CME Details Member Default Policies

Terry Flanagan

CME Clearing employs a variety of default management policies and procedures specific to each major asset class in order to minimize the impact of a clearing member’s default on other clearing members and their customers.

“Our number one mission, together with liquidating the clearing member that has defaulted, is to port non-defaulting customers of the clearing member to a solvent FCM (Futures Commission Merchant) across all products,” Jason Silverstein, executive director and associate general counsel at CME Group, said in a March 31 webinar sponsored by the Global Association of Risk Professionals.

With respect to the positions of the defaulted clearing member, CME utilizes default management tools in order to address the close out of that clearing member’s positions.

These generally involve an auction or market liquidation of the clearing member’s positions. For interest rate swaps and credit default swaps, “we have what are referred to as default-management committees,” said Silverstein.

The IRS Default Management Committee and CDS Default Management Committee have the discretion to hedge and/or liquidate in order to facilitate an orderly auction of a defaulted portfolio for IRS and CDS, respectively.

All IRS and CDS clearing members are required to have representation on the Default Management Committee associated with their membership. “Their task is to come to CME and assist with recommendation of hedge transactions and or liquidity transactions, which would then be effected by CME in order to facilitate an orderly auction of that defaulted portfolio,” Silverstein said.

Through default drills, CME is able to work on the operational flows of taking a portfolio and being able to bid in a short timeframe. Drills are conducted at least twice per year.

“One way in which we try to ensure the smooth operation of our actual default management, which we actually hope to be rare, is through default drills,” said Silverstein. “These drills are conducted twice a year for all of our product classes including base [future and options products] as well as IRS and CDS products.”

In the event of a default, CME maintains separate ‘waterfalls’ for each product category, consisting of the defaulting member’s performance bond, or initial margin, and the member’s guarantee fund contribution. “To date, all of our clearing member defaults have all been satisfied within that first bucket, which is the defaulted clearing member’s initial margin,” said Silverstein.

To the extent that’s not sufficient, there’s quite a bit of additional funds within the clearing system. “This is what’s referred to as a mutualization of losses among the solving clearing members and the CME,” said Silverstein. “As a last step, we would assess the non-defaulting clearing members for additional funds. Each one of has its own respective cap, so that the clearing members aren’t subject to an unlimited liability.”

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