«PREFACE This document describes the clearing of equity, fixed income and commodity derivatives at Nasdaq Clearing and how the role as clearing house ...»
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PREFACEThis document describes the clearing of equity, fixed income and commodity derivatives at Nasdaq Clearing and how the role as clearing house and central counterparty (CCP) is fulfilled. It provides the reader with information relating to central counterparty activities, the counterparty risks inherent to clearing operations, how these risks are managed and the financial resources available to support the clearing operations.
One of the principal functions of a clearing house is to guarantee that all contracts traded will be honored. Nasdaq Clearing becomes the counterparty in all transactions, i.e. acts as a buyer to the seller and as a seller to the buyer.
Counterparty risk is the risk that one party in a transaction will not be able to fulfill its obligations in due time. In order to ensure that the clearing house has the capacity to fulfill its obligations, it requires and receives collateral from the participating counterparties. In addition, it holds a member sponsored default fund and retains its own capital resources as well.
The ability to manage the counterparty risk is dependent on pro-active risk management, a sound legal foundation and the financial strength of the clearing house. Furthermore, rigid financial and operational requirements are applied to its members. Nasdaq Clearing also relies on advanced portfolio based margining models to determine the amount of collateral appropriate for the counterparty risks it assumes. In the event of a loss resulting from a counterparty default exceeding margins and default fund contributions of such defaulting counterparty, Nasdaq Clearing has a member sponsored default fund as well as its own funded risk-bearing capital, the latter serving as a buffer between any defaulting counterparty and all other counterparties.
The credit enhancing effects of a centralized clearing house boost market efficiency, reduce risk and allow broader client participation. Each of these features contributes to increasing liquidity in the marketplace.
CHAPTER 1 INTRODUCTION
1.1 NASDAQ OMX GROUP
1.2 NASDAQ CLEARING
1.3 BRIEF HISTORY
CHAPTER 2 MARKET PARTICIPANTS
CHAPTER 3 CLEARING MODEL
3.1 A HARMONIZED CLEARING MODEL
3.2 ACCOUNT STRUCTURE
3.5 CLEARING ACCOUNT MODEL
3.6 TECHNICAL ACCOUNTS
CHAPTER 4 PRODUCTS
4.2 FLEXIBLE DERIVATIVES
4.3 FIXED INCOME
CHAPTER 5 CLEARING OPERATIONS
5.1 DAILY CASH SETTLEMENT
5.2 PHYSICAL SETTLEMENT
5.3 EXPIRATION AND EXERCISE
CHAPTER 6 COLLATERAL MANAGEMENT
6.3 CASH OPTIMIZATION
6.4 DAILY CYCLE
CHAPTER 7 PAYMENT SYSTEM
7.1 APPROVED SETTLEMENT BANKS
7.2 CONCENTRATION BANKS
CHAPTER 8 RULES AND REGULATIONS
8.1 LEGAL FRAMEWORK
8.2 THE LEGAL STATUS OF NASDAQ OMX CLEARING AB
8.3 RULES OF NASDAQ OMX CLEARING AB
CHAPTER 9 COUNTERPARTY RISK MANAGEMENT
9.1 COUNTERPARTY RISK
9.2 CLEARING RISK MANAGEMENT DEPARTMENT
9.3 COUNTERPARTY RISK MANAGEMENT FRAMEWORK
9.4 RISK MANAGEMENT PROCEDURES
CHAPTER 10 DEFAULT MANAGEMENT
10.1 DEFAULT RULES
10.2 DEFAULT PROCESS
10.3 PORTABILITY – ASSUMPTIONS AND PROCESS
10.4 DEFAULT HISTORY
CHAPTER 11 MARGIN METHODOLOGY
11.1 CALCULATION OF RISK PARAMETERS
11.2 GENIUM RISK - THE MARGINING SUBSYSTEM
11.3 OMS-II – EQUITY DERIVATIVES MARGINING
11.4 CFM - FIXED INCOME DERIVATIVES MARGINING
11.5 SPAN - COMMODITIES DERIVATIVES MARGINING
11.6 CORRELATION BETWEEN INSTRUMENTS
11.7 MARGIN SIMULATION
11.8 MARGIN BACK-TESTING
CHAPTER 12 CCAR
12.1 CALCULATING CCAR PARAMETERS
CHAPTER 13 FINANCIAL RESOURCES
13.2 CLEARING CAPITAL
13.3 OTHER REGULATORY CAPITAL
13.4 THE DEFAULT FUND CONTRIBUTION PROCESS
INTRODUCTIONNasdaq Clearing is part of the NASDAQ OMX Group – a leading provider of trading and clearing services, exchange technology, information and public company services across six continents.
