April 15, Central Clearing Questions and Answers from the Buy-Side Perspective

Transcription

1 April 15, 2010 Central Clearing Questions and Answers from the Buy-Side Perspective

2 Agenda Welcome and Opening Remarks Robin Powers, Sutherland Dealers in the Clearing Process Alessandro Cocco, J.P. Morgan Products and Operational Process Corry Bazley, ICE Trust Mark Cox, CME Group Energy/CFTC Issues Michael Brooks, Sutherland Legal and Credit Issues Warren Davis, Sutherland Paul Turner, Sutherland Q&A 2

3 Welcome Welcome Overview of Current Environment Introduction of Speakers Alessandro Cocco, J.P. Morgan Corry Bazley, ICE Trust Mark Cox, CME Group Michael Brooks, Sutherland Warren Davis, Sutherland Paul Turner, Sutherland 3

4 Dealers in the Clearing Process Alessandro Cocco Managing Director, Associate General Counsel

5 Dealers in the Clearing Process CH CM1 X CM2 5

6 Dealers in the Clearing Process CH CM1 Client 6

7 Dealers in the Clearing Process CH ED CM Client 7

8 Dealers in the Clearing Process CH House A/C ED X Client X CM Client A/C 8

9 Dealers in the Clearing Process ED House A/C IM IM CM House A/C IM CM Client A/C IM House A/C CH IM Client A/C ED X CM X IM Client 9

10 Products and Operational Process Corry Bazley Senior Sales North America Mark Cox Director, CME Clearing Solutions

11 CME Group Solution Model In the more than 110-year history of CME Clearing, there has never been a failure by a clearing member to pay settlement variation or meet a performance bond call, nor has there ever been a clearing member failure resulting in a loss of customer funds CME Clearing Financial safeguards Transparent daily margining Multilateral position netting Clearing Member Collects margin, processes mark to market from clients in accordance with CME Clearing policies & other regulatory requirements Customer positions and margin held in segregated account Buy-side Firm Collateral and Positions protected through segregated accounts Margins calculated on net portfolio basis 11

12 Benefits of CME Group s Cleared OTC Solution Total Financial Safeguards Package Overview CME Group s Financial Safeguards Package is Being Extended to CDS, IRS and FX Products Total Guaranty Fund: ~$8B Temporary Liquidity Facility = $600million CME Capital Contribution = Up to $100 million Total Collateral: >$100B Designed to anticipate potential market exposures and ensure sufficient resources are available to cover future obligations Based on ability to cover at least the largest potential net debtor, accounting for collateral damage Wide variety of accepted security deposit collateral, including: Cash (USD) US Treasuries CME-approved money market mutual funds Note: Financial Safeguards funding reported as of March 31,

13 Benefits of CME Group s Cleared OTC Solution Portability of Customer Positions in the Event of a Clearing Member Default CME Clearing Defaulting Clearing Member Non-Defaulting Clearing Member Defaulting members positions Market access restricted Collateral captured Buy-side Firm Customer protection Collateral held in segregated account Positions maintained and moved to a new clearing member 13

14 CDS: Open Access and Point of Trade Clearing Clearing CDS trades real-time throughout the day, every day providing immediate cleared trade confirmation, significantly reducing the credit exposure between bi-lateral parties IDBs Trade Submission into CME Clearing Markitwire * Bloomberg CME ClearPort Executing Dealers & Customers Portfolio Back-loading Negotiate, execute, and submit trades through multiple venues to CME Clearing Straight through processing and T+0 confirmation Full life cycle trade management by CME Clearing CME Clearing Copper Record Reporting DTCC TIW Back-loading of legacy bilateral trades to CME Clearing More than 100 years of experience in clearing, settlement and risk management Clearing Member Firm Clearing Member Firm Clearing Member Firm 14* CME Group is in discussions with other affirmation vendors for trade submission into CME Clearing

15 ICE: Diverse Global Derivatives Markets IntercontinentalExchange (ICE) is the leading operator of integrated futures and over-thecounter (OTC) markets, clearing, processing and data services for global derivatives markets. Global derivatives markets across energy, agriculture, equity indexes, FX and credit ICE Integrated Marketplace Integrated execution and clearing: 3 futures exchanges, 2 OTC markets and 5 clearing houses Market participants in more than 55 countries Industry-leading innovation in products and technology CDS infrastructure that fully encompasses trade execution, processing and clearing 15

16 Global Leader in CDS Clearing Liquidity 13 dealers together with leading hedge funds and asset managers actively clearing today 61 index contracts and 151 single names across US & Europe Risk Management World class risk management specifically designed for CDS $3 billion guaranty fund -- completely separate from all other products Guaranty fund sized to cover losses from simultaneous default of 2 largest clearing members CDS and Clearing Expertise Managed numerous Credit Events since launching CDS clearing Leading market connectivity processing thousands of CDS trades a day Co-administrators of ISDA Cash settlement auctions Ease of Doing Business No changes to existing OTC trade execution required Simple legal framework leveraging existing ISDA documentation Open access provided through support of multiple affirmation platforms 16

