EquityClear OTC CFD Model Service Description

Transcription

1 EquityClear OTC CFD Model Service Description Not for distribution Issued : 30/10/2013

2 Table of Contents 1. INTRODUCTION Service overview - execution Readership SERVICE OVERVIEW Service overview - clearing Products EquityClear Functions Trade management Position management Settlement management Risk management Financial management Reconciliation PARTICIPANTS POSITION MANAGEMENT Member accounts Trading firms Client Segregation TRADE MANAGEMENT Trade validation Trade correction Trade types Member accounts & client segregation RISK MANAGEMENT Introduction Overview Default Management Membership Margin Calculation & Payments Margin Cover & Payments Margining Summary: SETTLEMENT MANAGEMENT TARIFFS Introduction MEMBER REPORTS & TRADE CONFIRMATIONS Member Reports Member real time confirmations ABBREVIATIONS Page 2 / 24 Issued : 30/10/2013

3 The copyright in this work is vested in LCH.Clearnet Ltd and is issued in confidence for the purpose for which it is supplied. It must not be reproduced in whole or in part or used for tendering or manufacturing purposes except under an agreement or with the consent in writing of LCH.Clearnet Ltd and then only on the condition that this notice is included in any such reproduction. No information as to the contents or the subject matter of this document or any part thereof arising directly or indirectly there from shall be given orally or in writing or communicated in any manner whatsoever to any third party being an individual firm or employee thereof without the prior consent in writing of LCH.Clearnet Ltd LCH.Clearnet Ltd. Page 3 / 24 Issued : 30/10/2013

4 1. INTRODUCTION 1.1 Service overview - execution LCH.Clearnet operates a central counterparty service for the clearing and settlement of cash equities. The EquityClear service has been expanded to include Contracts For Difference (CFDs) and will be tailored to clear OTC CFDs, Synthetics & Futures from the broker trade source The diagram below is a high level diagram describing the trading model for. Trades between client and broker, as well as Hedge trades will be cleared by the LCH EquityClear service. The ATP may delegate authority to send in trades to Prime Brokers Page 4 / 24 Issued : 30/10/2013

5 1.2 Readership This Service Description provides the reader with a general overview of the EquityClear service for OTC CFDs. It is drafted as a generic document that highlights the differences in functionality or process, where they exist, between the standard EquityClear service for cash equities and the OTC EquityClear service for CFDs. Page 5 / 24 Issued : 30/10/2013

6 2. SERVICE OVERVIEW 2.1 Service overview - clearing OTC trades will be sent to LCH via a dedicated FIX interface. LCH will novate the OTC trades and clear both sides of the transaction. LCH Clearing hours will be 07:30 to 21:30GMT (adjusted for daylight savings as appropriate). 2.2 Products The table below describes the main product types and whether they are cleared; Security class Initial Margin MTM P&L Financing Expires Launch Single name Equity CFD Daily & Intra-day Daily Reset No No EU UK US Single name synthetics Daily & Intra-day Daily Reset No No EU UK US Indices Daily & Intra-day Daily Reset No No EU UK US The OTC contracts traded are defined by the broker. For the purpose of this document the term CFD will be used to describe all the products above, unless specifically distinguished. 2.3 EquityClear Functions The EquityClear service will comprise the following key functions for CFDs: 2.4 Trade management CFD trades are received and validated to ensure they correctly identify valid Trade Participants. Approved/valid trades are novated placing LCH.Clearnet Ltd as the legal central counterparty. Trades are registered and details enriched to clear in line with the members preferences. 2.5 Position management As trades are received by LCH.Clearnet they are legally added to the member s positions in real time. In other words as a member s trade hits LCH.Clearnet the obligation of that trade is transferred to the real time net position per CFD instrument (ISIN/currency/trading Page 6 / 24 Issued : 30/10/2013