The European arm of the NASDAQ OMX Group includes the stock exchanges in Copenhagen, Stockholm, Helsinki, Reykjavik, Tallinn, Riga and Vilnius, the central securities depositories in Estonia, Latvia, Lithuania and Iceland as well as NLX, the London based interest rate derivatives market. Derivatives operations are conducted organizationally in the business area Nordic Transaction Services, which runs the stock exchanges in Stockholm, Helsinki, Copenhagen and Reykjavik, the derivatives exchanges in Stockholm and Oslo, and the derivatives clearing house Nasdaq Clearing.
1.1 NASDAQ OMX GROUP
The NASDAQ OMX Group (Nasdaq) is a leading provider of trading services, exchange technology, information and public company services across six continents. Through its diverse portfolio of solutions, Nasdaq enables customers to plan, optimize and execute their business vision with confidence, using proven technologies that provide transparency and insight for navigating today’s global capital markets. As the creator of the world’s first electronic stock market, its technology powers more than 80 marketplaces, clearing houses and central securities depositories in 50 countries, and 1 in 10 of the world's securities transactions. Nasdaq is home to more than 3,500 listed companies with a market value of over $9 trillion.
The Global Market Services business comprises six exchanges in the US, as well as eight exchanges, seven growth markets, one interest rate derivatives trading venue, four central security depositories and one derivatives clearing house in Europe, and a global commodities business that provides access to the world’s largest power derivatives market and one of Europe’s leading carbon markets. The commodities offering also includes natural gas, freight, fuel oil, iron ore and seafood.
In Europe Nasdaq has created a truly integrated multi asset offering enabling members to trade and clear cash and derivatives within equity, fixed income and commodities on the same technical platform and with one membership, one account structure and one collateral report. This enables members to gain substantial cost efficiencies and collateral efficiencies.
Nasdaq Nordic serves as a central gateway to the Nordic and Baltic financial markets, with over 700 listed companies on the main markets and the growth markets, Nasdaq First North.
1.2 NASDAQ CLEARING Nasdaq Clearing operates central counterparty clearing for derivative instruments and offers clearing of equity and index derivatives on Swedish, Norwegian, Finnish and Danish instruments; fixed income derivatives on Swedish, Norwegian and Danish underlying; commodity derivatives on Nordic power, emission rights, gas, German and Dutch power as well as freight, iron ore, fuel oil, electricity certificates and salmon derivatives and derivative contracts on the British electricity market. Nasdaq Clearing clears exchange transactions as well as OTC trades done outside the regulated markets and reported to the clearing house for clearing.
NASDAQ OMX Clearing AB is a wholly-owned subsidiary of NASDAQ OMX Nordic Oy, which itself is a wholly owned subsidiary of OMX AB (a Swedish limited liability company incorporated under the Swedish Companies Act). The clearing house is organized within the legal entity of NASDAQ OMX Clearing AB (Nasdaq Clearing). The marketplace for equity, fixed income and commodities derivatives is organized within the legal entity of NASDAQ OMX Stockholm AB.
NASDAQ OMX Oslo ASA is the legal entity responsible for the commodities derivatives marketplace.
Nasdaq Clearing is authorized and supervised as a multi-asset clearing house by the Swedish Financial Supervisory Authority, and is also authorized to conduct clearing operations via its Norwegian branch NASDAQ OMX Oslo by the Norwegian Ministry of Finance. As the first CCP in Europe, Nasdaq Clearing received authorization under Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (“EMIR”) in March 2014.
1.3 BRIEF HISTORY
1.3.1 EQUITIES AND FIXED INCOME DERIVATIVESEquities and fixed income trading in standardized derivatives began in Sweden in 1985 when OM started its operations.
OM was founded as a for-profit, privately owned derivatives exchange and was the first exchange to offer electronic trading integrated with clearing and settlement. Standardized American style call options on six Swedish stocks were the first contracts traded and Sweden thereby became the sixth country in the world to introduce standardized options trading.
