Default Management

CME Clearing has defined default management plans for managing a clearing member default event. These plans are designed to minimize losses and ensure the continuity of CME Clearing’s clearing services to non-defaulting clearing members and their customers, while supporting the stability of the broader financial system. Consistent with CFTC Part 190 Regulations, one of CME Clearing’s priorities is to attempt to transfer non-defaulting customers’ positions and performance bond of the defaulted clearing member to a non-defaulting clearing member or multiple non-defaulting clearing members – this is often referred to as “porting.”

Clearing Member Default Event

The CME Group Exchange Rules provide CME Clearing the ability to declare a clearing member in default upon its failure to promptly discharge any obligation to CME Clearing or where the clearing member becomes subject to any bankruptcy or insolvency proceedings. 

In the event of a clearing member default, CME Clearing may liquidate any performance bond, Guaranty Fund contributions, and any other assets deposited by the defaulted clearing member to cover its outstanding obligations (e.g., settlement variation payments) and costs associated with managing the default. This includes the costs associated with liquidating, porting, and managing the positions of the defaulted clearing member. Losses that exceed the clearing member’s resources would be satisfied by the remainder of the relevant financial safeguards waterfall (i.e., CME Contributions, Guaranty Fund contributions of non-defaulting clearing members, and Assessment Powers against non-defaulting clearing members). 

Porting

In the event of a clearing member default, CME Clearing seeks to port the defaulted clearing member’s customers. If the defaulted clearing member supports customer clearing and the customers are not in default themselves, CME Clearing would endeavor to port the customer accounts, including positions and performance bond value, to a single or multiple non-defaulting clearing member(s). If a bankruptcy trustee has been appointed to manage the estate of the defaulter, CME Clearing would work with the trustee to facilitate the porting process. 

CME Clearing conducts ongoing default management planning and regular drills, which include exercises to identify clearing members with similar or complimentary customer profiles, which may be well positioned to accept non-defaulting customers in the event of a clearing member default. 

Further, porting success is increased as a result of CME Clearing’s gross margining practices for all unaffiliated customer accounts. In particular, with customer gross margining, CME Clearing sets the minimum performance bond level as the sum of the requirement calculated for each individual customer account, meaning a customer’s positions cannot offset another unaffiliated customers positions, as permitted in a net margining regime. Gross margining improves the likelihood of porting since each customers’ positions are independently fully margined at the CCP level. This provides the flexibility to port to multiple different clearing members if necessary and appropriate. 

Clearing Member Default Management Auction and Liquidation

At the onset of the default management process, CME Clearing would assess the risk of the defaulted clearing member’s portfolio. Based on this analysis, CME Clearing would determine the appropriate strategy for handling the clearing member default, including liquidating and/or executing hedging transactions itself or through agents, and facilitating an auction (or multiple auctions) of the defaulted clearing member’s portfolio. CME Clearing would select the auction style depending on the specific characteristics of the portfolio, including the risk profile, magnitude, and liquidity in the market. The ultimate goal of the hedging process is to neutralize the risk of the defaulted clearing member’s portfolio, thus minimizing the impact of liquidation.

Exchange-Traded Derivatives Products’ Default Management Process

CME Clearing would determine the appropriate design of the auction process for an exchange-traded derivative products’ portfolio of a defaulted clearing member, which may include auction participation by clearing members and non-clearing member market participants. Participation in the default management auction of an exchange-traded derivative product’s portfolio is voluntary. 

CME Clearing selects auction participants that have the appropriate level of expertise and ability to risk manage the portfolio being auctioned. This selection process is designed to ensure that CME Clearing receives bids on the defaulted clearing member’s portfolio from participants that are well suited operationally and financially to manage the risk of such portfolio. CME Clearing may conduct an auction for selected buy- and sell-side participants to bid on a sub-set of or the entire portfolio of the defaulted clearing member. As described further below, clearing members’ participation in twice-yearly default management drills for each financial safeguards waterfalls provide clearing members the opportunity to become familiar with CME Clearing’s default management plans. 

Cleared Swaps Products’ Default Management Process

With regard to cleared swaps, default management committees comprised of seconded traders from clearing members would be convened, as necessary, to assist CME Clearing in managing a clearing member default. These committees are the IRS Active Default Management Committee and Base Active OTC Default Management Committee—collectively referred to as the Active Default Management Committees. The Active Default Management Committees are responsible for providing guidance to CME Clearing and relevant CME Clearing Risk Committee1  on areas related to a potential or actual default of a clearing member carrying swaps positions at CME Clearing. 

CME Clearing would determine the appropriate design of the auction process for a portfolio of a defaulted clearing member with cleared swaps exposures. Both Base (i.e., cleared swaps) and IRS clearing members are required under the CME Rules to participate in the auction of a defaulted clearing member’s portfolio, relative to their membership(s) and the product class(es) for which they clear at CME Clearing. Similar to exchange-traded derivative products, non-clearing members may also participate, and all auction participants must have the appropriate level of expertise and ability to risk manage the portfolio being auctioned.

CME Clearing employs a structure that is designed to incentivize clearing members to construct appropriate bids. With respect to IRS products, the failure to provide an appropriate bid would result in the juniorization of an IRS clearing members’ IRS Guaranty Fund contributions. 

Default Management Drills

CME Clearing conducts default management drills with its clearing members and other interested participants with sufficient risk management and operational expertise at least twice annually for each financial safeguards waterfall. CME Clearing’s default management drills test the systems and processes at CME Clearing for managing a default. These drills guide who participates in the management of clearing member failures and defaults to affirm participants have adequate experience with the process. Default management drills are designed to ensure both CME Clearing and auction participants are technologically, operationally, and logistically prepared for a potential clearing member default event. 

CME Clearing conducts default management drills for a diverse set of portfolios across Base and IRS products. The drills contain large and complex portfolios representative of the risks held by existing clearing members and provide a forum for participants to test their ability to evaluate sizable portfolios under simulated extreme but plausible market conditions, where applicable. Each drill consists of a hedging phase, where appropriate, and an auction and/or liquidation phase of the hypothetically defaulted clearing member’s portfolio. The results of each drill are reviewed internally and with the relevant CME Clearing Risk Committee and the Clearing House Oversight Committee. Where appropriate, feedback received after the drill exercise may lead to changes to default management processes in an effort to continually enhance operational capabilities. 

References


This summary page is designed to provide a brief overview of a topic related to the CME Clearing. The information contained in this summary has been compiled by CME Group for general purposes only. While some relevant CME Group Exchange Rules may be discussed with respect to CME Clearing's practices, all matters pertaining to rules and specifications herein are made subject to, and are superseded by, the CME Group Exchange Rulebooks. Current versions of the Rules should always be consulted.

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