RBA: Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties Standard 17: Access and Participation Requirements

Participation requirements for access to CME's services are based on risk-related principles, designed to ensure that clearing participants are of suitable financial standing and have sufficient operational capabilities to conduct business.

Overview of participation

CME offers a number of different participation categories, depending on the type of participation sought. To clear exchange-traded futures and/or options on futures, a firm must become a clearing participant of the relevant CME Group exchange (i.e. CME, CBOT or NYMEX/COMEX).

Exchange clearing participants may also be eligible to clear non-IRS and non-CDS OTC derivatives products (i.e. cleared swaps and forwards), subject to meeting certain additional requirements (see below). CME Exchange Clearing Members are required to seek separate CCP and CHRC approval to be eligible to clear FX OTC. Separate criteria are evaluated as part of the risk review in order for CME Group exchange clearing participants to clear other classes of non-IRS and non-CDS OTC products, with eligibility to clear each class of product linked to direct participation in the relevant exchange. For example, CBOT, NYMEX and COMEX clearing participants are eligible to clear ethanol and grain swaps, energy OTC products and metal forwards, respectively, subject to satisfying Risk Management Department that positions in these OTC products and associated accounts can be managed effectively.

CME also maintains a category of participation for participants that only clear OTC derivatives. As noted above, all participants that clear OTC products are subject to specific risk and operational requirements.

Based on the products for which CME is seeking a CS facility licence, Australian clearing participants would be eligible to apply for the following categories of participation: CME Clearing (for eurodollar products); CBOT Clearing (for US Treasury futures); and IRS Clearing.

A summary of participation categories is published on CME Group's website.^[1]

Participation requirements

Clearing participant applicants must meet requirements stipulated by CME. At a high level, clearing participants must satisfy requirements in areas including: fiscal and moral integrity; capital; Guaranty Fund contributions; operational and technological capabilities; OTC products; notification and financial reporting; overseas clearing participation (if applicable); and disaster recovery and business continuity. CME also maintains the right to impose additional requirements on clearing participants specific to the products they would propose to clear.

Regardless of the products traded or type of entity, all approved clearing participants may access the same level of clearing services. However, a participant may be required to meet additional clearing participation requirements depending on its type. Participants that are authorised banks are subject to different clearing participation requirements to non-banks (e.g. relating to capital). Further, within the clearing participation category, each of the exchanges offers separate and distinct clearing participation options depending on the type of participant, which include corporations, hedge funds, banks and FCMs. For example, hedge funds are required to have a minimum amount of capital under management, are subject to additional reporting requirements and must maintain separate clearing accounts for each fund for which it clears.

A number of CME's clearing participation requirements are elaborated below.

i. Fiscal and moral integrity

CME requires that clearing participants demonstrate ‘fiscal and moral integrity’ to justify the CCP's assumption of the risks inherent in clearing its trades. This includes the clearing participant: being a registered corporation, partnership or cooperative association as defined under US law (see below for further requirements applying to clearing participants incorporated in non-US jurisdictions); assuming responsibility for all trading activity routed through it by customers; and maintaining a ‘good standing’ under each applicable regulatory regime to which it is subject.

ii. Capital

CME imposes minimum capital requirements on clearing participants, which are determined based on the asset class cleared (e.g. Base or IRS) and the classification of the participant (i.e. non-bank or bank). For non-bank clearing participants, capital is defined as Adjusted Net Capital, calculated in accordance with CFTC regulations. For bank clearing participants, capital is defined as Tier 1 Capital, which in turn is defined in accordance with regulations applicable to the bank clearing participant.

Non-bank participants clearing only exchange-traded Base products are required to have US$5 million in capital, or US$5 billion if the participant is a bank. Participants clearing OTC-traded Base products must have at least US$50 million in capital, regardless of the type of entity. All IRS and CDS clearing participants must hold capital equal to: 20 per cent of their aggregate margin across both proprietary and customer accounts for IRS and CDS, subject to a minimum of US$50 million.

If CFTC or SEC capital requirements for a clearing participant exceed CME's requirements, CME would hold the clearing participant to the higher requirement.