7 platform) per trade participant. Following margin calculations. Daily P&L flows are applied. Trades are added to existing positions on a real time basis. 2.6 Settlement management CFDs are daily rolling cash settled and thus no connection to a CSD or settlement agent for CFDs is required. 2.7 Risk management CFD trades will be margined on the Equity Risk Analysis (ERA) algorithm as per equities, and equity & index related CFD positions will offset for initial margin purposes where appropriate. CFD settlement to market (i.e. variation margin) will be in cash (while equities will remain as contingent margin). Intra-day CFD margining will be contingent the same as equities. Member defaults are managed by the LCH.Clearnet Risk Management department through the existing LCH.Clearnet process and EquityClear portion of the default fund. 2.8 Financial management The Treasury Department manages member s cash and collateral for margin cover and payments as well as financing and stock borrow payments to Clearing Members. 2.9 Reconciliation LCH.Clearnet will perform trade reconciliation with the trading platform daily after the close of business, which is expected to be at approximately 9.15pm each evening. Trade reconciliation will confirm whether LCH.Clearnet has received all trades accurately. LCH.Clearnet is the legal register of all CFD positions generated. Page 7 / 24 Issued : 30/10/2013

8 3. PARTICIPANTS As a central counterparty, LCH.Clearnet becomes the buyer to the seller and the seller to the buyer for each trade it clears. The buyer and seller must each be a member of LCH.Clearnet, must be acting in a principal capacity and must be one of the two membership categories which confer Clearing Member status, namely: An Individual Clearing Member (ICM), which can: clear trades it executes as a participant of a trade source 1. A General Clearing Member (GCM), which can: clear trades it executes as a participant of a trade source. clear trades executed by other participants of a trade source. EquityClear supports a membership category which does not have Clearing Member status, namely: A Non Clearing Participant (NCP), which can: execute trades as a participant of a trade source using the services of a GCM to clear such trades. Full membership details can be found on our website at 1 A Trade Source being a source of matched trades to LCH.Clearnet, including exchanges, MTFs, MROs and OTC matching services. Page 8 / 24 Issued : 30/10/2013

9 4. POSITION MANAGEMENT The open principal positions between LCH.Clearnet and its members are maintained in real time as trades are registered on a net per trade participant account per ISIN basis. 4.1 Member accounts Each member can operate using one or more notional business units which are each identified by a unique member mnemonic. For each member mnemonic two sub-accounts are available, a mandatory House account, and an optional Client account. Each member mnemonic and sub-account combination is referred to as a member account. Positions are netted per member account for the purposes of margin calculation and cover. Therefore each trade and settlement must be attributable to one member account. 4.2 Trading firms The buyer and seller of each trade are given a unique identifier by the trading platform. Each trading firm so identified is the primary determinant of the member account through which the trade is cleared. EquityClear maintains positions per trading firm and reports these to clearing members. EquityClear allows for such trading firm identifiers to be grouped into a new single trading firm identifier. The new trading firm identifier is substituted at the start of the clearing process and is used for trade enrichment as if it had been sent in the trade details from the trading platform Client Segregation Under EMIR CCPs are required to provide for the segregation of client positions, the key relevant text being as follows. 1. A CCP shall offer to keep separate records and accounts enabling each clearing member to distinguish in accounts with the CCP the assets and positions of that clearing member from those held for the accounts of its clients ( omnibus client segregation ). [Level 1, Article 39(2)] 2. A CCP shall offer to keep separate records and accounts enabling each clearing member to distinguish in accounts with the CCP the assets and positions held for the account of a client from those held for the account of other clients ( individual client segregation ). Upon request, the CCP shall offer clearing members the possibility to open more accounts in their own name or for the account of their clients. [Level 1, Article 39(3)] At the request of a clearing member, the CCP shall maintain separate records and accounts enabling each client to distinguish in accounts held with the CCP the assets and positions of the client from those held for the accounts of the indirect clients of the client. [Level 2 RTS (Indirect Clearing Arrangements), Article 3(1)] 2 To allow GCMs to pass on clearing fees to NCMs, volumes are reported using the original trading firm identifier and not the grouped one. Page 9 / 24 Issued : 30/10/2013

