Principles of Clearing and Margin

Question 1

what is clearing?

Answer 1

process by which derivatives trades are confirmed and registered

Question 2

what must clearing members maintain and what does this minimise?

Answer 2

must maintain an account in the clearing house’s currency, minimises

Question 3

what does the clearing house face in the case of default?

Answer 3

one day market risk, which will be negated due to daily margin payments all members must pay

Question 4

what is the major advantage of having a clearing house?

Answer 4

greatly reduces counterparty risk and guarantees the financial performance of the contract

Question 5

what impact did Brexit have on UK-based CCPs and clearing firms?

Answer 5

introduced some operational and regulatory risk, these firms lost their passporting rights

Question 6

what is a mutual offset system?

Answer 6

agreement between two exchanges that allows trades executed on one exchange to be booked and cleared through another

Question 7

what is a principal-to-principal system?

Answer 7

where the clearing house guarantees the performance of the trades executed by its members on the exchanges that it serves

Question 8

what is the reason for an increase in trade reporting procedure for OTC derivatives?

Answer 8

reduces counterparty credit risk and better

Question 9

what are the two types of clearing members?

Answer 9

general and individual?

Question 10

what are the requirements for ICE Clear Europe guarantee?

Answer 10

• hold an account with an approved bank
• initial margins collected in cash, will be used in the case of a default
• member default fund access is allowed via deposits being made

Question 11

what is the default waterfall?

Answer 11

when a clearing member defaults on their obligations and the below sources are used to cover losses:

• default members margin
• default fund contributions
• insurance policy

Question 12

what is a prime broker responsible for in relation to derivatives?

Answer 12

• efficient and best execution
• confirmation of client trades
• settlement
• providing custody and safekeeping
• keeping clients aware of issuer correspondence

Question 13

what are additional value-added services prime brokers may provide?

Answer 13

• capital introduction (prime broker introduces it’s hedge fund to qualified hedge fund investors)
• office space leasing and servicing
• risk management and advisory services
• consulting services

Question 14

what regulation governs prime brokers and hedge funds with their potential clients?

Answer 14

FCA, MiFID II

Question 15

who provides OTC clearing as part of the LSEGroup?

Answer 15

LCH Group

Question 16

what clearing does the CME Group’s Clearing360 provide?

Answer 16

More restricted service for OTC interest rate derivative contracts and FX option block trades

Question 17

what firms is Clearing360 limited to?

Answer 17

firms that act as a principal or agent for the OTC trades e.g., hedge funds, major banks, prime brokers and prop. trading firms

Question 18

what is a clearing fund?

Answer 18

pool of assets contributed to by clearing members in a CCP to meet the obligations of defaulting CCP participant- every clearing member required to contribute

Question 19

what are the acceptable types of collateral by clearing funds?

Answer 19

• cash in liquid and stable currencies
• high quality gov’t bonds

Question 20

what is a price limit?

Answer 20

circuit breakers imposed by the exchange that limits maximum bounds on price movements on the contract on any day

Question 21

what are the down-price limits the CME Group has?

Answer 21

starting at 5% down to 20% down

Question 22

what is a position limit?

Answer 22

when the maximum amount of positions someone can undertake in an asset or market is limited so as not to affect the entire market and create a monopoly

Question 23

what are the steps clearing house can take to protect itself ?

Answer 23

• quality of membership
• financial resource requirements on members
• margining system
• have its own financial resources and perhaps a default fund

Question 24

what is SPAN?

Answer 24

Standard Portfolio Analysis of Risk

system used to calculate daily margin requirements, uses a set of algorithms to measure and determine a portfolio’s daily risk and margin requirement based on the entire portfolio

Question 25

what is an initial margin?

Answer 25

good faith deposit, lodged with the clearing house- calculated by looking at the member’s position

Question 26

when is initial margin recomputed?

Answer 26

every business day, and is called first thing in the morning before markets open

Question 27

what forms can initial margin be provided in?

