Central Counterparties, Clearing Houses & Exchanges

The goal of this course is to explain the role of central counterparties (CCPs) in exchange-traded and bilateral markets. The workshop will explain the basics of exchange-traded and over-the-counter (OTC) derivatives, central clearing and risk management.

Key Learning Outcomes:

• The markets, mechanics and risk mitigation in bilateral and exchange-traded derivatives
• Mechanics of central clearing in securities and derivatives markets
• Bilateral margin requirements and the ISDA SIMMTM
• Comparison of exchange-traded, bilateral OTC and central cleared OTC derivatives
• Initial margin methodologies
• Risk management frameworks

COURSE CONTENT

Markets: The Mechanics and Participants

The goal of this section is to review the roles and differing business models of central counterparties, clearing houses and exchanges in the securities and derivatives markets and to appreciate the impact of changing macro, competitive and regulatory issues.

Markets

• How risks arise in the trade cycle from execution to settlement: Securities and derivatives, OTC and exchange-traded markets
• Market characteristics: Order-driven and quote-driven markets, exchange traded and over the counter markets
• The changes in the OTC derivative markets and their implications:
  • New trading platforms: Swap Execution Facilities (SEFs) and Organized Trading Facilities (OTFs)
• New roles for Central Counterparties

Market Participants

• The major infrastructure participants and how they mitigate risk: Exchanges, central counterparties and settlement agents

Settlement and pre-settlement risk

• Settlement mechanics
• Pre-settlement risk (counterparty risk) in exchange traded, bilateral and OTC cleared environments

Risk Mitigants

• Settlement mechanisms and the risks: Delivery vs. payment (DVP) systems, free delivery risk and how to mitigate the risks
• General techniques for counterparty risk mitigation
  • Netting
  • Compression
  • Collateral (margin)
• Segregation and rehypothecation of collateral

The basics of central clearning

• The CCP landscape
• CCP membership, default process, and client clearing

Operating Environment

The goal of this section is to understand the operation and regulation of Exchanges, Settlement Agents and CCPs and to examine more around the mechanics of central counterparties.

Exchanges and settlement agents

• Settlement agents (e.g. Euroclear, CLS, DTCC)
• Exchanges (e.g. London Stock Exchange, Eurex, Chicago Mercantile Exchange, Singapore Exchange)
• Business activities and competition

Central Counterparties

• Central counterparties and clearing houses (e.g. LCH Clearnet, CME Inc., IceClear, Japan Securities Clearing Corporation)
• Regulation and timescales around central clearing
• Business models

Regulation

• Regulatory initiatives to extend the use of central clearing: Dodd-Frank in the USA, EMIR, MIFID and MIFIR in the European Union, major Asian markets
• Timeline for introduction of central clearing
• Basel III rules on risk weighting exposures to CCPs and impact of the leverage ratio
• CPSS/IOSCO principles for FMIs

Central counterparties - mechanics

• Novation process
• Impact of netting
• Client clearing: Porting, segregation and account structures

Central counterparties - risk management

• How central counterparties manage risk: Membership criteria, margining approaches, default fund structures, waterfall in the event of a clearing member default
• Managing an OTC default

Risk and Financial Analysis

The goal of this section is to discuss the risk mitigation methods of central counterparties and the risks they face.

CCP analysis

• Risks faced by a CCP
• The use of margin

Margin methodologies

• SPAN
• Initial margin for OTC derivatives
• Eligible collateral

Default fund methodologies

• Balance between initial margin and default funds and skin-in-the-game
• Auctions and default fund tranching
• Stress tests and allocation of default funds

​Other CCP risks

• Settlement, custody and investment risks
• Operational and liquidity risks
• Systemic risks and interoperability

Exposure Structuring

The goal of this section is to review the risks presented by central counterparties and how they might arise via initial margin methodologies and loss allocation methods.

Historical CCP defaults

• CCPs failures: Caisse de Liquidation, Kuala Lumpur Commodity Clearing House, Hong Kong Futures Guarantee Corp, CME Clearing Corp, Options Clearing Corp, Bolsa de Mercadorias and Futuros, London Metal Exchange
• Lessons from historic CCP failures

Initial margin calculations

• Initial and variation margin and the margin period of risk (MPR)
• Value-at-risk (VaR) and expected shortfall
• Historical simulation for determining intial margin requirements
• The challenges of historical simulation
• Wrong-way risk
• Case study: Initial margin problems

Other loss allocation methods

• CCP resolution and loss allocation: Rights of assessment, VMGH and partial tear-up
• Comparison of loss allocation methods