long and a short position across multiple accounts or within client accounts, they may require the warrants that they are expecting to be allocated to fulfil their delivery obligation on their short position. If this is the case. A Round Robin process is used. LME Clear DSS - BAU Version

28 This is not a business as usual process and is at the discretion of LME Clear operations to facilitate this process. o Members will allocate their warrants for short positions as usual, o The first run of the warrant allocation process is run. As there will not be enough warrants to completely fulfil the delivery requirements, a pro-rata allocation will take place. o LMEC Operations can manually adjust the allocations if required, to ensure that the Member who requires delivery of warrants to fulfil their allocations receives sufficient warrants. o Once the allocations have been authorised, the Member is then able to allocate the warrants against their short delivery position. o The warrant allocation process is run again to deliver the newly allocated warrants. The Member can borrow warrants from the ex-cleared market for allocation LME Clear can perform a manual settlement rollover. If there are any partial or non-deliveries, LME Clear Operations will manually perform a settlement rollover for any remaining quantity. This will be done by means of submitting trades via the LME Clear GUI. The price for any trades will be the sum of the settlement price plus any penalty or premium. The entered trades (cash today) will not be replicated in LMEsmart. The Exchange reference for these trades has the format YYYYMMDD9nnnnnnn where the first numeric digit after the date is a 9 to distinguish the trade as an internally entered trade in LME Clear. There will not be any fees associated with these trades. The partial/non-delivery trade entry process cannot be delayed beyond 16: OTC Loco London Bullion Market Forward Expiry and Settlement Delivery Day -1 o By 16:00 Hours - The Delivery Position, in respect of each Account of the Member is calculated for each type of underlying asset. The Invoice and Account Sales Report is made available via an enquiry screen in the Clearing System. Delivery Day o o o o o By 09:00 Hours - LME Clear will debit Members (as Buyers) their Cash Payment Obligations in respect of their receive entitlements for the amount specified in the Invoice and Account Sales Report. By 11:00 Hours - Members (as Sellers) shall instruct their Bullion Clearer to transfer unallocated metal to LME Clear in order to fulfil their delivery commitment. From approximately 11:30 Hours - The seller will receive notification from their Bullion Clearer that their unallocated metal transfer instruction has been executed. From approximately 12:30 Hours - Following receipt of all LME Warrant Delivery Obligations from the Member (as Seller) LME Clear will credit the Settlement Payment amount to the Member's Settlement Accounts at its Approved Settlement Banks via the Secure Payment System, for value on the Prompt Date. At 16:00 Hours - End of LPMCL Bullion Transfer Day Monthly Average Futures Expiry For Monthly Average Futures a net profit or loss Cash Settlement for the Prompt Date is calculated for each Member Account. This profit or loss is calculated as the difference between the Monthly Average Settlement Price (MASP) and the open contract prices. LME Clear DSS - BAU Version

29 Product Expiry Date Settlement Date Monthly Average Futures The last day of the month. 2 days after the last day of the month Futures Expiry All LME Futures positions are cash settled in the currency of the underlying Instrument. For LME Index and LME Mini positions a net profit or loss Cash Settlement for the Prompt Date is calculated for each Member Account as the difference between the Final Settlement Price on the day of expiry and the final open position price of the previous day s mark to market. The dates of cash settlements as derived from Futures expiry can be found below. Product Expiry Date Settlement Date LME Futures LME Minis Last business day of the contract month 2 days preceding the 3 rd Wednesday of the month. 1 st business day after the last business day of the contract month 3 rd Wednesday of the month. LME Index 2 nd Wednesday of the month. 1 day after the 2 nd Wednesday of the month. 6.5 Position Transfers Members have the ability to transfer existing positions as per rule 6.13 in the LME Clear Limited (LMEC) Rules and Procedures, which permits the Transfer of Contracts in the absence of default. LME Clear provides a mechanism whereby Members can affect the transfer of positions via the LME Clear GUI, thus circumventing the need to carry out the transfer in LMEsmart in certain circumstances. Provided it complies with LME Clear s eligibility criteria, a position transfer can be carried out: From one Member to another, Between accounts within the same Member. Prior to commencing the position transfer process, Members are required to contact their LME Clear Relationship Manager who will advise them on how to progress and ensure that any supporting documentation is completed Criteria for LME Clear Position Transfers A position transfer using the LME Clear mechanism will be assessed for eligibility provided it fulfils one of the following criteria: 1. A Member is exiting the LME market and transferring their House and /or Client Accounts (whole portfolio) to another Member(s), 2. A Member is exiting a significant LME business line, i.e. proprietary execution business, OTC /paper financing business, client clearing business (whole client portfolios in that business line), LME Clear DSS - BAU Version

