|
CPSS Publications No. 23
(March 1997)
FOREWORD
The rapid growth of financial derivatives over the last decade has been the subject of
numerous studies by central banks and regulatory authorities and by private sector groups. Much of
this work has focused on derivative transactions privately negotiated in the over-the-counter markets.
Exchange-traded derivatives have received less attention, perhaps because the regulatory framework
for such instruments has been in place for some time, and the financial integrity of futures and options
markets has withstood some rigorous tests. Nonetheless, stresses that were evident following the
October 1987 stock market declines and the February 1995 failure of Barings underscore the need to
critically examine the financial safeguards available in the various markets across the world.
The financial integrity of futures and options markets depends on the robustness of their
arrangements for clearing and settling trades. The present report, prepared by the Ad Hoc Study
Group on Exchange-Traded Derivatives, describes and analyses clearing arrangements for exchange-traded
derivatives in the G-10 countries. The focus is on exchanges' clearing houses, which are at the
heart of their clearing arrangements and are absolutely critical to their integrity. The Study Group's
work is analytical rather than prescriptive - it discusses the sources and types of risks to clearing
houses and the risk management safeguards that clearing houses employ to manage those risks. The
report identifies several specific sources of potential vulnerability in clearing house risk management
systems: (1) inadequate financial resources to meet losses and liquidity pressures from member
defaults induced by extreme price movements; (2) a lack of mechanisms to monitor and control
intraday risks; and (3) weaknesses in money settlement arrangements, including reliance on payment
systems that entail the risk of unwinds of provisional funds transfers late in the day.
For each potential weakness identified, the report points out ways to strengthen clearing
arrangements: (1) the use of "stress testing" to identify and limit potential exposures to clearing
members from extreme price movements, and to ensure that the clearing house's financial resources
are adequate in such circumstances; (2) enhanced intraday risk management through more timely trade
matching and more frequent calculation of exposures and through the development of the capacity to
reduce intraday exposures by means of more frequent settlements; and (3) strengthening of money
settlement arrangements through the use of real-time gross settlement (RTGS) systems for payments
and securities transfers and by clarifying settlement agreements with clearing members and settlement
banks. As the report suggests, clearing houses should carefully assess whether implementation of
these steps would produce benefits, including reductions in systemic risk, that outweigh the costs.
The annexes to the report contain a wealth of information on the risk management
procedures and money settlement arrangements at selected clearing houses in the G-10 countries.
While the body of the report emphasises the similarities in approaches to risk management across
clearing houses, the details often differ, and these differences can be significant to the assessment of
the effectiveness of risk management procedures at individual clearing houses. The analytical
framework developed in the report should aid both market participants and those responsible for the
supervision and regulation of clearing houses in making informed assessments of the robustness of
individual clearing arrangements.
The Committee is indebted to Patrick Parkinson for his excellent leadership in chairing
the Study Group. Able assistance in editing and publishing the report was provided by the BIS.
| William J. McDonough, Chairman | |
| Committee on Payment and Settlement Systems | |
| President of the Federal Reserve Bank of New York | |
Annex: [Executive summary]
|