SFE Clearing Guarantee and Capital Adequacy, Mutualisation of Risk

SFE Clearing Guarantee and Capital Adequacy

Through the novation process SFE Clearing becomes the principal to all trades and liable to perform against all contracts to which it is a party and effectively 'guarantees' performance to other Clearing Participants. Novation and thus the clearing guarantee become effective on registration of the contract between a buyer and seller.

This exposure is then managed and the clearing guarantee put in place in a number of ways. Firstly this is achieved by the collection of the various margins as discussed in an earlier section. The collection of these moneys protects against extreme price movements and prevents participants from accumulating large unpaid losses that could potentially impact on the financial position of other market users. This is a key component that differentiates exchange-traded markets from over-the-counter (OTC) markets, where such a strict margining regime is not in place.

The second is the setting up of a Clearing Guarantee Fund for use in the event of default of one or more Clearing Participants. The Clearing Guarantee Fund represents a significant component of the overall capital adequacy of SFE Clearing, and the amount and composition of both are aspects of the SFE business that are continually being reviewed.

In particular, the adequacy of the Clearing Guarantee Fund is regularly assessed by comparing it with the Clearing Participants’ potential loss exposures as determined by the Board-approved stress testing process. SFE Clearing's stress testing is performed on a daily basis against each Clearing Participant's portfolio of major contract open positions and the methodology calculates the potential loss exposures for all Clearing Participants over a number of varied scenarios constructed to encapsulate a range of extreme, but plausible, movements in the major contracts. The potential losses are net of any and all margins currently held in respect of each Participant's relevant account and therefore represent the potential loss SFE Clearing would be exposed to under the given scenario if any Clearing Participant(s) were to default.

SFE Clearing has assigned each Clearing Participant a Stress Test Exposure Limit (STEL) on the potential losses incurred in the stress testing process based on their respective credit rating and reported NTA. Each Participant's STEL is compared daily with the potential losses generated by the stress testing process and those Clearing Participants that exceed their limits are required to deposit additional Initial Margins within a prescribed time. The STEL are reviewed and revised as required each month in line with any changes in the Clearing Participants’ NTA.

When looking at the SFE's capital adequacy the main objectives include:

  • To establish how much capital the SFE Group requires to cover its risk profile.
  • To establish an appropriate composition of the required capital between group equity, participant commitment and third party insurance.
  • To establish how the capital of the group should be allocated between the various business activities.
  • To identify how SFE should effect any changes to its capital structure recommended as a result of ongoing review.

Such reviews may include:

  1. A statistical analysis of the hypothetical losses in excess of margins revealed by the existing 'stress testing' methodology. The aim is to draw a conclusion as to the likelihood of the guarantee fund being fully utilised.
  2. A comparison of the SFE Clearing guarantee fund with other international clearing entities.
  3. A benchmarking study of SFE Clearing's controls and procedures against industry 'best practice' as promulgated by overseas bodies such as Bank for International Settlements (BIS), International Organisation of Securities Commissions, (IOSCO), Futures Industry Association (FIA).

On the basis of its most recent review in 2007, the Board approved a further increase in insurance cover and Clearing Participant Commitment contributions to the Clearing Guarantee Fund.

The current structure of the Clearing Guarantee Fund is:

Available SFE Clearing capital $30 million
Clearing Participants' Commitments $120 million
Insurance cover $150 million
Subordinated Debt $70 million
Clearing Participant Secondary Commitment $30 million
  $400 million

Mutualisation of Risk

A clearing and settlement provider mutualises its risk exposure by spreading the position risk of a clearing participant defaulting, between it and all other participants. This is accomplished by Clearing Participants providing a financial commitment to a risk guarantee.

This guarantee is known as the SFE Clearing Guarantee and is one of the major components of the SFE's capital adequacy.