Have the risks posed by financial derivatives in the context of the current, still evolving, regulatory landscape been properly addressed? Michael Piracci, Director of PCB Compliance at Barclays, said that nowadays he has “a lot of interactions day-to-day with the clearinghouse” and overall, “it makes me feel a little more comfortable there’s a good system in place.” Piracci was the first of four presenters at a webinar titled Derivatives Regulatory Update held on March 31, 2015, sponsored by the Global Association of Risk Professionals.
Piracci began by explaining the role of the Central Counterparty (CCP) and the Futures Commission Merchants (FCM) in reducing systemic risk. The FCM is a clearing member of the derivatives clearing organization (DCO), and therefore must meet capital, risk management and operational standards set by the U.S. Commodity Futures Trading Commission’s (CFTC) and DCO. The FCM acts as the agent for market participants entering into swaps, and thus monitors customer and proprietary risk throughout the trading day on a 6/24 basis.
The FCM has a solid, proactive risk management program in place that includes stress testing at the individual and aggregate level, and review by internal or third-party auditors.
Piracci distinguished between initial margin (performance bond) and variation margin (settlement variation). The latter is “calculated for market moves… once, twice, or more often if they see the need,” he said.
The acceptable collateral policy refers to the highly liquid assets that the clearing member exchange (CME) wants. These are evaluated by a credit risk team prior to confirmation, monitored constantly, and haircuts are applied. “From the FCM’s perspective, they monitor both collateral and who is posting it,” Piracci said.
Customer protections for the cleared swaps centre around customer segregation, which is mandated by the Commodity Exchange Act, CFTC regulations, and CME clearing rules in order to protect customer funds if the clearing member suffers significant losses. One form of protection is Customer Gross Margining (CGM) and the other is legally segregated, operationally commingled (LSOC).
If an FCM defaults, the CME can minimize the impact of the default on the healthy firms and quickly transfer the positions of healthy swaps customers to one or more other FCMs with as much collateral as possible. In this way, the risks of derivatives are mitigated in the new regulatory landscape. ª
Click here to view the webinar. Piracci’s portion is slides 6 to 13.