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Assessment of Chicago Mercantile Exchange Inc. Against the Financial Stability Standards for Central Counterparties

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Assessment of Chicago Mercantile Exchange Inc. Against the Financial Stability Standards for Central Counterparties Attachment 2: Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties September 2014 The Chicago Mercantile Exchange Inc. (CME) has applied for a licence to operate a clearing and settlement (CS) facility in Australia. Accordingly, under the Corporations Act 2001, CME is required to comply with the Financial Stability Standards for Central Counterparties (CCP Standards). The Reserve Bank of Australia (the Bank) has identified several areas in which it expects CME to conduct further work to ensure that it fully observes the CCP Standards, should a licence be granted. Some of these expectations arise from the Council of Financial Regulators’ (CFR) policy Ensuring Appropriate Influence for Australian Regulators over Cross-border Clearing and Settlement Facilities (the CFR influence policy), which is embedded in the CCP Standards. The Bank does not expect that CME will be systemically important to Australia or have a strong connection to the Australian financial system in the near to medium term. Therefore, at least initially, CME would be subject only to the foundational requirements of the CFR influence policy. The Bank has developed a set of expectations related to CME’s provision of services to the Australian market, which ensure CME’s operational and governance arrangements promote stability in the Australian financial system. The Bank’s other expectations relate to CME’s observance of the CCP Standards more broadly, and reflect areas where the Bank considers that CME should make changes to its policies, or progress as a matter of priority, work that is already ongoing. The Bank’s expectations are reflected in a set of regulatory priorities, summarised below. ASSESSMENT OF CME AGAINST THE FINANCIAL STABILITY STANDARDS FOR CENTRAL COUNTERPARTIES | SEPTEMBER 2014 1 The Reserve Bank of Australia’s Regulatory Priorities for CME Standard Recommendation Comments Regulatory Priorities Specifically Related to CME’s Provision of Services to the Australian Market 2. Governance The Bank expects CME to CME has in place governance arrangements to take account of the ensure that Australian interests of clearing participants. The Bank will engage with CME to representation in governance assess the adequacy of those arrangements or consider whether arrangements appropriately other arrangements to accommodate Australian interests would be reflects the scale and nature of appropriate. Australian participation. 5.Collateral The Bank expects CME to CME has indicated that it will investigate the acceptance of Australian 6. Margin ensure that local market government bonds as initial margin during the second half of 2014. practices are accommodated, The Bank will review CME’s progress by year end. including considering accepting In addition, the Bank will engage with CME to understand the Australian government bonds as potential impact of the timing of routine margin calls for non-USD initial margin in the event that currencies (which currently fall outside Australian business hours) on direct Australian-based Australian participants and on CME’s exposures, and whether any participation in CME becomes changes are necessary. material. 12. Participant default The Bank expects CME to The Bank will engage with CME and the Commodity and Futures rules and procedures ensure that there is appropriate Trading Commission (CFTC) on how it is envisaged that the default representation of Australian of an Australian-based participant, or any participant with a large membership and regulators in Australian dollar-denominated portfolio, would be managed. default management. It is expected that such dialogue will clarify the roles of Australian- based participants in this process and the nature of cooperation with the Australian regulators. 16. Operational risk The Bank expects CME to CME has informed the Bank that, in the first instance, operational provide adequate operational assistance to Australian participants would be provided from Chicago, support arrangements to with support also available from CME’s London office. CME will also Australian participants, work with Australian participants to meet their training needs. particularly during Australian The Bank will monitor these arrangements to establish whether they market hours. appropriately meet Australian participants’ needs and adequately mitigate operational risks associated with their participation. Other Regulatory Priorities 3. Framework for the CME should implement an CME has informed the Bank that it is in the process of developing a comprehensive appropriate recovery and wind- recovery and wind-down plan. The CFTC has granted CME an management of risks down plan. The Bank will expect extension to finalise its recovery and wind-down plan by 14. General business to conduct a review of these 31 December 2014. This will enable CME to take into account plans once this work has been Committee on Payment and Settlement Systems (CPSS) and the risk completed. Technical Committee of the International Organization of Securities Commissions (IOSCO) guidelines on recovery, which are expected to be finalised in the second half of 2014. One aspect the Bank expects CME to address in its recovery plan is how it plans to raise additional equity if required. 