17 ICE CDS Milestones and Volume Cleared ICE Global CDS Cumulative Volume Over 135,000 Trades Cleared Open Interest of $645B Cleared over $490MM in Buy-side Notional ICE Trust Launches Buy-side Clearing ICE Trust/ICE Clear Europe Clear Single Names ICE CDS Clearing Surpasses $7 Trillion Globally* ICE Trust Surpasses $3 Trillion In Billions ICE Clear Europe Launches CDS Clearing ICE Trust Launches CDS Clearing * As of April 9th, Visit for most recent total. 17

18 Why Clear CDS Through ICE? MARGIN PROTECTION Gross margin held at clearing house NOT at DCM Default protections designed to work within existing bankruptcy laws Separate swaps and futures guaranty funds PORTABILITY INDEPENDENCE Position and collateral linkage facilitates pre and post default DCM transfer Timely and operationally simple transfer in the event of a default Contingency planning allows establishment of new DCM prior to default Governance structure includes independent board Margin calculated using independent EOD pricing process ICE margin requirements transparent to buy-side REAL-TIME CLEARING Trades cleared intra-day, on near real-time basis Minimizes intra-day bilateral counterparty risk SIMPLICITY Leverage existing OTC infrastructure one operational process Can clear through non-us Domiciled DCMs (in US) No costly legal negotiations or significant technology build 18

19 Ease of Doing Business ICE Supports the Existing OTC Model and Multiple Platforms Trade Execution & Capture Affirmation & Clearing Consent Clearing & Confirmation Voice or e-trade Trade Capture Affirmation Platform ICE DTCC Executing Broker Alleges Block Trade Buy-side Affirms, Allocates and Routes to DCM DCM Affirms and Routes to ICE ICE Runs Risk Filter Checks and Accepts Trade Trade Cleared & Confirmed Trade Routed to TIW No Changes to Trade Execution Multiple Platforms Supported Multiple Affirmation Platforms Supported (ICE Link, Bloomberg, Tradeweb) Trades Cleared Intra-day on Near Real-Time Basis 19

20 Buy-Side Steps to Clear CDS To begin clearing CDS with ICE Trust, Buy-Side Customers need to: Establish relationships with one or more DCMs 1 Sign ICE Standard Terms Annex, review ICE Rules and ICE DCM Annex Establish access to an authorized affirmation source and provide necessary authorizations to allow them to act on your behalf 2 1 Bank of America/Merrill Lynch, Barclays, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, RBS and UBS 2 Authorized affirmation sources include ICE Link, Bloomberg and Tradeweb 20

21 Customer Margin Protection Hybrid of traditional Net and Gross margin models Gross margin held at clearing house, NOT DCM DCM s Client Omnibus Account Gross IM of $3MM DCM Minimum Initial Margin (MIM) for all (2) clients is $3MM DCM 2 Buy-side A Positions Gross IM of $2MM Buy-side B Positions Gross IM of $1MM DCM Minimum IM: Buy-side A $2MM, Buy-side B $1MM Buy-side positions partially offset - Net Margin is $750k, Custodial is $2.25MM Buy-side A Net $500K Custodial $1.5MM Buy-side B Net $250K Custodial $750K Buy-side Gross margin is posted and segregated Net margin is determined pro-rata by Gross IM Net margin at risk only in the event that another client at same DCM defaults and causes the DCM to default 21

22 The ICE Risk Waterfall Provides Multiple Layers of Protection Layers of Protection Risk Management Waterfall Membership Criteria Initial Margin Requirement Mark-To-Market Margin Requirement Intra-day Risk Monitoring Special Margin Call Execution Guaranty Fund Limited One-Time Assessment Ensure CP has sufficient financial resources, operational capabilities and risk management experience Collateralize potential Clearing Participant portfolio loss under plausible distressed conditions Adjust Clearing Participant collateral through a daily debit/credit based on EOD MTM Identify additional margin requirements based on unusual market fluctuations Mutualize losses under extreme but plausible market scenarios Oblige Clearing Participants to contribute a limited amount of additional default funding 1. Defaulting Buy-side Margin (net & custodial) 2. Defaulting CP House Margin 3. Defaulting CP Guaranty Fund 4. Non-default clients of CP (net only) 5. ICE Priority Guaranty Fund (GF) 6. Non-defaulting CPs GF / ICE remaining GF 7. One Time Assessment on CPs 22

