Creation of the Clearing House KDPW_CCP Dr Iwona Sroka, President of KDPW and KDPW_CCP

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1 Creation of the Clearing House KDPW_CCP Dr Iwona Sroka, President of KDPW and KDPW_CCP Warsaw, 27 June 2011

2 KDPW s Main Strategic Goals Implement a new KDPW business model KDPW Strategy Developed and approved in late 2009 Position KDPW as the main depositorysettlement institution in CEE Integrate KDPW with European structures Launch new services growing the value of the capital group Improve the quality and scope of existing services 2

3 New Business ModelKDPW CAPITAL GROUP CLEARING HOUSE: 1. CCP for the regulated market Possibly OTHER SUBSIDIARIES - Diversified sources of revenue 2. CCP for the OTC market 3. CCP for WSE Energy Market poee Cash flows (service fees, dividends, etc.) Flow of intra-group services 3

4 From Clearing Guarantor to KDPW_CCP Step 1 Creation of the Clearing Guarantor KDPW_CLEARPOOL Step 2 Legal transformation of KDPW_CLEARPOOL into KDPW_CCP KDPW_CCP prepares to take over some functions of KDPW Step 3 KDPW creates a Division to be incorporated into CCP KDPW spins off part of its business and transfers it to KDPW_CCP Step 4 KDPW_CCP starts business operation (1 July 2011) 4

5 CCP vs. CSD (1) In accordance with international standards, in view of the different risk profile of CCP clearing house services and of CSD (KDPW) operation, it was necessary to create a stand-alone legal entity to provide clearing house services: KDPW_CCP. The main function of a clearing house is to clear transactions using mechanisms which ensure systemic mitigation of the risk of counterparty default. 5

6 CCP vs. CSD (2) The National Depository has transferred to the company KDPW_CCP all functions related to the clearing of transactions executed on the regulated market and in the alternative trading system and the operation of the clearing guarantee system as of 1 June KDPW remains responsible for transaction settlement and central securities depository functions. The process implements world-class standards at KDPW and enhances the competitiveness of the Polish capital market. The spin-off of the clearing house from KDPW s structure derives from the National Depository Strategy adopted in late 2009 and consistently pursued. The Strategy has among others implemented a new business model and largely accelerated the development of services while ensuring adequate safety of clearing. 6

7 Legal Basis of KDPW_CCP The National Depository for Securities (KDPW) hands over to the company KDPW_CCP all functions within the scope of Article 48.2 of the Act on Trading in Financial Instruments: Clearing transactions concluded on the regulated market; Clearing transactions concluded in the alternative trading system in dematerialised securities; Operating a clearing guarantee system including a clearing guarantee system for transactions concluded on the regulated market. 7

8 CCP and CSD Functionalities CCP CSD Manage clearing risk Operate the depository Clearing Settlement Administer collateral Corporate Actions 8

9 Market Infrastructure Before KDPW_CCP Trade WSE BondSpot OTC KDPW Clearing Clearing and Settlement Guarantee System Settlement CSD NBP 9

10 Market Infrastructure After KDPW_CCP Trade WSE BondSpot OTC KDPW_CCP Clearing Clearing Risk Management System Settlement KDPW Settlement CSD NBP 10

11 KDPW_CCP: New Quality on the Capital Market 1 July 2011: The Clearing House KDPW_CCP starts business operation _ Company founded by the National Depository for Securities _ Professional clearing house for the regulated market and the ATS _ International risk management standard under SPAN methodology _ New structure of the clearing gurantee system _ New KDPW_CCP membership types _ Development of new services for the banking market OTC Derivatives CCP _ Development of services for the regulated market repos, lending 11

12 Why KDPW_CCP _ Reduced counterparty risk thanks to guarantees of cleared transactions _ CCP interposed as a party to transactions ensuring reduction of the impact of counterparty default _ More effective risk management _ New categories of entities eligible as clearing members _ Improved perception of the Polish capital market infrastructure by Polish and foreign financial institutions _ Development of clearing and settlement functionalities under international standards _ Co-operation with foreign CCPs and CSDs _ Stronger interest in the Polish capital market 12

13 KDPW_CCP: Main Changes _ Introduction of the international risk management standard under SPAN methodology _ New structure of the clearing guarantee system _ New KDPW_CCP membership types _ Development of new services for different market segments (OTC derivatives, commodities) 13