10 That is, the CCP needs to provide three levels of segregation for client business. 1. Omnibus segregation of client business from house business. The established segregation achieved through the house and client member accounts described above. 2. Individual segregation of client business from omnibus segregated client business. This provides clients of clearing members the option to have their positions and collateral segregated at the CCP so that they can port these to a new clearing member in the event of the default of their current clearing member. 3. Segregation of indirect client business from individually segregated client business 3. This provides clients of the client of a clearing member (indirect clients) the option to have their positions and collateral segregated at the CCP from that of the client of the clearing member. The segregation is of both open positions and collateral lodged with the clearing house. The position segregation is managed through the EquityClear service and the collateral segregation is managed through the common LCH.Clearnet Treasury systems [Banking and CMS (Collateral Management System)]. The different account segregation levels are illustrated below. It should be noted that client segregation does not change the principal relationship between LCH.Clearnet and clearing members on all cleared trades. 1. Omnibus client segregation The diagram below shows an example client account structure of a clearing member where all the client business is cleared through the client member account, also identified as a Net OSA (Omnibus Segregated Account). 3 Only required in EMIR for OTC derivatives but offered in EquityClear for cash equities. Page 10 / 24 Issued : 30/10/2013

11 In EquityClear the only actual accounts are the Settlement Firms (position accounts). In the example four are shown. The positions from all the position accounts are netted together to provide an omnibus position for the purposes of calculating the associated margin liability. This liability is sent to the Banking system as being against the omnibus client member account ( C ). An example is shown below for the above scenario. 2. Individual client segregation The diagram below is as the previous example but where the clients whose positions are held in Settlement Firms SFID3 and SFID4 have elected to have their positions individually segregated, identified on the diagram as ISAs (Individually Segregated Accounts). Page 11 / 24 Issued : 30/10/2013

12 Only the positions in Settlement Firms SFID1 and SFID2 are netted together to provide the omnibus position for the purposes of calculating the associated margin liability. The positions in SFID3 and SFID4 are used to calculate the margin liability for these accounts individually. The liabilities for SFID3 and SFID4 are sent to the Banking system as being against the corresponding individual collateral accounts Sxxx and Syyy. An example is shown below for the above scenario. 3. Indirect client segregation The diagram below is as the previous example but where the (indirect) clients of the client using SFID4 want their positions segregated from those of the client. To do this the new Settlement Firm SFID5 is created to hold the segregated indirect client positions, which could be for one, some or all these clients. SFID5 is identified as an Indirect OSA on the basis that it could hold the positions of more than one indirect client. It is important to note that in order to segregate the indirect client positions the trades of these clients must be executed using a different Trade Participant identifier on the trading platform. SFID4 holds the positions of the client and any of the indirect clients who did not opt for indirect client segregation. Page 12 / 24 Issued : 30/10/2013

13 The positions in SFID5 are used to calculate the margin liability for this account which is then sent to the Banking system as being against the corresponding individual collateral account Vzzz. In the collateral systems the account IDs are differentiated, with ISA IDs starting with an S and Indirect accounts starting with a V. Page 13 / 24 Issued : 30/10/2013

14 5. TRADE MANAGEMENT Trade details entered into the ATP system will be forwarded on to EquityClear on a continuous real time basis. This information is used by EquityClear to process the trade for clearing and to report appropriately to clearing members. 5.1 Trade validation LCH.Clearnet checks that it is legally obliged to clear trades received from trade sources. Trades would therefore be rejected if: The CFD has not been agreed to be cleared by LCH.Clearnet. A trading firm does not have clearing arrangements in place. In both cases the trade source should not have sent the trade to LCH.Clearnet for clearing. Trades received may fail initial validation for a range of technical, syntactical, logical or operational reasons. All such cases will be investigated and sought to be resolved as soon as possible on trade day, working internally and with the trade source and members as necessary. No pending trades will exist overnight (unlike some equities which can in exceptional circumstances). All trades will either by accepted as valid trades or rejected by the close of business each day. 5.2 Trade correction Where the broker has sent an invalid trade for clearing it can send a trade cancellation on trade day and the trade will be removed from clearing. The ATP can correct trades by sending a contra trade, being an opposite trade to the original, to reverse the original trade. This is cleared as a new trade, with the trade reference to the original trade reported by EquityClear. 5.3 Trade types EquityClear accepts CFD trades with contract formation by novation Member accounts & client segregation Each trade to be cleared is identified as having a dealing capacity of principal or agency and optionally identified with a clearing sub-account 4. Members define through reference data the margin account through which each trade is to be cleared. It is defined for each combination of: Trade source Settlement firm Dealing capacity Sub-account (optional) The following table shows examples of the choices that can be made. 4 In general the clearing account is not identified on the trade message. This may be because the trade source does not provide the facility to do so or the Trading Participant chooses not to provide it. Page 14 / 24 Issued : 30/10/2013