30 3. A Member is transferring contracts to meet regulatory requirements, i.e. regulation mandates that Members move Clients contracts from an OSA to an ISA, or from an OSA to another OSA (whole portfolio per client); 4. A Member is transferring its LME business from one legal entity to another legal entity to meet a regulatory requirement or as a result of an internal restructuring or acquisition (the new entity would need to be on-boarded by the LME and LME Clear in the usual manner prior to the transfer taking place). Transfer requests for any reason other than the above will be assessed on a case by case basis, but it should be assumed that all other position transfers will be affected in LMEsmart Risk Management All position transfer requests will be subject to a pre-emptive risk calculation prior to transfer. This calculation will be carried out internally by the LME Clear Risk team and will assess the impact of the transferred portfolio in terms of the change in initial and variation margin that it will bring about. Members will subsequently be advised of any pre-funding should the theoretical application of the position transfer necessitate it. Transfers will only take place once any such pre-funding is settled with the relevant SPS bank Position Transfer File Position transfers conducted in the LME Clear GUI require Members to upload a.csv file that complies to a predefined template. Files contain the following attributes: Field Example Mandatory Description Source Member AAA Yes Mnemonic of member positions being ported from Source Account AAA_OSA_1 Yes Member account ID where positions being ported from Source Client Client1 No Member client ID where positions being ported from. If sent in, system will populate field but not validate the information Destination Member BBB Yes Mnemonic of member positions being ported to Destination Account BBB_OSA_2 Yes Member account ID where positions being ported from Destination Client Client2 No Member client ID where positions being ported to. If sent in, system will populate field but not validate the information Instrument CAD010414, AHDMAR14_2000C Yes. for Forward For Options Tradable Instrument for position transfer LME Clear DSS - BAU Version

31 Underlying CA, AH No Underlying commodity of the instrument Instrument Type Forward, Mini, OptionOnForward No LME instrument type Currency USD No Currency of instrument Trade ID No (Leave blank for Options) LME mercury Trade ID Trade Price Forward- use Original trade price, Futures- use Previous day s closing price, Options - Leave blank Swap - use Original trade price, TAPO - Use zero price No (Leave blank for Options) Traded price of the position being ported Trade Date 01/06/2014 No (Leave blank for Options) Trade date of the position being ported Prompt Date 01/12/2015 No Prompt date of trade Long Quantity 100 No Number of long position Short Quantity 200 No Number of short position Strike Price 1800 No Option strike price Completed files are then uploaded to the LME Clear GUI where they will be verified systemically before being processed by the LME Clear Operations team provided they meet the criteria as specified earlier in sections and Members can view the status of their file as it processes in a dedicated screen within the LME Clear GUI. Provided the LME Clear Operations team has not begun processing an uploaded file, Members have the ability to cancel an upload should they wish to for any reason Position Transfer Fees The LME Clear position transfer mechanism will incur a flat rate per lot fee that will be calculated internally and collected from Members along with their manual fees that are collected on a monthly basis. LME Clear DSS - BAU Version