The CHRC, IRSRC, CDSRC or CME could prescribe additional capital requirements or grant exemptions.

iii. Guaranty Fund deposit

Clearing participants must maintain a Guaranty Fund deposit with CME. The size of the deposit depends on the risk the clearing participant presents to CME and the products the participant clears.

The minimum Guaranty Fund deposit required for each type of product is:

• Exchange-traded futures and options is US$500 000 or its proportionate share of the aggregate Guaranty Fund deposit.
• Exchange-traded futures and options and OTC products (excluding IRS and CDS) is US$2.5 million or its proportionate share of the aggregate Guaranty Fund deposit.
• IRS is the greater of US$50 million or the participant's proportionate share of the two largest IRS clearing participant's losses.
• CDS is the greater of US$50 million or the participant's proportionate share of the two largest CDS clearing participant's losses.

See CCP Standard 4 for further details on the calculation of the Guaranty Funds.

iv. Requirements for clearing OTC products

Participants clearing OTC IRS or CDS are subject to additional requirements beyond those that apply for participants clearing only exchange-traded products. These participants must agree to guarantee and assume responsibility for all OTC derivatives trading activity submitted for clearing by customers. In addition, participants must have appropriate risk management and operational arrangements in place to support their OTC clearing activity. This is to ensure that clearing participants are able to implement CME's default management procedures in a timely manner. IRS and CDS clearing participants are also required to participate in default management drills. See CCP Standard 12 for more information on CME's default management procedures.

Additional information on requirements pertaining to OTC clearing participants is outlined in the CME Rulebook.^[2]

v. Notification requirements and financial reporting

Clearing participants are subject to certain notification requirements. Key events that participants must notify CME of include: failure to meet capital requirements; failure to maintain trading books and records; ownership changes; failure to meet regulatory requirements; and insolvency. Non-bank clearing participants are required to submit monthly financial reports and annual certified financial statements. Bank clearing participants are required to file with CME any financial reports that are filed with their primary banking regulator, including annual certified financial statements.

vi. Clearing participants in non-US jurisdictions

Clearing participants incorporated in non-US jurisdictions are required to be subject to a legal and insolvency regime acceptable to CME (see CCP Standard 1). CME staff and the Legal Department review relevant legal opinions and advise the appropriate Risk Committee on the content of such opinions and any potential issues prior to the clearing participant's approval.

vii. Disaster recovery and business continuity management

Clearing participants are required to have disaster recovery and business continuity policies and procedures to ensure certain basic operational functions would continue in the event of significant internal or external interruptions to operations. Depending on the type of participant, they may be required to have procedures that would enable them to continue operations during periods of stress or to transfer customer accounts to another participant. Clearing participants are required to: conduct periodic testing of disaster recovery and business continuity plans; have duplication of critical systems at backup sites; and periodically back up critical information.

Additional information on disaster recovery and business continuity requirements is outlined in Rule 983.

viii. Other requirements

Clearing participants must have written risk management plans, policies to comply with anti-money laundering requirements and comply with the operational and risk management standards of the CFTC and CME. In addition, clearing participants must hold the relevant exchange licences to clear contracts listed on CME Group exchanges. For participants clearing only OTC products, an exchange-licence-equivalent deposit of US$5 million is required to be deposited with CME.

Clearing participants with capital of less than US$300 million are required to obtain written agreement from any entity or person owning 5 per cent or more of the equity securities of the participant to guarantee all obligations of the clearing participant from proprietary trading accounts.

Application process

As part of the application process, prospective clearing participants are required to submit a range of documents to CME and submit to an on-site review by CME staff. Following receipt of a completed application, CME will notify existing clearing participants during a 20-day posting period. Any concerns raised by an existing clearing participant regarding an application would be brought to the attention of the appropriate Risk Committee, which (as discussed below) is ultimately responsible for approving applications, during its review of the clearing participant applicant.

Clearing applications are reviewed by the Financial and Regulatory Surveillance Department. Staff will investigate the applicant's qualifications, which may include a review of the books and records of the applicant. Once all documentation has been submitted by a prospective applicant, the review process takes approximately four to six weeks.