In 1989, OM opened the London based derivatives exchange OM London Exchange and launched the world’s first electronic link-up of exchanges with real-time trading and clearing. In 1997, the link was extended to Oslo Børs and VPS Clearing (at that time Norsk Opsjonssentral A/S), and LEC (Linked Exchange Clearing) was established. LEC was the world’s first derivatives link for real-time trading and clearing between independent exchanges and clearing houses. In 2001, Copenhagen Stock Exchange and FUTOP Clearing Center joined the LEC cooperation. OM London Exchange was later replaced by EDX London and LCH Clearnet. The LEC agreement was terminated March 2008 and the cooperation came to an end in December 2009. From that point on, all members trade and clear directly with NASDAQ OMX Stockholm AB and approximately 50% of the members are located outside the Nordic region.
Derivatives trading in Finland started when SOM (Finnish Securities and Derivatives Exchange/Clearing house) was established in 1987 and served as an integrated exchange and clearing house for the trading and clearing of standardized derivatives instruments. In 1997, the Helsinki Stock Exchange Ltd and SOM Ltd merged to form HEX Ltd. In November 1998, HEX began cooperating with Eurex AG in derivatives trading. The most actively traded Finnish derivatives started to be traded on the Eurex trading platform and all other Finnish derivatives at OM. In 2003 OM and HEX, including the Tallinn and Riga exchanges, merged and established OMX. The acquisition of the Vilnius Stock Exchange took place in 2004.
Trading of standardized derivatives in Denmark started in 1988 when The Guarantee Fund for Danish Options and Futures began its operations as a clearing house. All derivatives instruments were traded on the Copenhagen Stock Exchange. The Guarantee Fund for Danish Options and Futures was founded in 1997 and the Guarantee Fund merged with Copenhagen Stock Exchange to form the FUTOP Clearing Center. In 2005 OMX and the Copenhagen Stock Exchange merged.
In 2006 OMX and Iceland Stock Exchange merged, and Icelandic derivatives were introduced to the market in May
2007. Since the end of 2008, Icelandic derivatives are no longer offered.
Since September 2009, Nasdaq also offers trading in Norwegian single stock and index derivatives.
Today, all trading and clearing of options and futures within the Nasdaq Nordic market is fully integrated and conducted through NASDAQ OMX Stockholm AB and NASDAQ OMX Clearing AB respectively.
1.3.2 COMMODITIES Nasdaq Commodities Europe dates back to 1991, when the Norwegian Parliament (Stortinget) resolved to deregulate the market for power trading by passing of a new energy act. As a consequence of the new legislation, Statnett Marked AS was established as a subsidiary to Statnett SF, which is the Norwegian transmission system operator (TSO). The company was set to operate the newly formed Norwegian power market.
In 1995, the financial market was established. Market participants could initially enter into transactions in futures contracts. Forward contracts were introduced in 1997.
In 1996, Norway and Sweden set up a common market for electricity and the Swedish TSO, Svenska Kraftnät, became a co-owner; the company was renamed Nord Pool ASA. Nord Pool ASA was the world’s first multinational exchange for trading and clearing of financial power contracts. Finland was integrated into the Nordic power exchange area in 1998, and Denmark followed in 1999 and 2000.
Electricity derivatives contracts with cash settlement were introduced in 2001, and Nord Pool ASA was licensed as a regulated exchange in 2002. At the same time, the clearing business was demerged into a separate company, Nord Pool Clearing ASA, which became licensed as a clearing house. The physical market activities were then demerged into a separate company, Nord Pool Spot AS, co-owned by Nord Pool ASA and the four Nordic TSOs.
The Nord Pool market established itself as the world’s largest and most efficient power market, offering unprecedented transparency and liquidity for market participants. It also helped develop other energy markets in Europe and worldwide.
Nord Pool ASA started listing European Union Allowances (EUAs) as standardized exchange contracts early 2005, thereby pioneering the exchange trading of carbon credits. Trading in project-based Carbon Emission Reduction units (CERs) was introduced in 2007, becoming the first exchange market for CERs.
In 2008, the NASDAQ OMX Group acquired Nord Pool Clearing ASA and Nord Pool Consulting AS from Nord Pool ASA.