Answer 27

cash or acceptable non-cash collateral

Question 28

what happens to margin as contracts near maturity?

Answer 28

clearing house may wish to minimise speculative and delivery pressures by increasing initial margin to make sure underlying is in place for delivery or there is enough capital for settlement

Question 29

what is TIMS?

Answer 29

theoretical intermarket margining system

Question 30

what do SPAN, TIMS and STANS do?

Answer 30

examine the risk of F&O positions in the same portfolio and work out the worst scenario from a set of standard scenarios to reflect clearing house risk

Question 31

what does SPAN look at?

Answer 31

the impact on a position of F&Os contracts if the price, time to maturity and volatility of the underlying asset changes by set amounts

Question 32

how many scenarios are considered with SPAN?

Answer 32

16

Question 33

what additional charges does SPAN add?

Answer 33

• charge for inter-month spreads
• charge for additional risk of spot delivery

Question 34

what needs to be considered when looking at the margin for futures contracts?

Answer 34

only price movements, so initial margin will stay the same unless the scanning range changes

Question 35

what is the scanning range?

Answer 35

point price movement up or down as well as a change in the volatility of the underlying

Question 36

what needs to be considered when looking at the margin for options?

Answer 36

changes in volatility is the most important element, margin likely to change daily

Question 37

what is TIMS?

Answer 37

Theoretical Intermarket Margining system.

uses portfolio-based margining methodology, well-suited for measuring the risk of mixed portfolios

Question 38

what does TIMS look at?

Answer 38

identifies the risks of options on specific underlying’s, provides for offsets between positions in different but highly correlated underlying assets

Question 39

what does the premium margin represent?

Answer 39

market value of a particular position at the close of trading, represents daily change or price movement

Question 40

what is STANS?

Answer 40

system for theoretical analysis and numerical simulations

propriety risk margining system based on more modern approach to measuring risk. requires more statistical methods and greater computing power

Question 41

what does STANS seek to address?

Answer 41

certain shortfalls of TIMS; correlations in price movements and the modelling of extreme events

Question 42

what are inter-commodity spreads?

Answer 42

spreads between different instruments that always exhibit correlation in their price movements e.g., Gas Oil and Crude oil

Question 43

how does the closing price come about?

Answer 43

By exchanges providing outlines for the calculation of MTM variation margin and positions at the end of the day

Question 44

what is the closing range?

Answer 44

measure of the range or spread of prices that are quoted during a specified time just before trading ends

Question 45

how is variation margin calculated?

Answer 45

= ticks moved on the day x tick value x number of contracts of the open position

where: ticks moved on the day = today’s closing price – yesterday’s closing price

Question 46

what is variation margin?

Answer 46

where there is an arrangement between a member of a clearing house and their client, they will expect the client to deposit more than the initial margin to provide a safety cushion and reduce correspondence

Question 47

what is collateral?

Answer 47

assets that are used as a guarantee or as security for a line of credit or loan

Question 48

what are the acceptable forms of collateral?

Answer 48

• cash
• bank guarantees
• certificates of deposit
• government debt

Question 49

what is collateral management?

Answer 49

process that allows market participants to reduce the counterparty credit exposure from longer maturity OTC contracts

Question 50

what is a CSA?

Answer 50

credit support annex

legal document that regulates and defines the criteria for collateral payments for OTC derivatives transactions

Question 51

what other key procedural details foes the CSA also include?

Answer 51

• threshold amounts for credit exposure
• minimum transfer amounts
• haircut applied to collateral (to protect receiver from a fall in value)

Question 52

what are uncleared market rules?

Answer 52

global policy framework released by BCBS containing detailed guidance on new margining requirements for uncleared OTC derivatives

Question 53

what is AANA?

Answer 53

aggregated average notional amount

sum total gross notional value of all outstanding uncleared derivatives, calculated March-May every year, US firms take average AANA everyday during this period, EU/UK firms use an average every business day

Question 54

what is the most used threshold for AANA?

Answer 54

8 billion