32 6.6 Compression LME Clear will provide Unilateral Risk Neutral Post Trade Compression service for forward and Monthly Average Futures contracts. Compression will result in the termination of the old contracts and creation of a new contract(s). The service is optional and available for trades which cleared the previous day or prior to the previous day. Compression through LME Clear enables Members to compress contracts held in a House or Client Account and reduce the overall notional value and number of line items without changing the overall risk profile of the compressed contracts. The compression service can be split into 3 different types of compression; auto, manual and file based compression Auto Compression This type of compression is suitable for House Position Accounts and ISA accounts where there is a single member/client allocated to the account. Members can request to auto compress trades daily, weekly or monthly in an account by updating their Reference Data Form and advising LME Clear to make the system change. LMEmercury will run a compression simulation on the entire account which has been selected and illustrate to the Member the outcome of the compression in the File Upload perspective. The illustration will be available from 3am UK time at the start of the business day. If the Member agrees with the simulation and wishes to proceed with the compression, no further action is required. The Member has the opportunity to cancel the compression via the LMEmercury GUI prior to 2pm UK time Manual Compression This type of compression is suitable for all types of account. Members manually select trades in LMEmercury and assign a unique reference ID/number per individual client in an OSA, which is then included on the selection of trades to be compressed. Two or more gross positions in the same account can be compressed which result in the same net position at a new calculated trade price within the set of tolerance from the current market price. A new trade date is created using the date of compression as the trade date. On completion of positive validation, LMEmercury will run a compression simulation illustrating the outcome of the compression. This is then made available to the Member in the File Upload perspective. If the Member wishes to proceed with the compression, they are obliged to provide positive affirmation via the LMEmercury GUI by 5pm UK time. The member also has the opportunity to cancel the manual compression. Amendments cannot be made to the compression simulation; they must re-select trades and submit a new manual compression. Members are responsible for managing compression within OSA s to ensure they do not compress across clients. The reference added to the compression requests will be used by LMEmercury to compress items with the same reference. In the absence of a defined reference ID/number the file will be rejected as a reference has to exist for LMEmercury has to differentiate Clients within an OSA account. LME Clear DSS - BAU Version

33 6.6.3 File Based Compression This type of compression is suitable for all types of account. The process is the same as the manual compression process however, instead of trades being manually selected in the LMEmercury GUI by the Member; they can submit a file to LMEmercury containing the trades they wish to compress. All trades with the same reference ID/number in the file will be compressed together. A file can include more than one reference ID/number to compress. Validation will be undertaken in a similar manner as for Manual Compression and a simulation will also be completed and made available to the Member. The Member will also have until 2pm UK time to provide confirmation in order for the compression to process at the end of day. If no confirmation is provided then the file will be automatically cancelled. Amendments cannot be carried out on the compression simulation. If the Member does not wish to proceed with the proposed compression simulation they will cancel the compression simulation and re-submit a new file with trades that they wish to compress. A new compression simulation will be run and can be approved via LMEmercury if they wish to proceed with the compression simulation. The file cannot be more than 10Mb in size, and will need to adhere to the following format below. Filename format: Compression_MemberMnemonic_Date_*.csv Where _* is optional. The system will only validate against Compression_MemberMnemonic_Date. Rules: MemberMnemonic must be that member uploading the file Date must be current business day of format yyyymmdd Must be CSV Must be less than 10MB All mandatory fields are filled in o Each row contains either UTI/CTI OR Trade ID o Each row contains REFERENCE_ID if account is OSA or ISA Indirect Field Example Mandatory Description Source Member AAA Yes Mnemonic of member positions being compressed Source Account AAA_OSA_ 1 Yes Member account ID where positions being compressed Compressio n Set Client1 No Yes for OSA/ISA indirect Set of trades that will be compressed, e.g. Member client System will validate that field is populated for OSA and ISA indirect accounts LME Clear DSS - BAU Version

34 Instrument AAE No Tradable Instrument for trade to be compressed. Underlying AH No Underlying commodity of the instrument System will not validate field, it will be populated using information from Tradable instrument. Currency USD No Currency of instrument System will not validate field, it will be populated using information from Tradable instrument. Trade ID Yes** LMEmercury Trade ID Trade Date No Trade date of the position being compressed Prompt Date No Prompt date of trade System will not validate field, it will be populated using information from Tradable instrument. Trade Price 1780,50 No Traded price of the trade position Short Quantity Long Quantity 10 No Number of short position 2 No Number of long position UTI/CTI E01LMEC ABC Yes** Trade identifier. Either Cleared trade UTI or LMEC compressed trade CTI* (set by system at trade compression). *Either Trade ID or UTI/CTI is required at file upload External Reference A1 Group No Field that can be set per trade by member. System will not validate this field. Maximum number of characters are 255. Allowed characters: A-Z, 0-9, /,\,@, -, _ LME Clear DSS - BAU Version

