Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties – September 2014 Regulatory Priorities

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.

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 ensure that Australian representation in governance arrangements appropriately reflects the scale and nature of Australian participation. CME has in place governance arrangements to take account of the interests of clearing participants. The Bank will engage with CME to assess the adequacy of those arrangements or consider whether other arrangements to accommodate Australian interests would be appropriate.
5.Collateral
6. Margin		 The Bank expects CME to ensure that local market practices are accommodated, including considering accepting Australian government bonds as initial margin in the event that direct Australian-based participation in CME becomes material. CME has indicated that it will investigate the acceptance of Australian government bonds as initial margin during the second half of 2014. The Bank will review CME's progress by year end.

In addition, the Bank will engage with CME to understand the potential impact of the timing of routine margin calls for non-USD currencies (which currently fall outside Australian business hours) on Australian participants and on CME's exposures, and whether any changes are necessary.
12. Participant default rules and procedures The Bank expects CME to ensure that there is appropriate representation of Australian membership and regulators in default management. The Bank will engage with CME and the Commodity and Futures Trading Commission (CFTC) on how it is envisaged that the default of an Australian-based participant, or any participant with a large Australian dollar-denominated portfolio, would be managed.

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 provide adequate operational support arrangements to Australian participants, particularly during Australian market hours. CME has informed the Bank that, in the first instance, operational assistance to Australian participants would be provided from Chicago, with support also available from CME's London office. CME will also work with Australian participants to meet their training needs.

The Bank will monitor these arrangements to establish whether they appropriately meet Australian participants' needs and adequately mitigate operational risks associated with their participation.
Other Regulatory Priorities
3. Framework for the comprehensive management of risks
14. General business risk		 CME should implement an appropriate recovery and wind-down plan. The Bank will expect to conduct a review of these plans once this work has been completed. CME has informed the Bank that it is in the process of developing a recovery and wind-down plan. The CFTC has granted CME an extension to finalise its recovery and wind-down plan by 31 December 2014. This will enable CME to take into account Committee on Payment and Settlement Systems (CPSS) and the 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
6. Margin		 The Bank expects CME to finalise and implement its model testing and validation, specifically for its margin, haircut and stress-testing models. CME has informed the Bank that it will develop its model testing and validation processes during the second half of 2014.

The Bank also expects to engage with CME on the results of its model validation and testing.
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.
7. Liquidity risk The Bank expects CME to continue to enhance its liquidity risk framework, and will continue to engage with CME as it develops its formal framework. CME recently implemented a formal framework to manage and monitor liquidity risk, effective from the December quarter of 2013.
15. Custody and investment risks CME should continue to manage counterparty concentration risk in the investment of its treasury investment portfolio. CME currently invests the bulk of its cash collateral on an unsecured basis with a relatively small number of commercial bank counterparties.

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 credit to cover exposures across its link with Singapore Exchange Limited (SGX). The Bank will monitor these arrangements, with a view to revisiting this issue in 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.		 As well as the link with SGX, CME maintains two cross-margining agreements with the Fixed Income Clearing Corporation (FICC) and Options Clearing Corporation (OCC). The SGX link is the only link that is potentially of direct relevance to Australian clearing participants. The Bank expects to be notified by CME of any material increase in exposures.