15 Trade Source Settlement Firm Dealing Capacity Subaccount Member mnemonic Subaccount XXXX BIC12345 Principal (P) MMA House (H) XXXX BIC12345 Agency (A) MMA Client (C) XEEE BIC98765 Principal (P) House (H) MMA House (H) XEEE BIC98765 Principal (P) Client (C) MMA Client (C) XEEE BIC98765 Agency (A) House (H) MMB Client (C) XEEE BIC98765 Agency (A) Client (C) MMB Client (C) The first two rows show the case where no sub-account is provided on trades and the rest where it is provided. It can be seen in the fifth row that the sub-account defined by the member is different from the one provided on the trade. This caters for the situation where an NCP may incorrectly mark a trade to be cleared through the house clearing account whilst the GCM wants all the NCP s business cleared through their client clearing account. In this way the GCM can auto-correct the NCP s mistake. Members can further define through reference data that the positions in a Settlement Firm are to be segregated from the omnibus client account. This Settlement Firm then operates as either an ISA or Indirect OSA as described in the Position Management section above. Page 15 / 24 Issued : 30/10/2013

16 6. RISK MANAGEMENT 6.1 Introduction The Clearing House provides robust and prudent risk management in order to meet its overriding objective: to provide Clearing Members with a central counterparty of the highest quality and to safeguard the interests of the company's shareholders and contributors to its Clearing Funds. LCH.Clearnet Ltd is a CCP of long standing with an extensive record of successful risk management. To support members and interested parties detailed presentations on the following topics can be found on our website at LCH.Clearnet General Introduction to Risk Mitigation Risk Management compared to External Standards Default Protections LCH.Clearnet Default History Clearing Members (membership criteria and member monitoring) 6.2 Overview LCH.Clearnet, in assuming the role of central counterparty to the CFD market, will have explicit contractual relationships with its Members. This relationship is set out in the Clearing House Rulebook and the bilateral Clearing Membership Agreement that the LCH.Clearnet has with its Members. The normal equity GCM, ICM, NCM (trade participant) structure will apply to CFDs. CFDs will be margined by ERA using the underlying securities published prices, pre corporate event changes for equities. EOD CFD positions are settled to market as cash only payments (cash equities is contingent margin) and intra-day as contingent margin (the same as equities). 6.3 Default Management CFDs will be added to the EquityClear section of the default fund and no increase in the default fund is expected on launch. The standard/usual LCH.Clearnet Ltd Default Protections would be applied in the order shown. 1. Membership Criteria 2. Variation Margin 3. Initial Margin 4. Intra-day Margining 5. Defaulter s own Default Fund Contribution 6. Ltd s own capital (capped) 7. Remaining Default Fund 8. Remainder of Ltd s capital In the event of a member default non-defaulters positions are unaffected. Page 16 / 24 Issued : 30/10/2013