35 *Only mandatory if UTI_CTI is not provided. **CTI Definition: 7 Market Data Management LME Clear will retrieve prices from various sources, including the LME and market vendors. LME Clear will process prices through an internal price validation tool. Validation rules will include; Range check if price changes are more than reasonably expected (dependent on product) Zero price check for any zero prices received Negative price check for any negative prices received Check for missing prices 7.1 LME Settlement prices LME Settlement prices will be received from the LME at approximately 13:30 via Select MD (market data,) validated and then published within the clearing system. 7.2 LME Closing prices LME Closing prices, including option volatilities, will be received from the LME at approximately 17:50 via Select MD, validated and then published within the clearing system. LME Clear will not receive the LME provisional prices. 7.3 Closing Interest Rates OIS rates are taken from a data vendor for all currencies (USD, EUR, JPY and GBP). Currently these are from Reuters and are taken and validated at 17:00. Discount factors will be calculated from these OIS rates and then fixed to 6 decimal places. 7.4 Closing FX Rates These are validated and taken from a data vendor at 17:00. To ensure consistency, the same FX spot rates will be used for the conversion of any non-usd collateral assets into the base currency USD. The following FX rates are required GBP/USD EUR/USD JPY/USD For the purpose of calculating the non-usd prices for the LME base metal forward contracts an FX forward curve is required. The LME provide the prices for the USD based contracts and LME Clear will use a vendor forward curve (currently Reuters) to convert these prices to EUR, GBP and JPY. LME Clear DSS - BAU Version

36 7.5 Collateral Pricing LME Clear have in place a robust and timely valuation methodology for all collateral types and will make all valuation prices available to members via the GUI or the Member reports detailed in section On the basis that LME Clear will always be long of collateral, the price set used will be based upon the bid price. With regards to financial instruments, prices used for valuation purposes will be dirty, and so include accrued interest. Yield quotes for discounted instruments will be converted to a price basis prior to valuation being applied. Spot prices used FX conversions for collateral will be the same as those used for cleared products. Spot prices used in the valuation of Gold collateral will be sourced directly from Reuters. LME Clear will use bid prices in the valuation of gold collateral instead of mid prices. All cover valuation will be calculated following the application of appropriate haircuts. In order to ensure robustness of collateral prices, LME Clear will have the following in place: Standard validation processes The ability to obtain prices from at least two established data vendors; A methodology in order to assess the robustness of pricing sources with parameters in place to adjust valuations based upon this. Access to market participants to regularly verify its pricing methodology and verify individual prices. LME Clear will capture official End of Day prices at two points in the day. These points will be at the End of Day in European time for all European and Asian securities and at the end of the New York day for US securities. The official end of day prices will be used within the overnight cover distribution activities. 7.6 Intra-day Pricing LME Clear will receive metal market prices directly from the LMEselect MD system on a near realtime basis. Market prices will be applied to positions at various points during the day, at which time prices will go through a standard validation process. After each calculation all Members variation margin, on all open positions, will be revalued. As trades are registered between calculation periods the variation margin will be calculated in real-time, based on the price used for the last recalculation. These will then be updated along with all other trades at the point that the next recalculation is undertaken. To obtain a price curve across all maturities rapidly, the curve is shifted using the change in the most liquid 3 month point, across all maturities (parallel price shift). Options will be re-priced intra-day using the previous day s closing volatility and the latest price snap for the maturity concerned. Interest and FX rates are also fully updated using the same source as the EOD prices Intraday Collateral Revaluation LME Clear will monitor all collateral prices on a near real-time basis and intra-day revaluation of collateral will occur at least once every day in alignment with the scheduled intra-day margin call (see Section 8.2). Further collateral revaluations will take place through the day and during times of volatility LME Clear will have the ability to increase the valuation frequency on all of its collateral or only a sub-set of collateral. Members will receive the benefit of intra-day increases in collateral value in order to offset increased liabilities and, where outside of credit thresholds, will be called for reductions in collateral value that LME Clear DSS - BAU Version

37 are greater than reductions in liabilities. Members will not be repaid Cash Collateral based upon intraday revaluations and will only be allowed to release excess non-cash based upon cut off times within LME Clear Rules. 7.7 Price Substitution Process Trades can be matched in LMEsmart and received in clearing with an abbreviated price code which will be substituted once the corresponding price is known. In the instance of YS and V, this is in LMEsmart as the prices are known at this point. The abbreviated price codes offered are: S Settlement price, YS Yesterday s Settlement price, B Basis Closing price, C Closing price, V valuation. 8 Risk Management 8.1 Real Time Risk Calculation LME Clear will recalculate a Member s margin requirements and collateral holdings in real time as their positions/collateral change or as market data is updated. The price set will be updated at least hourly throughout the day via the application of market prices to Members positions. Collateral holdings will also be subject to revaluation basis the current market price. If a Member s available collateral, including a credit tolerance, does not cover the liabilities posed by their positions they can be called for additional collateral intraday. LME Clear will perform a full revaluation of the portfolio margin requirement on an account following the receipt of a new trade and on an hourly basis following a re-capture of prices. A credit tolerance will be granted above the total available collateral, at which point a request for additional collateral will be made. The proximity of a Member s liability to their credit tolerance can be seen in the LME Clear GUI, whereby the following colour coding is applied to their Margin/Collateral comparison: Green The Member s margin requirement is less than 50% of their available collateral (including credit tolerance). Amber The Member s margin requirement is between 50% and 80% of their available collateral. Red The Member s margin requirement is between 80% and 100% of their available collateral. Purple The Member s margin requirement is above 100% of their available collateral. A margin call will be initiated when a percentage of the credit tolerance has been utilised. This allows trades to continue to be registered while a request for additional collateral is processed. If at any point the margin requirement exceeds the total available collateral on the account then any further trades will be temporarily sent to the pending queue. LME Clear DSS - BAU Version

