Under the Commodity Exchange Act and Commodity Futures Trading Commission (“CFTC”) regulations, customer positions and funds must be segregated from the positions and funds of their clearing member. Segregation is achieved by utilization of the “Customer Segregated Account” class for domestic exchange-traded derivatives and “Cleared Swaps Customer Account” class for cleared swaps.
Additionally, customers’ exchange-traded derivatives positions and funds are segregated from customers’ cleared swaps derivatives positions and funds – unless customers proactively elect have their exchange-traded derivatives and cleared swaps positions portfolio margined and such commingling is permitted by the CFTC.
Segregation of customer positions and funds required at every level of the cleared ecosystem, including the clearing member (i.e., futures commission merchant), CME Clearing and the relevant depository. Under U.S. law customers cannot opt-out of customer segregation or customer gross margining.
In line with CFTC regulations, CME Clearing requires clearing members providing clearing services to customers to collect and pass through performance bond on a gross basis for each customer account, for both exchange-traded derivatives and cleared swaps. With customer gross margining, CME Clearing sets minimum performance bond levels as the sum of the requirements calculated for each individual customer account, meaning one customer’s position cannot offset another unaffiliated customer’s position, as is permitted in a net margin regime. By ensuring that each customer is independently fully margined, fellow customer is reduced, including by mitigating the likelihood of pro-rata loss sharing and position liquidation in the event those customers’ clearing member defaults. Additionally, the practice of collecting and passing through gross margin for customer accounts to CME Clearing ensures that the positions within a customer account are fully margined at the CME Clearing-level.
As described further below, since each customer is fully margined at the CME Clearing-level under a gross margining regime CME Clearing has greater flexibility to port customer accounts of a defaulted clearing member to a single clearing member or multiple clearing members.
In comparison to customer gross margining regimes, customer net margining regimes result in significantly less margin at a CCP. Challenges can arise in the CCP’s management of a clearing member default under a customer net margining regime because the CCP will likely only have enough margin to port customers to a single clearing member. If the defaulting clearing member’s customer accounts are ported to multiple clearing members in a net margining regime, the risk offsets between customers (which reduced the margin posted to the CCP) are eliminated and thus, the risks can no longer be covered with the margin on hand at the CCP.
The diagram below illustrates the enhanced porting flexibility offered by a customer gross margining regime compared to a customer net margining regime. The ability to port fully margined customer accounts to multiple non-defaulting clearing members under a customer gross margining regime may be critical in a situation where a clearing member with a large and/or diverse number of customer accounts has defaulted. In such a situation, the ability to port customer accounts to multiple clearing members is particularly important in stressed market conditions, where the liquidations of large customer accounts may further destabilize an already volatile market.
Clearing members often provide clearing services for affiliated entities – also known as self-clearing. CFTC regulations require the positions and funds of affiliated entities to be carried in the proprietary account of the clearing member and thus, segregated from the positions and funds of customers. This provides critical protections in times of market stress as it ensures that losses on positions held by the clearing member for its own benefit or its affiliates cannot be borne by customers. In contrast, placing the positions and funds of a clearing member’s affiliate in the customer account class negates, or at a minimum reduces, the protections associated with customer segregation; additionally, in doing so, affiliate positions are likely to be net margined with customer positions, which further hinders portability.
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