no 61/17 Summary of amendments to Nasdaq Clearing AB’s Default Fund Rules
This summary includes information about amendments made in respect of Nasdaq Clearing AB’s (“Nasdaq Clearing”) Default Fund Rules, which are part of the Nasdaq Commodity Clearing Rules (the “Clearing Rules”). Defined terms have the meaning set out in the Clearing Rules.
In the current waterfall structure, Nasdaq Clearing funds two capital tranches, the Junior Capital (which is a requirement under EMIR) and the Senior Capital (which is not an explicit requirement under EMIR – the funds could either be provided by the Clearinghouse or the clearing participants).
Clearing participants are funding two of the capital tranches, the default fund for respective Clearing Service, and the Mutual Default Fund.
The size of the Junior Capital is set as a function of Nasdaq Clearing’s regulatory capital for non-default losses (i.e. EMIR Article 16 Capital).
The size of the default fund(s) is set at a level equal to the largest of the Top 1 exposure and the sum of Top 2 and Top 3 (i.e. the stressed market value of these exposures less the posted margin). The Mutual Default Fund is set at 15 per cent of what clearing participants contribute to each default fund. The different tranches of the waterfall are updated on a quarterly basis or more frequently if it is required.
Nasdaq Clearing must ensure that the sum of all available financial resources is sufficient to cover the sum of Top 1 and Top 2 exposures. This means that the sizing of the Senior Capital tranche is set based on any shortfall between the aggregated Top 1 and Top 2 exposures less the sum of the respective Junior Capital, the respective default fund and the Mutual Default Fund. Hence, the size of the Senior Capital will depend on the relative size of the Top 1, Top 2 and Top 3 exposures.[1]
Nasdaq Clearing is quite unique in providing a second capital tranche. Most other European CCPs only provide the Junior Capital tranche.
The purpose of the Senior Capital tranche is to create an additional incentive for Nasdaq Clearing to run the default management process as efficiently as possible and to avoid tapping into the Mutual Default Fund. However, the current mechanism for determining the Senior Capital could result in that Nasdaq Clearing would have to capitalize the waterfall to a significant extent, which is not the purpose of this capital layer. In order to ensure that this layer only serves its original purpose, the Senior Capital is set to a fixed amount.
In conjunction with this change, other amendments are planned to be implemented which relate to the waterfall:
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Sizing of default funds
When the Senior Capital is set at a fixed level, the residual amount to ensure that the Cover 2 requirement is fulfilled is proposed to be added to respective Clearing Service’s default fund. Thereby, any requirement for additional financial resources as a result of relative changes between Top 1, Top 2 and Top 3 will be carried by respective Clearing Service and will not have an effect on any other Clearing Service. Therefore, the rule for the sizing of the applicable default fund must be changed. Currently, the sizing of the default fund was determined by the maximum of the Top 1 exposure or the sum of the Top 2 and Top 3 exposures. The change means that the sizing of the default fund should ensure the fulfillment of both a) the current requirement, and b) the requirement that the sum of Top 1 and Top 2 exposures is covered when taking into account the available resources in i) the Junior Capital, ii) the Senior Capital, and iii) the Mutual Default Fund.
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Flexibility to set the default fund size with a 20 per cent buffer
In the current framework, the sizing of the default funds does not allow Nasdaq Clearing to set any buffer even if the current stress test values are very close to the highpoint in the look-back period. When the Senior Capital will be fixed at SEK 200 million, it is no longer possible to set this capital tranche to ensure a certain buffer is available, which could minimize the risk for intra-quarterly changes to the waterfall. Therefore, Nasdaq Clearing will be allowed to set a buffer in a Clearing Service’s default fund equivalent to maximum of 20 per cent of the Cover 2-requirement for that Clearing Service to minimize the risk that intra-quarterly default fund calls must be executed. The buffer will not be utilized in the event the current stress test values are lower than the highpoint in the look-back period and the difference provides a sufficient buffer.
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Look-back period
In the current framework, Nasdaq Clearing has defined that the highpoint in stress test values during the last 12 months (“the look-back period”) should be the minimum size of the financial resources when determining the size of the financial resources. The look-back period is not defined in EMIR but has been applied since Nasdaq Clearing received its EMIR-authorization. The look-back period will be reduced from 12 months to 6 months.
By introducing the reduced look-back period and at the same time enable Nasdaq Clearing to set the default fund with a 20 per cent buffer, the overall default fund sizing rule will become a less backward looking and more forward-looking model.
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Number of days to meet updated default fund requirement
Currently, clearing participants have 10 business days to post default fund contributions after they have been notified about the default fund requirements. Since the Senior Capital will not be utilized as an interim funding in the event there is a shortage in financial resources compared to stress test values and until clearing participants have posted additional default fund contributions, the number of days is reduced to 5 business days. Nasdaq Clearing has other tools available (apart from increasing the default fund(s)) in case there is a shortage in financial resources: 1) increase of margin parameters; and 2) change of margin scaling / add-on margins. These alternatives will primarily be utilized as a temporary measure until the normal quarterly default fund update is conducted.
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Pro-rata calculation of default fund requirements
In the current pro-rata calculation for individual clearing participants’ contributions, Nasdaq Clearing aggregates three month average of a clearing participant’s total net initial margin for all account types. The clearing participant’s relative share compared to the aggregated amount for all clearing participants will determine how much the individual participant will contribute to the default fund.
By including all account types, clearing participants that hold more than one individually segregated accounts (ICA) will be obligated to contribute a larger share of the default fund compared to the risk they pose to the Clearinghouse. The reason for this is that i) ICA accounts are margined on a gross basis which means that market risk scenarios are not consistent among the ICA accounts, and ii) in the event of a default of a clearing member, ICA positions are more likely to be ported than other client positions.
To obtain a pro-rata calculation which better mirrors the risk that clearing participants pose to the Clearinghouse, ICA accounts should only be weighted 50 per cent when aggregating a clearing member’s average net Initial Margin.
Nasdaq Clearing’s waterfall can be found on Nasdaq Clearing’s website: http://business.nasdaq.com/media/Nasdaq-Clearing-AB-Waterfall_incl-LSP_tcm5044-30798.pdf
For updated rulebooks and appendices please see: http://www.nasdaqomx.com/commodities/Marketaccess/legalframework/upcoming-changes-to-rules
[1] In the event the size of the Top 1, Top 2 and Top 3 are the same, the required size of the Senior Capital would be zero since the size of the default fund (which would be set to cover Top 2 and Top 3) also would cover Top 1 and Top 2. However, if Top 1 and Top 2 are of a similar size but Top 3 is very small, the Senior Capital would be large in order to close the shortfall arising from the difference in the Top 1 and the Top 3 exposures (which is not covered by the Junior Capital and the Mutual Default Fund).
For further information, please contact Nasdaq Commodities:
Tomas Thyblad, VP, Head of Financial Risks & Treasury Services EMEA - APAC
+46 8 405 75 14, tomas.thyblad@nasdaq.com
Karl Klasén, Senior Advisor, Nasdaq Clearing Risk Management
+46 8 405 6397, karl.klasen@nasdaq.com
Media contact:
Sara Aadnesen, Head of Corporate Communication Commodities, phone +47 9060 0759, sara.aadnesen@nasdaq.com
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About Nasdaq Clearing
Nasdaq Clearing is the trade name of Nasdaq Clearing AB which is authorized and supervised as a multi-asset clearinghouse by the Swedish Financial Supervisory Authority in Sweden as well as authorized to conduct clearing operation in Norway by the Norwegian Ministry of Finance.
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