Currency Derivatives Clearing Service Development Project Version 2.1 24 September 2013
Table of Contents Introduction... 3 1 Project timeline... 3 1.1 Stage 1... 3 1.2 Stage 2... 4 2 Clearing model... 5 2.1 Single-currency transactions cleared in currencies other than PLN... 5 2.2 Cross-currency transactions... 7 3 Main conditions for clearing of currency derivatives... 7 3.1 Securing PVP clearing in currencies... 7 3.2 Securing collateral deposited in securities denominated in foreign currencies and collateral in currencies... 8 3.3 Developing the rules of building projection and discounting curves for currencies and valuation rules... 8 2
Introduction KDPW_CCP is planning to add a currency derivatives clearing service to the CCP s OTC clearing service. The service is to be made available in stages starting at the beginning of 2014. It will expand the service dedicated to interest rate derivatives cleared in PLN. This document presents the currency derivatives clearing service development project. The content below has been developed in consultation with interested banks. 1 Project timeline 1.1 Stage 1 In Stage 1, KDPW_CCP will provide clearing services for interest rate derivatives cleared in the currency of the contract in the same way as it does now for the clearing of available instruments. The clearing service for EURIBOR/EONIA interest rate contracts will be offered in the first place. The valuation of cash flows for interest rate derivatives will be performed in the currency of the contract, i.e., EUR for the EURIBOR/EONIA rates. Settlement will be processed in the Target2 system. Consequently, MtM, VM, PAI, interest payments and Settlement Adjustment for such contracts will only be provided in the currency of the contract; however, calculated margin requirements will be provided in PLN. The list of instruments offered for clearing in Stage 1 includes the following EURIBOR/EONIA contracts: FRA, OIS, Basis Swap, IRS. Furthermore, in Stage 1, KDPW_CCP will also offer clearing of FX instruments for the EUR/PLN currency pair. This will enable automatic processing of currency purchase in the event of participant insolvency and currency delivery to the non-defaulting participant based on the existing auction mechanism. 3
1.2 Stage 2 In Stage 2, the project will be implemented in parallel in the following strands: Clearing of interest rate derivatives in other currencies (USD as well as other currencies following consultation with banks, e.g., CHF, GBP); Clearing of cross-currency derivatives. At this stage, the project will involve the development of a solution ensuring safe settlement of payments and providing KDPW_CCP with liquidity in selected currencies in the event of participant default. Provision of the clearing service in a currency will require co-operation with a commercial clearing bank which will process clearing in the currency as well as another bank to which clearing can be automatically transferred in the event of default of the primary clearing bank. In Stage 2, KDPW_CCP will also offer a clearing service for FX derivatives such as FX SWAP, FX FORWARD (SPOT) and CIRS (including swaps with the exchange of principals). Similar to other transactions, MtM, VM, PAI, interest payments and Settlement Adjustment will be cleared in the base currency of the contract while IM will be cleared in PLN. The clearing currency for each currency pair will be defined in consultation with Clearing Members. As an alternative solution to be consulted with banks, the clearing currency could be defined by participants for each transaction or for each clearing account. The clearing service for EUR/PLN derivatives will be offered in the first place. Afterwards, the clearing service will cover the other main currency pairs with USD and other currencies, e.g., GBP, CHF. For EUR/PLN FX, FX Swap, CIRS, the contract clearing currency will be PLN. List of instruments offered for clearing in Stage 2: 1) Interest rate derivatives cleared in currencies other than PLN and EUR: FRA OIS, Basis Swap, IRS. 2) Cross-currency derivatives: CIRS, 4
FX Forward, FX Swap. 2 Clearing model 2.1 Single-currency transactions cleared in currencies other than PLN The clearing mechanism for single-currency transactions in currencies other than PLN is the same as the clearing mechanism for such transactions cleared in PLN. No later than by 08:45 hours (15 minutes before the opening of a clearing session on the OTC market), the participant is required to have in its account in the relevant settlement system a balance sufficient to execute payment instructions generated at the netting session on the preceding day. For PLN, it is the balance in the account with the National Bank of Poland s Payment System Department (DSP NBP); for EUR, the balance in the account with Target2; for other currencies, the balance in the account with the clearing bank designated by KDPW_CCP. Settlement in EUR will be processed by NBP via Target2. The following items will be calculated in the currency: Marking to market (MtM) The marking to market formulae for specific types of financial instruments are presented in Appendix 6 to the Detailed Rules of the OTC Clearing System. Variation Margin (VM) The Variation Margin is the difference between the present marking to market of a transaction and its marking to market at the previous clearing day. For transactions accepted for clearing during the day, their marking to market at the previous clearing day is assumed to be equal to 0. VM is calculated at the PB account level. ( ) (Formula 1) Adjustment for lost economic benefits/price alignment interest (PAI) PAI is calculated according to the following formula: 5
