Derivatives Clearing Organizations Regulation - Financial Resources Requirements - Comment Letters

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Dodd-Frank Timeline, Financial Resources Requirements for Derivatives Clearing Organizations
Proposal Date Final Rule Issue Effective Date
December 13, 2010 October 18, 2011 January 9, 2012

JPMorgan Chase - November 17, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
November 17, 2010

This comment letter addresses the requirements for DCOs, DCMs, SEFs regarding the mitigation of conflicts of interest; financial resources requirements for DCOs; ownership limitations and governance requirements for security-based swap clearing agencies.

JPMorgan Chase strongly agrees “that a derivatives clearing organization must maintain sufficient resources to cover its exposures with a high degree of confidence and to enable to perform its functions in compliance with the core principles set out in the Commodity Exchange Act… We do not believe that there should be a two tiered approach to membership, where some clearing members are subject to loss mutualization and others not.” Furthermore, “we believe it would be appropriate to require that clearing members have the ability to provide daily executable binding quotation for all points in the curve for all products cleared.”

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Options Clearing Corporation - December 10, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 10, 2010

The OCC offers the following suggestions to the commission:

  • While we agree that all clearing organizations should consider possible simultaneous defaults by multiple clearing members, constructing a stress test involves making numerous assumptions, and mandating one particular assumption (the "two largest" assumption) does not necessarily have a beneficial result because it restricts the ability of a DCO to measure its resources against those contingencies that it deems to be the most likely threats to its liquidity and solvency.
  • OCC believes that an equity capital requirement for DCOs is not appropriate because clearing organizations rely primarily on member-supplied resources, such as clearing fund deposits and margin, to meet their obligations.
  • The Commission should clarify that a clearing member has the ability to meet its potential assessment if it has net capital equal to or greater than the clearing member's assessment requirement.
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International Swaps and Derivatives Association - December 10, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 10, 2010 Regarding the proposed rule, ISDA explains that:

  • A DCO centralizes and concentrates counterparty and operational risks and the responsibilities for risk management. Therefore, it is critical that DCOs have both effective risk control and adequate financial resources. In addition to sufficient capital provided by the CMs, this means stricter and more uniform rules on the posting of collateral to cover counterparty exposures than has been seen in bilateral OTC derivatives markets.
  • In the event of a large CM default where the DCO only has the level of financial resources sufficient to enable it to withstand that default, non-defaulting CMs may consider that the DCO’s financial resources are largely “used up” and lose confidence in the DCO to the detriment of a stable and orderly market in the product.
  • The calculation of initial margin must ensure a safety standard that is “robust”, which should mean in this context that an exception should not occur on average more than once a year. This entails: a confidence level that is greater than 99% for whatever holding period is prudent for that asset class; regular DCO back-testing of its initial margin calculation; and periodic public disclosure by the DCO of its back-testing methodology and results.
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Natural Gas Exchange - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

From the comment letter:

“ We believe that the Commission's proposed liquidity requirement should be amended so that it applies only to contracts cleared by a DCO that provide for a daily variation pay and collect as part of their margin risk management systems. The proposed liquidity rule should not be applied to contracts that do not provide for a daily pay and collect because these contracts do not result in a liquidity exposure to the DCO.” Additionally, NGX believes that “immediately accessible bank lines of credit should be an additional acceptable form of financial resource to cover the liquidity-related risk where the underlying commodity is itself traded in a liquid market. Where a clearing participant fails to make a margin payment as owed, the clearing house will respond to such a default by applying the defaulting participant's collateral to the shortfall and liquidating the defaulting participant's portfolio. Thus, the clearing house liquidity exposure is only for the time needed to liquidate the defaulting clearing participant's portfolio.”

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Kansas City Board of Trade Clearing Corporation - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

From the comment letter:

“Proposed Regulation 39.11(a)(1) would require a DCO to maintain sufficient financial resources to meet its financial obligations to its clearing members not-withstanding a default by the clearing member creating the largest financial exposure for the DCO in extreme but plausible market conditions. Therefore, a separate capital requirement would be redundant. In addition, onerous capital requirements placed on DCOs could have an anti-competitive effect.” Furthermore, “instead of a flat haircut percentage across every clearing member, a better approach would be for the DCO to be allowed the latitude to determine clearing member assessment haircuts on an individual basis, based on each clearing member’s financial capabilities… By having their own capital at risk, clearing members have a strong financial incentive to pay an assessment. Failing to pay an assessment would put a non-defaulting clearing member’s own positions and capital at risk.”