38 While credit tolerance is assigned to each account on a proportional basis based on initial margin, changes have been made to the clearing system to improve the utilisation of credit tolerance and excess collateral on the House account; unutilised tolerance on one account can cover and increase in margin requirement on another account excess collateral on House can cover an increase in margin requirement on client accounts excess credit DCVM/NLV on House can cover an increase in margin requirement on client accounts 8.2 Scheduled Intraday Margin Call At 14:00hrs, a scheduled risk calculation will be applied to all positions using the most recent market prices. At this point a full cover distribution calculation will be performed using the same rules as at end-of-day. Members collateral will be compared to their risk requirement per account and margin will be called in order to ensure a Member s liability is fully covered. At this point the available collateral will not include the credit tolerance provided by LME Clear to Members. The intention of the call is to reduce the likelihood of further collateral requirements, and resultant SPS calls under US SPS, later in the day. Intra Day Margin Call 14:00 Phase Trade and Position Management Snap Positions 14:00 Market Data Management Create Current Price Set 14:00 Market Risk Management Calculate portfolio risk (snapped position) Run Cover Offsetting Manage Default No Treasury Call All Losses Monitor for confirmation of receipt of collateral Collateral Received Yes Collateral received Settlement Bank Manage Collateral Request Any non-cash collateral that becomes unencumbered following the 14:00 cover call process will be available for withdrawal by Members via the GUI provided that instructions to do so are received within applicable cut off times. 8.3 End of Day Risk Process All positions will be subject to a daily end of day risk calculation following the close of business. The total margin requirement will be calculated on a position account level, and compared to the lodged collateral. If required, a margin call request for the impacted account will be initiated. Once confirmation is received from the SPS Settlement bank that the funds are received, this will be reflected in the balance of the cash account associated with the impacted position account. Risk LME Clear DSS - BAU Version

39 reports available to Members will give a breakdown of the component factors that contributed to the margin call If there is a shortfall in collateral then the request for additional collateral is due to be paid no later than 09:00hrs on the next business day. End of Day Risk Management Phase Trade and Position Management Calculate open positions to be carried forward to the next day Market Data Management Manage Closing Prices Market Risk Management Calculate portfolio risk (EOD Positions) Run Cover Offsetting Manage Default Run Backtesting No Treasury Margin Call Monitor for confirmation of receipt of collateral Collateral Received Yes Collateral received Settlement Bank Manage Collateral Request 8.4 Initial Margin Initial Margin is a payment required on all open positions that aims to ensure LME Clear s market risk is covered in the instance of a Member default. Initial Margin is calculated on a Member s account in real time throughout the day each time a new trade is registered for clearing or there is a shift in the relevant market data. It is also calculated on Member s account in the end of day Risk Process. LME Clear will use Standard Portfolio Analysis of Risk (SPAN) to calculate Initial Margin. SPAN considers how the value of an entire portfolio of options and futures will respond to changes in futures (or underlying) prices and volatilities. SPAN simulates potential market moves and calculates the profit or loss on individual contracts. SPAN utilises the margin parameters to calculate the Initial Margin. SPAN splits the Initial Margin calculation into four components; Scanning Risk - The Scanning Risk is a worst-case portfolio loss based on the net position. Scanning Ranges, Volatility Shifts and Inter-currency Shifts are all part of the Scanning Risk calculation. Inter-prompt Spread - SPAN Scanning Risk assumes that forward prices move by identical amounts across all prompt dates. The Inter-prompt Spread utilises the Inter-prompt Spread Charge to calculate the margin requirement to cover the differences in price moves between prompt dates. Inter-contract Credit - SPAN provides a credit to recognise cases where offsetting positions in related contracts reduce overall portfolio risk. This is calculated using the inter-contract spread credit. LME Clear DSS - BAU Version