14 SPAN Methodology SPAN Methodology (Standard Portfolio Analysis of Risk): _ precise estimation of risks for both cash and derivatives transactions _ calculation of contributions to the clearing fund _ widely known and recognised standard on global financial markets _ more transparency and attractiveness of the Polish market _ safer clearing _ designed and introduced by Chicago Mercantile Exchange Inc. (CME) 14

15 SPAN Methodology The change of the risk measurement methodology and consequently the calculation of margins and contributions to the clearing fund will be accompanied by a change of the structure of contributions to the clearing guarantee system. The change involves a shift of the main burden from solidary funds (clearing fund) to individual margins, which will not be used in case of another member s default. The main benefit of the change is that the margins contributed by a member will be protected. 15

16 Changes to the Clearing Guarantee System: Comparison Before KDPW_CCP one-tier system based on a mutual guarantee fund non-standard risk calculation methodology Cash Market After KDPW_CCP two-tier system based on individual maintenance margins and a mutual guarantee fund for a complex of markets risk calculation based on SPAN Liquidation Risk methodology Derivatives Market two-tier system based on maintenance margins and a mutual guarantee fund non-standard risk calculation methodology two-tier system based on individual maintenance margins and a mutual guarantee fund for a complex of markets SPAN standard Clearing Fund separate fund for each market fund for a complex of markets uncovered risk methodology CCP assets as a guarantee 16

17 New Clearing Guarantee System: Maintenance Margins _ Function: to cover the risk of change of the portfolio value in a certain time horizon _ New: maintenance margins for the cash and derivatives markets _ Application: open positions on the derivatives market and transactions in the clearing cycle on the cash market _ Description: _ Required by KDPW_CCP, released on closing a position / clearing a transaction in KDPW_CCP _ Contributed individually by clearing members to cover own risk _ Risk parameters estimated under normal conditions at a significant confidence level Glossary: Positions not yet cleared open positions in derivaties and transactions in cash market instruments in the clearing cycle Portfolio all positions recorded in an entity account 17

18 MM Normal MM Stress MM Normal MM Stress MM Normal MM Stress New Clearing Guarantee System: Clearing Fund CM 1 CM 2 CM 3 UR 1 UR 2 UR 3 CF=UR2 CM Clearing Member UR Uncovered Risk CF Clearing Fund MM Maintenance Margin CF=UR2 Clearing Fund resources equal the highest Uncovered Risk generated by a Clearing Member calculated as the difference between stress parameter Maintenance Margins and normal parameter Maintenance Margins 18

19 Changes of the Rules of the Clearing Fund (1) 1. Maintenance margin calculated both for the derivatives market and the cash market. 2. Clearing guarantee fund not to be divided into functional parts; it will be calculated using SPAN methodology on the basis of open positions on the derivatives market and outstanding transactions on the cash market based on stress-test parameters considering potential default of the member with the highest exposure. 3. KDPW_CCP guarantee liabilities to cover session transactions concluded on the regulated market and in the ATS Introducing KDPW_CCP liability using its capital and covering also ATS transactions currently guaranteed only by the ATS guarantee fund up to its total amount. 19

20 Changes of the Rules of the Clearing Fund (2) 4. Lower frequency of contributions: once per month Additional margins contributed by members on demand, where the member s uncovered risk exceeds the amount in the Fund; currently contributions to the clearing guarantee fund are updated daily. 5. Netting members receivables/liabilities under contributions to the clearing guarantee fund and receivables/liabiltiies under contributions to the ATS guarantee fund as well as maintenance margins and current mark-to-market. 20

21 New Clearing Guarantee System Clearing guarantee system structure before KDPW_CCP: members' contributions Clearing guarantee system structure after KDPW_CCP: members' contributions 20% 11% 19% 25% 69% 56% Derivative Market Margins Cash Market Clearing Fund Derivative Clearing Fund Cash Market Margins Derivative Market Margins Celaring Fund + EUR 25 mln (PLN 100 mln) KDPW_CCP capital 21

22 KDPW_CCP Members _ Local financial institutions: investment firms, banks _ Foreign financial institutions: investment firms, foreign entities performing functions of clearing transactions in financial instruments _ Companies operating a clearing house 22

23 New Membership Types _General Clearing Member (representative) GUR cash market: member clears all transactions of a third party on the cash market, including transactions of a non-clearing member; _General Clearing Member (clearing member-derivative accounts) GUR derivative market: member clears transactions of a third party on the derivative market, including transactions of a non-clearing member, if such transactions are on account of clients holding derivative accounts operated by the member or on own account; _Direct Clearing Member (clearing member-proprietary transactions) BUR member clears all transactions on own account or on clients account (cash and derivative market); _Non-clearing Member member executes transactions on the cash and/or derivative market but has no clearing member status. 23