17 LCH.Clearnet closes out the defaulter s positions and where necessary to cover losses uses the member s margin followed in order by items 5-8 in the list above. Members (ICM or GCM) are required to contribute to the Default Fund. The contribution is recalculated quarterly. Each member s contribution is based upon their proportion of the total initial margin requirement and their proportion of the total traded volume during the previous quarter. The minimum contribution to the default fund is GBP 1 million. 6.4 Membership EquityClear Clearing Members that wish to join the CFD service will be required to conduct thorough testing and sign a Clearing Agreement Schedule for each CFD market they wish to clear to extend their existing EquityClear Membership. 6.5 Margin Calculation & Payments EquityClear uses the Equity Risk Analysis, ERA, algorithm for the calculation of initial and variation margin. ERA was specifically designed for this service to maximise portfolio offsets across all EquityClear markets, thereby keeping margin requirements low compared to other methods, whilst meeting the necessary level of Risk Management prudence 5. Full details of the ERA algorithm are provided in a separate document, the ERA TIP (Technical Information Pack), which more details can be found on our website at This includes an overview of margin terminology and the algorithm, full calculation details and worked examples including full test data. LCH.Clearnet can make available PC ERA, a PC tool which performs the margin algorithm. LCH.Clearnet publishes its margin parameters. Current and historical data can be found on our website at Interested parties can use these to determine the margin requirements for portfolios they may wish to test. At the end of each trading day a margin calculation is made, the results of which are integrated into the margin requirements for each member account across all LCH.Clearnet product services. A mid-day margin calculation is made and where there is insufficient cover an intra-day margin call will be made. Further intra-day margin runs are made regularly and the facility for ad-hoc calculation due to exceptional circumstances is available to the Risk Management department. Additional margin calls can be made based on these calculations but they are not a frequent occurrence. ERA will be used for CFDs (and cash equities) for the calculation of initial margin (IM), variation margin (VM/unrealised P&L) and marked to market payments (MTM/realised P&L for CFDs). Existing PPS arrangements will be used for collecting margins on CFDs. IM and VM will be collected in the same currencies and terms that exist today for cash equities. MTM will be collected in the cash of the currency of the CFD. 5 LCH.Clearnet Ltd has a stated aim that its risk management should be best practice. It reviews its risk management against the following external standards: European Association of Central Counterparty Clearing Houses (EACH) standards of risk management control; the CPSS-IOSCO Recommendations for Central Counterparties Page 17 / 24 Issued : 30/10/2013

18 The PPS system will also be used to collect fees, for financing and stock borrow flows and cash movements on relevant corporate events. The process for end-of-day (EOD) margin calculations is as follows: Step 1: Run MTM - All existing positions (T) are cash settled daily (marked to market) to the night before s EOD equity price (T-1). Thus all existing CFD positions effectively have a trade price of the night before s EOD equity price (T-1). For trades that occur intra-day the trade price forms the base price to use for EOD margining on T. Note that all intra-day CFD margining is contingent so when the EOD run is performed the intra-day collections are effectively ignored in the calculation and credited back to members. Step 2 & 3: Run IM and VM - The VM run will generate a contingent margin of near zero as Step 1 has already realised the Member s potential VM. CFD IM is a contingent margin collection due on all open CFD positions. CFD and equities on the same stocks will be offset for margin calculations. Therefore, if a Clearing Member has an equal and opposite position between equities and CFDs the positions should be risk offset to reduce the initial margin to zero (if mid-pricing is used) or near zero (if bid and offer spread is used). Note this can only occur during the three days that LCH.Clearnet is the counterparty to the equity trades. 6.6 Margin Cover & Payments Initial Margin is always calculated in GBP, though can be covered by cash in a broad range of currencies and a range of other collateral. LCH.Clearnet Ltd operates a direct debit system, known as the Protected Payments System (PPS), for the transfer of funds to and from clearing members. A clearing member is required to maintain a PPS bank account in London in GBP and others as required. Further details can be found on our website at Any cash paid in respect of margin receives credit interest at the London Deposit Rate 6. Other acceptable collateral includes Government Securities, Certificates of Deposit and performance Bonds. Full details of acceptable currencies and collateral can be found on our website at The option to post collateral via Euroclear Autoselect is available. Members can achieve collateral efficiencies from the netting and consolidation of margin requirements across their business with LCH.Clearnet Ltd, covering all products and services. 6 London Deposit Rate is calculated daily for each currency by 10:00 hours. It is derived from bid rates for overnight funds quoted by selected money market brokers and/or major banks. For next-day value currencies, LDR is calculated the day prior using tom/next rate. Page 18 / 24 Issued : 30/10/2013

19 6.7 Margining Summary: Intra-Day Initial Margin Variation Margin Settlement to Market Equity Contingent Contingent N/A CFD Contingent Contingent N/A End-of-Day Initial Margin Variation Margin Settlement to Market Equity Contingent Contingent N/A CFD Contingent Contingent (will be zero VM) Cash Page 19 / 24 Issued : 30/10/2013