40 Short Option Minimum Charge - This covers the cost of closing out deeply out-of-themoney options which have very small intrinsic value. It therefore calculates a floor to the margin requirement for short option positions. For LME Clear SPAN uses the these components to calculate the Initial Margin requirements, being the maximum of; Scanning Risk plus Inter-prompt Spread minus Inter-contract Credit or Short Option Minimum Charge A SPAN Parameter File will be generated at the end of every business day. This will provide details of all margin parameters and risk arrays. This will be available to Members via their FTPS server and the LME Clear GUI. Calculate SPAN Initial Margin Phase Trade and Position Management Positions Market Data Management Price Set Volatility Shift Calculate Loss Arrays Market Risk Management Scanning Range Interprompt Spreads Intercommodity Offsets Calculate Scanning Loss Calculate Intercurrency RIsk Calculate Interprompt Spreads Calculate Intercommodity Offsets Calculate SPAN Total Margin Short Option Minimum Charge Calculate Short Option Minimum Charge SPAN Parameters To set the parameters to be used within the SPAN algorithm, LME Clear must assess the correct liquidation period, confidence interval and length of historical data to use in order to generate input parameters. LME Clear assumes a two day liquidation period in its margin calculation and a minimum confidence interval of 99%. In order to manage procyclicality LME Clear will calculate two Scanning Ranges based on 2 and 10 year historical periods, based on a historical VaR calculation. The historical VaR calculation based on the 10 year price history becomes the margin parameter floor. The level of the parameters is actively monitored and subject to a monthly review, with the ability to perform ad-hoc changes intra-month if required. Members will be informed in advance of any changes to SPAN parameters and the SPAN parameter file will show the updated parameters from LME Clear DSS - BAU Version

41 the go-live date. Full details of all live margin parameters will be available to Members at all times via the Member section of the website. 8.5 Variation Margin Calculation Variation margin is calculated for each Member account at the end of each business day against the Official Closing Prices. An indicative variation margin is calculated intraday on the receipt of new transactions and when LME Clear applies a new price set. Indicative variation margin is always unrealised. Variation Margin is calculated on a product specific basis using the following models: Product Variation Margin Model Exchange Traded Forwards Exchange Traded Monthly Average Futures Exchange Traded Futures (LME Mini,Index and Steel) Exchange Traded Options Exchange Traded Average Price Options (TAPOs) Discounted Contingent Variation Margin Discounted Contingent Variation Margin Realised Variation Margin Net Liquidating Value Net Liquidating Value Discounted Contingent Variation Margin DCVM Contingent Variation Margin is calculated as the difference between the value of open positions at the Official Closing Price with their value at the original trade price. As Contingent Variation Margin is a forward cash flow, it is discounted back to the present value, using a discount rate set by LME Clear, to create Discounted Contingent Variation Margin Cash Contingent Variation Margin CCVM Cash Contingent Variation Margin is calculated as the change in net present value. It is calculated as the difference between today s Discounted Contingent Variation Margin and yesterday s Discounted Contingent Variation Margin. Cash Contingent Variation Margin is realised on a daily basis, adjusted by the application of an interest rate factor calculated as a charge on cumulative variation margin received or a payment on cumulative variation margin paid. This adjustment factor, or Price Alignment Interest, maintains the parity of pricing between a cleared OTC contract and an un-cleared OTC contract Realised Variation Margin RVM Realised variation margin is calculated as the difference between the value of open positions at the Official Closing Price with their value as held in the Clearing System. For carried forward positions this is the previous Official Closing Price and for new trades this is the trade price Net Liquidating Value NLV Net Liquidating Value is calculated as the value of open option positions with reference to the Official Closing Price. Net Liquidating Value is not realised. 8.6 Back Testing In order to ensure the robustness of its margin methodology, LME Clear has executed and will continue to execute a number of back tests using different parameters and assumptions. This will be LME Clear DSS - BAU Version