24 Membership Types: CCP and CSD Trade Clearing Settlement REM GUR Member BH BUR Settlement Agent MARKET KDPW_CCP KDPW 24

25 Capital Requirements for Members New capital requirements have been defined for the new membership types. The capital requirements are identical for members on the cash and the derivatives market, and depend only on the number of entities represented in clearing. General Clearing Member (GUR; clears third-party transactions) is subject to the following capital requirements Banks: PLN 50 M plus PLN 5 M times the number of represented entities Brokerage houses: PLN 15 M plus PLN 2 M times the number of represented entities Direct Clearing Member (BUR; only clears transactions executed on own account or on clients account): Banks: PLN 25 M Brokerage houses: PLN 4 M 25

26 KDPW Settlement Agent Existing regulations will be modified by introducing the Settlement Agent function. According to the new solution, a KDPW_CCP clearing member will not be required to hold a depository account with KDPW. In this case, the member s transactions will be settled in the depository account of the member s Settlement Agent. This means that KDPW_CCP clearing members need not be KDPW direct members. The introduction of the KDPW Settlement Agent functionality will broaden the scope of services and of entities active in the business area of the clearing house, especially foreign investment firms. With the KDPW Settlement Agent functionality and the operation of the KDPW_CCP clearing house equipped with the necessary capital and an effective risk management system based on recognised methodology, foreign financial institutions will be able to become KDPW_CCP clearing members directly. 26

27 KDPW Settlement Agent: Assumptions _ Addressees of the new functionality: Foreign clearing members (CM) _ Beneficiaries: CM and Settlement Agents _ Purpose: To enable foreign investment firms to apply for KDPW_CCP CM status without opening and maintaining a KDPW account separation of clearing and settlement functions _ KDPW direct member (membership type: representative/settlement agent) authorised to operate a securities accout, a derivative instruments account or a depository account _ CM s financial instruments are recorded and CM transactions are cleared in the Settlement Agent s KDPW depository account 27

28 Foreign Investment Firms in KDPW_CCP Foreign investment firm: _ KDPW_CCP member with clearing member (CM) status; _ Not a KDPW (CSD) member cannot operate securities accounts (need not open a branch in Poland); _ Signs an agreement with one entity performing KDPW Settlement Agent (SA) functions; _ Indicates SA account to KDPW_CCP and presents a declaration authorising the entity to perform this function and the entity s declaration of consent; _ Pays cash liabilities depending on current mark-to-market; _ Is the only member of the clearing guarantee fund (contributes cash via the payer bank; securities contributed to the clearing guarantee fund are transferred to KDPW from CM account operated by SA). 28

29 Novation and Open Offer Typically, the Central Counterparty becomes a party to a transaction under one of two possible legal mechanisms: novation or open offer; both are missing from the Polish legal system. NOVATION The original agreement concluded on the market between counterparties is replaced by two agreements with the CCP whereby the CCP is a buyer for the seller and a seller for the buyer. OPEN OFFER Each counterparty (buyer and seller) concludes a transaction agreement with the central counterparty (CCP) immediately on matching the transaction details on the trading platform. KDPW_CCP functions: CCP GUARANTEE LIABILITY A transaction agreement indicates the technical counterparty, CCP s liability is activated if a counterparty defaults on the transaction settlement date. 29

30 Novation and Open Offer in European CCPs CCP Novation Open Offer Eurex Clearing No Yes SIX x-clear No Yes CCP.Austria No Yes EMCF Yes Yes Euro CCP Yes No LCH Clearnet Ltd. Yes Yes LCH Clearnet SA Yes No 30

31 KDPW_CCP Development Projects The KDPW Strategy provides for a number of projects supporting the growth of the Polish capital market and generating benefits to Polish retail and institutional investors and foreign investors. The division of clearing and depository functions between two separate entities will ensure harmonious development of services offered by both companies to meet clients needs, address market challenges and face international competition. The following projects (implemented by the Clearing House and KDPW) are crucial to further development of KDPW_CCP: _ Securities netting _ OTC Derivatives CCP _ Development of services offered by GIR KDPW _ Securities lending platform _ Hold-Release mechanism _ Partial clearing 31

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