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Name the risks borne by clearing members and those borne by non-members, and distinguish between the two.

FRM® Part I · Financial Markets and Products · Central Clearing · FRM1.FM.6.i

The idea

Clearing members belong to the CCP, post initial margin and variation margin to it, contribute to the default fund, and can be called for further assessments and obliged to join default auctions. They are liable to the CCP for their clients' trades, so a client default beyond its margin falls on the member. Non-members, the clients, clear through a member and have no contract with the CCP or default fund obligation. Their main risks are that the clearing member defaults, so positions must be ported to another member, and that margin held at the member is not properly segregated. In an omnibus account, a further risk is that fellow-customer losses reduce the margin available. Exam point: members bear loss mutualisation and client-guarantee risk, while clients bear clearing member default and segregation risk.

A practice question

From the question bank, with the reason each wrong option is wrong.

What is the main additional risk for a non-member client who clears through a clearing member?

  1. The CCP will charge it interest on the default fundWhy not: Clients have no default fund relationship with the CCP.
  2. Its clearing member may default and disrupt its positions - correct
  3. The client must give up its own legal ownership of its tradesWhy not: Ownership of the economic position remains with the client.
  4. The client's trades cannot be margined at allWhy not: Client trades are margined; the issue is how margin is held and protected.

A client relies on its clearing member for access, so the member's failure creates risk of delay or loss, handled through porting positions to another member.

A harder one

A client posts initial margin to its clearing member, which holds all clients' margin in a single omnibus account at the CCP. A different client of the same member defaults and its margin is insufficient. What risk does the first client face?

  1. Porting risk, which arises only if its own clearing member defaultsWhy not: Porting risk concerns the member's default; here a fellow client defaulted.
  2. Default fund assessment risk, because clients contribute to the fundWhy not: Clients do not contribute to the default fund.
  3. Fellow-customer risk from pooled client margin - correct
  4. Wrong-way risk on its own positionsWhy not: Not the risk described; the issue is pooling of client collateral.

In an omnibus account, client margin is pooled, so the loss of a defaulting client can be met from the pool, hitting the other clients. Individual segregation largely removes this fellow-customer risk.

The hardest tier

A client posts USD 10 million of initial margin to its clearing member. The member passes USD 6 million to the CCP, where it is held in an individually segregated client account, and keeps USD 4 million in its own accounts. The clearing member then defaults. The client's USD 4 million of margin is most likely to be:

  1. At risk, as an unsecured claim against the defaulted member - correct
  2. Fully protected, because the CCP guarantees all margin posted by clientsWhy not: The CCP protects only margin it holds; the amount kept by the member is not at the CCP.
  3. Returned immediately from the default fundWhy not: The default fund covers CCP losses from member defaults and is not used to return client margin held at the member.
  4. Ported automatically with the client's positions to another memberWhy not: Only the margin held at the CCP in the segregated account can be ported; the 4 million held by the member stays in the member's estate.

The USD 6 million held by the CCP in the client's segregated account can be ported with the positions. The USD 4 million held by the member is part of its estate, so the client is only an unsecured creditor for it.

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