42 performed on the cleared contracts via factor back testing and on Clearing Member s accounts using portfolio back testing. LME Clear will use the BASEL traffic light approach (BASEL II coverage test) to analyse the results of the back testing. LME Clear may choose to use other statistical methods in conjunction with the traffic light approach to verify the back testing it is performing, for example a Kupiec-POF test. LME Clear will perform portfolio back testing on all Members for each position account. The LME Clear risk appetite states that LME Clear s margining model seeks to ensure that at each position account level a minimum 99.5% of observed losses being less than the initial margin held set over the appropriate liquidation period utilising a rolling 2 year history. In line with factor back testing all portfolio back testing will be evaluated using the same BASEL traffic light approach. 8.7 Stress Testing The Default Fund is a key part of the protection that LME Clear has against potential losses which exceed the financial resources available from the margin requirement or upon collateral held as margin cover, in the event of a default of one or more clearing Members. Stress testing results are used to calculate the size of the default fund using a suite of stress scenarios developed to represent extreme but plausible historical and hypothetical stress conditions. Stress testing is performed on Member s positions and their collateral holdings, with both historical and hypothetical scenarios being used. Stress tests have therefore been designed to estimate extreme but plausible losses on metals, financial instruments and other forms of collateral, interest rates (impacting margin discounting and options valuation) and FX rates. These stressed events simulate the behaviour of Member s portfolios during historical crisis events or extreme potential events allowing LME Clear to determine the potential losses associated with each Member s positions and collateral holdings should these events (re-)occur. Historical stress scenarios are determined by analysing the time series of the major contracts. Crisis periods are defined and from within these the dates which experienced the largest returns are set as stress scenarios. Within each crisis period there will therefore be a number of stress scenarios each corresponding to different dates. A general period is set for dates which saw large returns but occurred outside of the historical crisis periods. The table below provides details of the current defined stress periods for cleared contracts. As new stress events occur, new hypothetical and historical scenarios will be added, and redundant scenarios will be removed. Scenario ID Historical Crisis Period Stress Period Black Monday 10 Sep Oct Black Wednesday 1 Sep Sep bond market crash 4 Jan Feb Sumitomo Copper crisis 1 May Oct Asian crisis 7 Jan Dec Rouble crisis 5 Aug Aug 98 LME Clear DSS - BAU Version

43 7 September Sep Sep New Orleans Zinc crisis 1 Jun Oct Lehman collapse 15 Sep Nov EU crisis 1 Jun Oct MF Global default 01 Nov Nov Extreme historical price swings for each metal The historical periods when each metal experienced largest volatilities Stress scenarios will be set as a relative shift. For example if the price rose from $2000 to $2500 this would be a 25% upward shift. If the price is now $4000 then it would be moved up $1000 to correspond to a 25% upward shift. Shifts will be set for each risk factor (Cash, 1month, 3month etc.) and interpolated for prompt dates between these factors. LME Clear has decided that results for combined stress testing (liabilities and assets) can only be based upon common scenarios, i.e. collateral stresses from one scenario and cleared product stresses from another scenario cannot be combined to deliver one result. Therefore for each historical scenario for cleared products there will be collateral shifts applied, based on the moves in collateral prices seen on those historical dates and vice versa for each historical collateral scenario, corresponding shifts for cleared products will be obtained. 8.8 Default Fund calculation LME Clear will determine the Default Fund size as follows: On the first business day of each month calculate the end-of-day stress losses over initial margin for the previous 6 months along with the stress losses over stressed encumbered collateral value to arrive at the total stress testing losses TSTL for each clearing Member, for each of their individual accounts. Any excess collateral in place is assumed to be unavailable to meet stress losses on the basis that it could be withdrawn at any point in time. This will be calculated for each clearing Member for each scenario and include the assumption that no client accounts succeed in porting. All clearing Members which form part of the same group of companies (sharing a common holding company as determined by LME Clear) shall be considered to default at the same time under the same scenario. LME Clear will calculate the average of the three largest TSTL for the two largest Clearing Member default (including affiliates) under the same scenario for each business day over the previous six calendar months. The default fund will have a minimum value which will override the calculation. This is detailed in Appendix A. LME Clear will then apply an additional default fund buffer to provide for future increases in stress testing losses in between calculations. This will initially be set at 10%. Member s contributions to the default fund are based on the risk created by them as a proportion of the total risk across all Members. An average of the previous months End of Day and Intra-day Initial Margin (based on 2pm initial margin) is used in a 50/50 split. The final contribution for each Member will be subject to a minimum value, as detailed in Appendix A. LME Clear DSS - BAU Version