(Formula 2) where: marking to market of transaction i at day t-1, i transaction index, - interbank deposit reference rate for the currency at day t, YF year fraction, t clearing day index Interest payments (coupon) Interest payments for the current interest period are calculated as per the specification of the transaction (for IRS, Basis Swap, OIS and FRA). Settlement Adjustment (SAdj) SAdj is calculated as the sum of all adjustments in respect of automatic termination of positions, termination of positions on demand (auction), settlement in other systems (for transactions subject to gross settlement), position transfers. In case of auctions, the Settlement Adjustment is the sum of amounts of accepted bids in all auctions held during the day. The amount of an auction is equal to the sum of the products of accepted prices per portfolio unit times the number of units. In case of a position transfer (porting) from an account, the Settlement Adjustment is the aggregate settled MtM of all transactions recorded in the account. The Settlement Adjustment offsets this amount, which means that the participant that takes over the position will pay the net adjustment only from the date of the last settlement. Adjustment for margins (IM) will only be processed in PLN (for all types of instruments). The settlement amount in a currency (other than PLN) is equal to: (Formula 3) The settlement amount in PLN is equal to: 6
(Formula 4) where: settlement amount in PLN calculated according to Formula 3 IMC amount of approved collateral deposited as a required margin cover IM amount of a required margin DFC amount of collateral approved as a contribution to the OTC guarantee fund DF amount of a required contribution to the OTC guarantee fund, calculated once per month AMC amount of approved collateral deposited as an OTC Additional Margin AM amount of a required Additional Margin Note: As a general rule applicable to KDPW_OTC system messages, amounts due to a participant from KDPW_CCP are presented as negative figures while amounts due to KDPW_CCP from a participant are presented as positive figures. At the coupon date, the interest payment (Cpn) is equal to the amount of interest due to be paid/received under the contract. At the same time, MtM of the transaction is reduced with the amount of the interest payment. This is reflected in VM of the contract. As the MtM change due to the coupon has already been cleared with transaction counterparties as a part of daily VM, the interest payment will in practice be largely offset with the opposite VM amount. As a result of the daily marking to market, settlement at the interest due date does not include interest due for the entire interest period but only the one-day adjustment of the contract value due to changes to market rates and its shorter time to maturity. 2.2 Cross-currency transactions A detailed clearing model for cross-currency transactions will be presented for consultation at a later date. 3 Main conditions for clearing of currency derivatives 3.1 Securing PVP clearing in currencies 7
The main risk of cross-currency clearing is the cross-currency settlement risk, also known as Herstatt Risk, which is the risk of execution of a credit transfer in one currency in the absence of execution of a debit transfer in another currency. KDPW_CCP via KDPW has access to the clearing systems RTGS SORBNET for PLN and TARGET2 for EUR. Clearing in currencies other than PLN and EUR will be processed by a commercial clearing bank. In the event of concurrent credits and debits in different currencies, KDPW_CCP first debits participants accounts in the debit currency and credits its own account with the relevant clearing bank. Non-execution of a debit transfer would imply potential insolvency of a participant. In that event, KDPW_CCP activates the procedure necessary to ensure proper settlement. The procedure involves the activation of a dedicated credit line from the clearing bank and the initiation of the mechanism of automatic termination of positions (auction) of the defaulting participant. 3.2 Securing collateral deposited in securities denominated in foreign currencies and collateral in currencies In the proposed clearing model, KDPW_CCP will accept the following collateral: cash in PLN and selected foreign currencies; securities denominated in PLN and selected foreign currencies. KDPW_CCP will calculate the required margins in PLN. The margin requirement may be covered with collateral whose amount is converted to PLN using a relevant haircut to account for the risk of volatility of the fx rate and the price of instruments. Acceptance of collateral deposited in foreign currencies will be offered irrespective of and in parallel to the development of the clearing service for transactions cleared in currencies as described herein. 3.3 Developing the rules of building projection and discounting curves for currencies and valuation rules The valuation of derivatives based on EURIBOR/EONIA rates will rely on 4 projection curves: 1M, 3M, 6M, OIS, as well as a discounting curve based on OIS. Preliminary assessment has identified the possibility of building 1M, 3M and 6M curves for FRA/FUTURES/SWAP rates for up to 50 years. 8