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FCA Derivatives > Chapter 6: Principles of Clearing and Margin > Flashcards

Chapter 6: Principles of Clearing and Margin Flashcards

1
Q

What is clearing?

A

Clearing is when derivatives trades are confirmed and registered.

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2
Q

Why do original exchange contracts become new one?

A

As every buyer and seller needs to be notated with the clearing house.

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3
Q

What is mutual offset or common settlement?

A

Certain exchanges can mutually offer the same derivatives and mutually settle these.

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4
Q

What is the structure of clearing?

A

Step 1: Trade execution
Step 2: Confirmation and matching
Step 3: Registration into account
Step 4: Novation - old contracts removed

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5
Q

What is a principle-to-principle guarantee?

A

Mutual agreement structure where clearing house guaranteed execution of a transaction.

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6
Q

What are the supporting financials for ICE Clear Europe?

A

Financial resources requirements:
Hold an account with approved Banks known as an Assured Payment System (APS) bank
Initial margins must be paid with applicable collateral
Default fund

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7
Q

How do clearing houses establish the amount a member firm should contribute towards the default fund?

A

Members contribute towards the default fund based on their individual trading volume with the clearing house.

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8
Q

What is drawn on in case a clearing member defaults? What is this process also known as?

A

Default member’s margin
Default fund contributions from that member
Default fund contribution of other members
Insurance policy

This process is called the default waterfall.

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9
Q

What is a primer brokers role in relation to derivatives?

A

Efficient and best execution of trades
Ensuring confirmation through required documents
Providing custody
Keeping clients aware of issuer correspondence such as corporate actions

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10
Q

What value add services can prime brokers provide?

A

Capital introduction - prime broker introduces hedge fund to qualified hedge fund investors
Office space and leasing services
Risk management and advisory
Consulting services

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11
Q

What regulations and regulators oversee prime brokers?

A

FCA
MiFID II
Federal Reserve
Securities and Exchange Commission
CFTC

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12
Q

What clearing houses allow OTCs to be cleared through exchanges?

A

LCH Group
CME Group’s Clearing360
Eurex

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13
Q

What are the advantages of having an OTC derivative cleared by an exchange’s clearing house?

A

Eliminates counterpart risk
Same margin requirements as ETDs
For delivery, both parties must be exchange members

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14
Q

What are the differences when an OTC product is cleared via a clearing house compared to the normal lifecycle of an ETD?

A

Clearing houses do not match buyers and sellers, but only have the same post-clearing lifecycle.

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15
Q

What is the definition of a clearing fund?

A

Another name for a guarantee fund. In special occasions it can also be used to provide liquidity. Contributions are based on risk assessment using levels of uncovered risk, based on trading volume.

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16
Q

What are price limits used by exchanges?

A

Maximum bounds that as circuit breakers, applying maximum bounds to price movements. When limits are reached, trading halts for a few minutes. This helps prevent huge down turns in share price values.

Price limits are also used to check new orders are within a prevailing spread of the market price.

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17
Q

What are position limits?

A

Position limits prevent a company from cornering the mallet by limiting the amount of contracts. The Silver 7 Rule was introduced by COMEX to prevent this.

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18
Q

Why is there extra risk taken on with contingent liability?

A

Contingent liability is when liability is based on another event such as in futures contracts and written options.

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19
Q

How do clearing houses protect themselves?

A

Quality of membership
Financial resource requirements
Margin system - initial and variation margin
Default / guarantee / clearing fund

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20
Q

What is Standard Portfolio Analysis of Risk (SPAN)? Which was the first exchange to onboard SPAN?

A

System used to calculate daily margin requirements.
Uses entire portfolio and algorithms.
SPAN has capacity to allow for both inter-maturity and inter-commodity spreads.

CBOT was the first exchange to onboard SPAN.

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21
Q

Why is it beneficial for a clearing firm to place positions in a house account?

A

Cashflow (and accounting) benefit to the clearing firm.

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22
Q

What is the process related to Payment Protected Systems (PPS)?

A

Margin payments have to made directly from client accounts.

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23
Q

In the UK, what are the rules around the minimum a clearing member’s client must pay when a margin call is made?

A

A clearing member client must pay the full value of the margin call that is made by the clearing house to the clearing member.

24
Q

What products are applicable to margin rules when exchange cleared?

A

CFDs and some energy products.

25
Q

What is initial margin? What is broker margin?

A

Initial collateral with a haircut, or broker margin, which the clearing house may require.

26
Q

Which account will a clients trade be held in once executed?

A

Held by clearing member in segregated or non-segregated account depending on their relationship.

27
Q

What margin is required by clearing house from the clearing member and therefore its underlying client on options?

A

No margin is required. Only the premium which is collected from the clients account into a segregated or non-segregated account. This is because options are non-contingent liability.

28
Q

How often is initial margin recomputed and when is it called?

A

Recomputed every business day and called first thing in the morning.

29
Q

What is Theoretical Intermarket Margining System?