44 The Default Fund will be re-valued on a monthly basis. The total size and Member contributions will be calculated on the last business day of the month. These will then be approved by LME Clear on the first business day to go-live on a day defined by LME Clear and communicated to Members. Members will be provided with a report showing their contribution. In extreme circumstances it may be required to be reset intra-month, for example in the event of a Member default. Members will be informed if this is required. 8.9 Additional Margin LME Clear may have cause to call additional margin on occasion where certain characteristics of the portfolio or Clearing Member dictate that the Initial Margin is deemed insufficient to protect LME Clear from the risk posed. Additional Margin can be taken in four main forms which are concentration margin, default additional margin, additional credit margin and discretionary margin Concentration Margin Concentration margin will be used to cover the risk of large positions that in a default would potentially take longer to close out than the two day assumed liquidation period. It is automatically calculated by the clearing system. The calculation is based on the average daily trading volume and the Scanning Range of each commodity. It is calculated at a Member level based on the net delta position in all accounts for each commodity. To determine the additional concentration margin for each clearing Member LME Clear will calculate the average traded volume for each commodity. LME Clear will utilise this, in conjunction with some assumptions of the market depth it could trade, to calculate the tradable volume in the event of a default. This is then compared to the net cleared position and encumbered warrants lodged as margin collateral of the same underlying metal that would be needed to liquidated in the event of the Member defaulting. If the position is determined to be larger than could be traded in a two day period, i.e. a concentrated position, then a charge is calculated based on the scanning range over the extended period required to close out the position. For example, the following inputs are required for the calculation: Threshold number a number of thresholds will be set based on how long (in days) it would take to close out the position, currently 1 to 10. Threshold the volume that is calculated to be traded for each day post default Charge the charge that is applied to the volume between thresholds No charge needs to be paid for the quantities that fall below the first threshold (2 days). Multiply the quantities that falls between each threshold by the appropriate charge, per tonne and multiply by the lot size. Two calculation examples are given below. LME Clear DSS - BAU Version

45 Example 1: Member ABC has a 40,000 lots of LONG cleared Aluminium positions across a number of maturity dates (lot size=25 tonnes). Member ABC has a 4,000 lots of Aluminium warrants lodged to cover the margin liability created by the long AHD forward position. The additional concentration margin will be driven by the net size of the member s cleared position (i.e. 40,000 lots ) and the meber's collateral position (i.e. 4,000 lots), which equates to 44,000 lots along with the Volume Thresholds table and the $ Charge per tonne : Example 2: Member ABC has a 40,000 lots of SHORT cleared Aluminium positions across a number of maturity dates (lot size=25 tonnes); LME Clear DSS - BAU Version

46 Member ABC has a 4,000 lots of Aluminium warrants lodged to cover the margin liability created by the short AHD forward position; The additional concentration margin will be driven by the net size of the member s cleared position (i.e. 40,000 lots ) and the meber's collateral position (i.e. 4,000 lots), which equates to 36,000 lots along with the Volume Thresholds table and the $ Charge per tonne ; Default Additional Margin LME Clear is required to hold resources that are sufficient to cover the simultaneous default of its two largest Members. LME Clear will therefore make sure that no Member has a total stress testing losses (TSTL) that represents more than 45% of the default fund size see section 9.9 for an explanation of the default fund calculation. This means that combined the top two Members will be no more than 90% of the default fund, providing a 10% overall buffer. The adequacy of the 10% buffer will be confirmed via back testing. Where changes are required to the 45% level due to adverse back testing results, Members will be informed in advance. If, at the end of each day, a Clearing Member has a TSTL of greater than 45% of the total level of the Default Fund then LME Clear will call for additional collateral to reduce the clearing Members TSTL to 45%. This amount is called default additional margin. This is an automatic calculation within the clearing system. For example; Member Stress Loss (mn) IM (mn) Collateral Haircut (mn) TSTL (mn) DF Size (mn) TSTL % DF Default Additional Margin (mn) Final % DF AAA % % Credit Additional Margin Members will be required to provide collateral to cover some or all of their total stress testing losses, if their credit rating based on the LME Clear internal credit risk assessment framework is below a minimum threshold. Members impacted will be told in advance of a collateral request being made. The review of a Member s credit rating will be conducted at least annually and when a material change in the Member s credit profile has occurred. LME Clear DSS - BAU Version