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CME Group - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

In their comment letter, CME Group offers the following suggestions, among others, to the Commission:

  • Regarding the haircut requirements – and the fact that nonpayment of an assessment would result in the non-paying firm itself being in default to the DCO – we do not believe that a further haircut is necessary, and we are aware of no valid reason to cap the use of assessments at 20 percent as proposed.
  • In response to the proposed liquidity requirement covering more than a one-day settlement cycle, CME suggests that if the clearing member had a pay in its customer account and a collect in its house account, the amount should be the greater of (i) the customer pay minus the house collect, or (ii) zero. If the result in such case were zero, that day’s variation settlement should not be included in the calculation.
  • Additionally, we suggest that, rather than adopting Regulation 39.29 as proposed, the Commission should adopt a regulation that subjects SIDCOs to more frequent stress testing and reporting requirements than any DCOs the Council does not designate as systemically important.
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LCH.Clearnet - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

From the comment letter:

“We believe it is of the utmost importance that the CCP’s resources following a member default – especially if the default is of such a magnitude as to exhaust the margin provided by that member – be immediately and unconditionally available. Such resources should therefore be pre-funded and under the control of the CCP. We believe that assessments should be allowed as part of the DCO’s “waterfall” of protections, but should not be taken into account to meet the specific test outlined under 39.11(a)(1).” Additionally, “in our view stress testing should be carried out by the DCO on at least a daily basis, and we would strongly urge the Commission to amend its proposal accordingly. LCH.Clearnet does not believe that monthly stress-testing is adequate, as experience has shown that market conditions and member positions can change rapidly during periods of market turmoil.”

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Eurex Clearing - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

From the comment letter:

Eurex Clearing believes that the proposals “will not inhibit competition among clearinghouses; if adopted as proposed, the rules will help assure that DCOs have the resources to withstand substantial defaults and continue operations for a period of time under adverse circumstances. While Eurex Clearing supports adoption of the Commission’s current proposal, it encourages the Commission to continue to align its proposal with that of the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions which is currently under review… The Commission further proposes that DCOs be required to have sufficient resources to enable them to continue operating for at least one year. Eurex Clearing agrees that this having such a requirement is reasonable, especially in view of the flexibility implied in the Commission’s proposed rules for types of financial resources, but cautions that the one year time frame may be unnecessarily long.”

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Futures Industry Association - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

FIA provides the following suggestions to the Commission:

  • Adoption of any of the suggested segregation alternatives other than the "baseline model" is likely to have far-reaching consequences for the modeling of risk by the DCOs. In particular, the adoption of rules that change the current treatment of customer margin deposits to provide some form of enhanced segregation will necessarily influence (among other things) how the DCOs calculate house and customer margin requirements and individual clearing member and aggregate guaranty fund requirements.
  • FIA recommends that all DCOs, including SIDCOs, be required to maintain resources sufficient to withstand the default of the two clearing members representing the largest financial exposure to the DCO, but that the Commission give DCOs that currently meet the CPSS-IOSCO standard reasonable time to come into compliance with the enhanced requirement.
  • FIA further recommends that the Commission make clear its expectation that the DCOs will, at a minimum, conduct a range of stress tests that reflect the DCO's product mix; include the most volatile periods that have been experienced by the markets for which the DCO provides clearing services; take into account the distribution of cleared positions between clearing members and their customers; and test for unanticipated levels of volatility and for breakdowns in correlations within and across product classes.
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Minneapolis Grain Exchange - December 13, 2010[edit]

Financial Resources Requirements for Derivatives Clearing Organizations
December 13, 2010

From the comment letter:

“The Commission’s proposed rulemaking is fairly clear: DCOs must have adequate capital, cash and financial resources. Certainly, very practical. However, the multiple requirements and methodologies that need to be employed are becoming somewhat unwieldy. The result of the proposed rulemaking and the multiple financial requirements may well be a tendency to overcompensate and ensure that a DCO has sufficient financial and liquidity cushions. Consequently, DCOs will raise security (guaranty) deposits, require more deposits posted in cash, and even keep margins high. All these actions will be significantly borne by clearing members and customers. That will have the unintended affect of negatively impacting the marketplace. Therefore, adding further significant financial requirements beyond that of covering a large clearing member default should be cautiously contemplated and implemented.”

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References[edit]

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