23 Energy and CFTC Issues Michael Brooks, Sutherland

24 Clearing OTC Energy Contracts Concerns about oil market volatility in have driven Congress and CFTC Chairman Gensler to press for greater transparency through mandated clearing and other means But there are real questions as to whether the system is broken Institutional longs largely have been operating in the regulated futures markets It is not at all clear that price spikes originate in the OTC markets, however much they may lack transparency Many standardized OTC energy contracts already have migrated to the clearing houses 24

25 Clearing OTC Energy Contracts There are real concerns that forced clearing of standardized agreements will undermine market efficiencies End users continue to lobby for exemption from clearing and margin requirements Some believe that important non-standardized OTC contracts will not survive the transition (e.g. basis swaps) Existing law gives the regulators substantial powers to supervise both the OTC and the forward energy markets There are hints that the final legislation will not be as aggressive as some on the Hill and at the Commission would wish 25

26 Legal and Credit Issues Warren Davis, Sutherland Paul Turner, Sutherland

27 Subchapter IV of Chapter 7 Bankruptcy Code s Subchapter IV of Chapter 7: Liquidation of Commodity Brokers Facilitates transfer of customer accounts to different (solvent) commodity broker If customer accounts identifiable, then trustee must heed requests for return of customer property and/or transfer to new commodity broker If cannot be identified or cannot be transferred, then contract liquidated If customer owed money after transfer/liquidation/offset, customer receives ratable distribution (higher priority than non-customer claims) CFTC has right to appear and be heard on issues Chapter 5 provisions apply 27

28 Bankruptcy Issues Many concerns originate out of Lehman bankruptcy LBIE (UK entity) had customer accounts released by exchanges to LBIE s administrators, leaving customers without adequate remedy Customer protection requires segregation & portability Factors in segregation: security interest vs. transfer of title, clearinghouse collection of margin, type of margin held, location where margin is held, commingling, rehypothecation Portability relies highly on segregation; e.g., margin must be held away from commodity broker and must not be commingled 28

29 CFTC Rule Final Ruling Effective May 6, 2010 Amends existing regulations to create new account class Significance of account class New category applies only in cases of bankrupt commodity broker that is FCM Applies to cleared OTC derivatives and money, securities or other property securing them Comments expressed concerns: Bankruptcy courts could decline to find cleared-only contracts as commodity contracts Rule did not address bankruptcy of clearing organization 29

30 Predictions Continued focus on bankruptcy issues for near- and intermediate- term, particularly if legislation passes requiring more derivatives to be cleared Legislative and regulatory response will leave some gaps As economy improves, most could lose focus on key issues Problems will not fully come to light until next major crisis 30

31 Selective Non-Insolvency Buy-Side Legal Issues Status of Trade Before Accepted for Clearing Initial Margin Issues Porting Transactions 31

32 Status of Trade Before Accepted for Clearing What happens if counterparty enters into a trade with the expectation that it will become a cleared trade and for whatever reason that does not happen? Possible Relevant Documentation: Clearing House Rules and Procedures Agreement with clearing member/counterparty and/or executing broker (in case of Give-Up Agreement ) Note: ISDA Nov Recommended Common Principles for Relationship Between Customer and Executing Broker and Clearing Member 32

33 Initial Margin Issues Questions: 1. Will Initial Margin always be custodied at the Clearing House? 2. Will Initial Margin required by the Clearing Member in excess of the Clearing House s requirement for Initial Margin be custodied at the Clearing House? 3. May a customer utilize securities to satisfy its Initial Margin requirements? 4. If yes, what kinds of securities will be eligible and will there be haircuts? 5. If a customer posts cash to satisfy initial margin, will he be entitled to receive interest on the cash? 6. If yes, will be rate be negotiated between the customer and the Clearing Member or between the Clearing Member and the Clearing House? 33

34 Initial Margin Issues Possible Relevant Documentation Clearing House Rules Agreement between Clearing House and Clearing Member Agreement between Clearing Member and Customer In case of ICE Trust Existing ISDA and CSA and New ISDA and for Cover Transactions. 34

35 Porting Transactions (Before Clearing Member Insolvency) Questions: 1. When can transactions be moved? 2. What is the procedures for moving transactions? Possible Relevant Documentation: Clearing House Rules Agreement between Clearing House and Clearing Member Agreement between Clearing Member and Customer Agreement between Customer and New Clearing Member 35

36 Questions? Corry Bazley Senior Sales North America ICE Processing Alessandro Cocco Managing Director Associate General Counsel J.P. Morgan Mark Cox Director, CME Clearing Solutions CME Group Michael Brooks Sutherland Asbill & Brennan LLP Warren Davis Sutherland Asbill & Brennan LLP Robin Powers Sutherland Asbill & Brennan LLP Paul Turner Sutherland Asbill & Brennan