A

Another margining system such as SPAN, TIMS and STANS.

30
Q

How is SPAN used and calculated? What factors does SPAN evaluate?

A

SPAN looks at an impact on futures and options if price volatility changes by a certain amount. SPAN is based on liquidation of a portfolio.

Possible changes of underlying price
Changes in the underlying volatility
Impact of time on an options value

SPAN calculates maximum loss and the required margin to offset this.

SPAN uses scanning range (initial margin rate)

31
Q

How many scenarios does SPAN analyse?

A

16 scenarios

32
Q

How is TIMS used and calculated? What factors does TIMS evaluate?

A

Useful for evaluating mixed portfolios
Option pricing model
Calculates premium margin and risk margin
PM margin is the market price eod
Risk margin is calculated using options pricing model
TIMS more complex than SPAN

33
Q

How is STANS used and calculated? What factors does STANS evaluate?

A

More modern approach
Addresses gaps in TIMS related to correlations in price movements
Generates hypothetical 10000 scenarios
Generates 7000 risk factors

34
Q

What are STANS and TIMS used for by the OCC?

A

STANS - derivatives initial margin calculation
TIMS - still used for some risk management calculation

35
Q

Why were TIMS and SPAN originally created?

A

Both calculated for derivatives and measuring risk associated.

36
Q

What is the Net Liquidation Value (NLV)? What’s the major benefit?

A

Based on net positions held by member firms. Margin due is based on liquidation of the constituent parts of portfolio.

Allows profits in portfolio to offset losses.

37
Q

What are spreads used for in initial margin?

A

Spreads in various positions across more than one delivery month.
Initial margin will be lower as positions offset eachother.

Spreads used to consider correlation between assets which will therefore allow for margin adjustments.

38
Q

How do exchanges calculate and require variation margin?

A

Settlement prices calculated every day for MTM margin calls. Sett price a.k.a closing price
Some exchanges use closing range (range of prices using chosen ranges and own criteria)

39
Q

What criteria does LCH to arrive at settlement prices?

A

A time is decided where settlement price will be calculated.
Settlement range 2 minutes - 90 seconds of this used to monitor spread levels
30 remaining seconds to calculate average weighted traded price
Market supervision can adjust price if it doesn’t reflect the market

40
Q

What is the settlement range used by LCH?

A

Settlement range ie time before settlement price calculated - for LCH this is up to 2 minutes before settlement price is calculated.

41
Q

What does LCH use settlement price for?

A

MTM to calculate additional top-up (variation margin) on open positions for clearing members

42
Q

What currency should margin be paid in?

A

Cash in currency used in contract.

43
Q

What is the variation margin formula?

A

Variation margin = ticks moved on the day x number of contracts of open position

Ticks = todays closing price - yesterdays closing price

44
Q

What is the maintenance margin?

A

An agreement between member and underlying client. Safety cushion of maintenance margin

45
Q

What forms of collateral are not commonly accepted?

A

Undated bonds
Bonds must be denominated in issuing currency of country
Collateral is MTM and is subject to a haircut - full market value not credited
Securities must be lodged with depositories

46
Q

What are credit lines? How many days can credit be extended to client under FCA rules?

A

Some exchanges allow members to extend credit lines to their client.
For 5 days.

47
Q

What is Credit Support Annex (CSA) similar to?

A

The daily margining process.

48
Q

What area did Credit Support Annexes (CSAs) address?

A

CSAs addressed ongoing counterpart risk of long dates swaps and options.

49
Q

What are Credit Support Annex (CSA) documents?

A

Regulates and defines criteria for collateral payments.
1/4 ISDA contracts
Defines rule for transfer between counterparts

50
Q

What do Credit Support Annexes (CSAs) define?

A

Minimum collateral transfer amounts
Timing behind MTM
Collateral accepted
Threshold amounts
Valuation percentage or haircut

51
Q

What did Uncleared Margin Rules (UMR) introduce?

A

UMR introduced near rules for OTC derivatives non-centrally cleared. Principles suggested
Margin requires to all
Variation and exchange margin
Initial and variation margin calculated by approved methodology
High quality collateral
Segregation and custody of margin]
Margining between affiliated firms non-mandatory
Regulators must cooperate
Daily variation margins must be exchanged

52
Q

Which derivatives are out of scope for Uncleared Margin Rules (UMR)?

A

Cleared instruments and ETDs

53
Q

What is the Aggregation Average Notional Amount (AANA)

A

Sum total gross notional value all O/S uncleared derivatives.

AANA used to define whether an entity is applicable for initial margining

54
Q

If a client is applicable for initial margin requirements by AANA, what is the minimum figure before initial margin becomes collectable?

A

50 million euros

55
Q

What are the approved initial margin calculations by BCBS and ISDA? Why is Grid less favoured?

A

Grid and Simm.

Grid is less favoured as it often requires greater initial margin.

56
Q

What are the 3 options owners of a future have?

A

Hold to delivery
Close out contract before settlement
Roll over the contract

FCA Derivatives (9 decks)

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