20 7. SETTLEMENT MANAGEMENT CFDs are a daily cash settled derivative through our PPS service and as such have no physical settlement in a CSD. In other words, LCH.Clearnet realise the profit and loss on Members CFD positions daily. Thus no settlement infrastructure is required for this service. Page 20 / 24 Issued : 30/10/2013

21 8. TARIFFS 8.1 Introduction CFDs will be added to existing Clearing Member equity volume to determine the member s overall volume and appropriate tariff. Thus CFDs and equities will be treated the same for clearing tariff purposes. The clearing tariff uses the average daily volume cleared over a month to determine the fee charged per trade. The higher the volume reached the lower the fee per trade. Membership of EquityClear will permit Clearing Members to become clearers of either equities or CFDs or both. Existing members of the EquityClear service will already qualify for the CFD service from a tariff perspective. They will not be required to pay a new joining or administration fee. Clearing Members that want to join EquityClear simply to clear CFDs will have to meet the same criteria as if they were joining the service to clear equities. Since CFDs are not physically settled there are no CSD costs that will be required to be passed back to Members. Fees are collected through the Protected Payments System. Details can be found on our website at Page 21 / 24 Issued : 30/10/2013

22 9. MEMBER REPORTS & TRADE CONFIRMATIONS 9.1 Member Reports 7 For CFDs EquityClear will provide Clearing Members with the same suite of reports plus some extra reports via its VPN, Extranet (as used by RepoClear, SwapClear and some EquityClear users) and TRS, as follows: Intra-Day (ITD): - Both Equity and CFD Reports EREP0001i Margin Positions at Clearing Account ITD EREP0002i Margin Positions at Settlement Counterparty Level ITD EREP0003i Margin Summary at Clearing Account Level ITD EREP0004i Margin VM Detail at Clearing Account Level ITD End-of-day (EOD): - Both Equity and CFD Reports EREP0001e Margin Positions at Clearing Account EOD EREP0002e Margin Positions at Settlement Counterparty Level EOD EREP0003e Margin Summary at Clearing Account Level EOD EREP0004e Margin VM Detail at Clearing Account Level EOD Other: - Both Equity and CFD Reports EREP0007 Fees Fee Basis Breakdown This is a monthly report. It will normally be available on the second business day of the next month, but may vary. Intra-Day (ITD): - CFD Report only EREP0008i CFD Trade Report ITD End-of-day (EOD): - CFD Reports only EREP0009 CFD End of Day Mark to Market Positions Report EREP0012 CFD Corporate Events Report EREP0013 CFD Cash Distribution Payments Report EREP0014 Start of Day CFD Positions Report End-of-day (EOD): - Both Equity and CFD Reports EREP0016 Fees Settlement Cost Breakdown 7 Please see the EquityClear Extranet Member Report Formats document for complete information Page 22 / 24 Issued : 30/10/2013

23 9.2 Member real time confirmations 8 LCH.Clearnet is investing in new member services, improving and increasing the information flow between LCH.Clearnet and its members. Real time messaging using industry standards is one such area of expansion. Enhancements to the network infrastructure will support these initiatives. For many members the core infrastructure is already in place and may just require capacity upgrades. Members will have flexibility to choose which products and markets they want to receive as they become available. 8 Please see Member Real Time Confirmations document for complete information Page 23 / 24 Issued : 30/10/2013

24 10. ABBREVIATIONS CCP CESR CFD CPSS-IOSCO CSD DTCC ERA EUI Central Counterparty Committee of European Securities Regulators Contract For Difference Committee on Payment and Settlement Systems - International Organization of Securities Commissions Central Securities Depository Depository Trust & Clearing Corporation Equity Risk Analysis Euroclear UK & Ireland GBP Pounds Sterling ( ) GCM HMRC ICM ISIN LCH LIBOR NCM PPS SDRT T UK General Clearing Member Her Majesty s Revenue & Customs Individual Clearing Member International Security Identification Number LCH.Clearnet Ltd London Inter-bank Offer rate Non Clearing Member Protected Payments System Stamp Duty Reserve Tax Trade Date United Kingdom Page 24 / 24 Issued : 30/10/2013