Clearing Flashcards
What is clearing?
the process by which derivatives trades are confirmed and registered
What is novation?
Novation means that the original contract no longer exists and instead two contracts exist, with the clearing house acting as a seller to the buyer, and another with the clearing house acting as a buyer to a seller. This structure effectively eliminates all counterparty risk.
What are the advantages of a clearing system?
1) Greatly reduces counterparty risk
2) Contracts become easier to trade (clearing house have an equal and opposite position making it easy to close out a trade
What is the structure of the clearing house?
1) Clearing House
2) Clearing Members
3) Individual & General Clearing Member
4) Non Clearing Member
What is a general clearing member?
A member that clear for themselves, clients and other exchange members
What is an individual clearing member?
A member that clears just for themselves and direct clients
Who owns the clearing house?
1) Member owned
2) The exchange whose contracts it clears
What is the process of clearing, step by step
1) Trade - reported and registered with a member firm
2) Confirmed and matched - member firm wait for counterparty to enter opposite side of trnsaction
3) Registration - Trade is registered and assigned to an account
4) Novation - contract becomes two new contracts (clearing house & counter party and clearing house & member firm)
The member firm will be responsible for collecting margin after novation takes place.
Why do some OTC products have an exchange cleared process?
1) Perceived counterparty risk of OTC
2) Exchanges wishing to diversify
3) Pressure from Dodd-Frank act
How to exchange cleared OTC products differ from exchange traded and cleared products?
The exchange do not need to match a buyer or seller for OTC products.
They just ensure delivery is made and monitored on both sides of the trade.
How do clearing members help ensure the clearing house’s guarentee?
Provide capital to a clearing fund (mandatory)
How are contributions to the clearing fund calculated?
On the basis of a members uncovered risk - done monthly (NYSE LIFFE) or quarterly
Why is the clearing fund a last resort?
It is only used after margin and other funds have been used.
Who develops the document structure for OTC products?
ISDA
What is the key document the ISDA mandate?
What is it?
The master agreement
The standard terms of the transaction. Both parties agree and it applies automatically from there on out. (just have to confirm a trade after this point)
What are the other 4 pieces of ISDA documenation
1) Schedule - allows for amendments to the master agreement
2) Collateral - defines term of collateral or capitalisation if needed
3) Confirmation - Sets out the terms of the trade
4) Definitions Booklet - defines terms incorporated in the trade
How is OTC transparency improved?
Trade Repositories
What is a trade repository?
A firm who operate an electronic network which stores records of OTC derivative contracts. They pass this information on to regulators and authorities.
What 3 things do EMIR mandate re: trade repositories?
1) Detailed information must be provided to TRs on each derivative contract
2) ESMA and the FCA are responsible for monitoring and supervising TRs
3) They must publish total positions for each class of derivative
What is the primary concern regarding TRs?
The confidentiailty of their date
The more and more authorities that request it, the greater the importance of its confidentiality