4. Credit risk The Bank expects CME to CME has informed the Bank that it will develop its model testing and finalise and implement its model validation processes during the second half of 2014. 6. Margin testing and validation, specifically The Bank also expects to engage with CME on the results of its for its margin, haircut and stress- model validation and testing. testing models. 5. Collateral CME has recently made changes to its collateral policy to reduce the scope of its acceptance of letters of credit as collateral. The Bank will monitor these arrangements, including through the provision of data from CME on the use of letters of credit as collateral. 2 RESERVE BANK OF AUSTRALIA Standard Recommendation Comments 7. Liquidity risk The Bank expects CME to CME recently implemented a formal framework to manage and continue to enhance its liquidity monitor liquidity risk, effective from the December quarter of 2013. risk framework, and will continue to engage with CME as it develops its formal framework. 15. Custody and CME should continue to manage CME currently invests the bulk of its cash collateral on an unsecured investment risks counterparty concentration risk in basis with a relatively small number of commercial bank the investment of its treasury counterparties. investment portfolio. CME has informed the Bank that it is working to diversify the number of counterparties for its investment of cash collateral and to make such investments on a secured basis. The Bank will continue to monitor CME’s planned diversification program. 19. FMI links CME currently accepts letters of As well as the link with SGX, CME maintains two cross-margining credit to cover exposures across agreements with the Fixed Income Clearing Corporation (FICC) and its link with Singapore Exchange Options Clearing Corporation (OCC). The SGX link is the only link Limited (SGX). The Bank will that is potentially of direct relevance to Australian clearing monitor these arrangements, with participants. The Bank expects to be notified by CME of any material a view to revisiting this issue in increase in exposures. 12 months or if there is a material increase in exposures across the link. The Bank expects that CME will not permit letters of credit as acceptable collateral for any future links. At the same time, the Bank will engage with CME on other aspects of its risk management of links, including the extent to which stressed market conditions are taken into account when calibrating collateral requirements for exposures to linked CCPs. ASSESSMENT OF CME AGAINST THE FINANCIAL STABILITY STANDARDS FOR CENTRAL COUNTERPARTIES | SEPTEMBER 2014 3 The CCP Standards are made up of 21 headline standards, each of which is accompanied by a number of more detailed sub-standards. In assessing whether a facility has met each of the CCP Standards, the Reserve Bank takes into account associated guidance.1 The following provides details of how CME observes each of the CCP Standards (including sub-standards). Standard 1: Legal basis A central counterparty should have a well-founded, clear, transparent and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions. 1.1 A central counterparty should be a legal entity which is separate from other entities that may expose it to risks unrelated to those arising from its function as a central counterparty. CME is a wholly owned subsidiary of CME Group Inc. (CME Group), and is organised under the laws of Delaware in the United States of America (US). CME Group is a publicly traded company listed on the NASDAQ Global Select Market. CME has numerous operating divisions which are part of the same legal entity, including the CME Clearing Division, which provides central counterparty (CCP) services. CME also provides exchange and exchange-related services (for futures and options on futures) in its role as a Designated Contract Market (DCM), and operates a Swap Data Repository (SDR) (trade repository, registered with the Commodity and Futures Trading Commission (CFTC)) and a Swap Execution Facility (SEF) (a trading platform for over-the-counter (OTC) products provisionally registered with the CFTC). In its role as a CCP, CME clears a number of exchange-traded derivatives and OTC derivatives. CME provides clearing services to each of the four CME Group derivatives exchanges, and two external exchanges.2 In OTC markets, CME offers CCP services for interest rate swaps (IRS) and credit default swaps (CDS), as well as certain commodity and foreign exchange products. CME has adopted policies and procedures to address conflicts of interest arising between its functional areas (see CCP Standard 2.9). Additionally, CME has separated its CME Clearing Division – and established Risk Committees to oversee the Clearing Division (see CCP Standard 2.2) – to ensure that CME’s DCM activities do not compromise its CCP activities.
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