Once reviewed, applications are presented by name to the relevant Risk Committee for approval by a majority vote. In the situation where a potential conflict of interest may arise (e.g. a Risk Committee member is associated with the applicant), the relevant Risk Committee member(s) do not participate in any discussion or voting regarding the applicant.

The relevant Risk Committee may reject an application if it believes the applicant does not meet the participation requirements; for example, if it is not satisfied the applicant demonstrates the required level of fiscal and moral integrity (see above). If unsuccessful, applicants may appeal the decision of the Risk Committee to the Board within 10 days of the notice of rejection. The Board, by majority vote, may overturn the Risk Committee's decision if it is satisfied that the decision was arbitrary, capricious or an abuse of discretion.

A list of all relevant application forms, instructions for completion and submission, and current clearing participants is maintained on CME Group's website.

Indirect participation

Indirect participation is possible through CME's customer clearing models. In order to clear for customers, clearing participants must be a registered FCM; FCMs offering indirect participation are subject to higher operational requirements (see CCP Standard 17.2). CME does not impose restrictions on customer eligibility; requirements for customers are at the discretion of the clearing participant so long as they comply with CFTC regulations. See CCP Standard 18 for details on CME's customer clearing models.

CME's participation requirements are designed to mitigate the risks that clearing participants pose to CME. At a high level, as outlined in CCP Standard 17.1, CME permits access to those clearing participants that demonstrate the highest levels of fiscal and moral integrity.

Capital requirements imposed by CME aim to ensure that participants are able to withstand unexpected losses (see CCP Standard 17.1). By varying minimum capital and other participation requirements according to product characteristics, CME aims to ensure that requirements have the least restrictive impact on access that circumstances permit. In addition, capital requirements for IRS and CDS clearing participants are proportional to the initial margin held by CME, reflecting the risk the participant poses to CME.

Reporting and operational requirements seek to ensure CME has access to timely information about clearing participants and that participants are able to monitor and manage the risks they pose to CME. Additional operational requirements for IRS and CDS clearing participants focus on the participants' ability to engage in the default management procedures.

FCMs that offer indirect participation to customers are subject to higher operational requirements. This reflects the higher operational burden of monitoring customer accounts and the importance of CME being able to access timely customer information in order to port the customers if the FCM defaults.

CME has outlined requirements for clearing participants in the publicly available Clearing Membership Handbook,^[3] OTC Derivatives Clearing Membership Handbook,^[4] Summary of Requirements for Clearing Membership,^[5] CME Rulebook and on its website more generally.

Monitoring compliance

CME monitors compliance with participation requirements on a regular basis. Under the CME Rulebook, a clearing participant must notify CME if it:

• fails to meet capital requirements
• fails to maintain current books and records
• fails to meet accounting, reporting or financial requirements
• has insolvency, or similar proceedings, brought against it.

The Financial and Regulatory Surveillance Department monitors clearing participant compliance with financial requirements. The Department conducts semi-monthly analysis of clearing participant reports of investments, and daily monitoring of customer segregated, secured and cleared swap balances with the aim of checking compliance with segregation requirements for customer funds and reviewing any material inconsistencies. The Department also monitors monthly submissions of financial statements from clearing participants including balance sheets, capital computation, net income statements and segregation, and cleared swaps customer statements. In addition, the Department reviews annual submissions of certified independent public accounting reports and accountants' reports on material developments.

Bank clearing participants are monitored via financial reports filed with the participant's home banking regulator; at a minimum these must be submitted quarterly. Non-bank clearing participants are required to submit monthly financial reports to the Financial and Regulatory Surveillance Department. These financial reports inform CME's internal risk rating of participants and can be used to identify participants for inclusion on the Watch List and Weak List (see CCP Standard 4.2).

The Risk Management Department reviews participants' compliance with risk management requirements, in accordance with Rule 982, at least biennially. For all clearing participants this review includes risk management capabilities. As part of the review process, CME conducts an on-site visit of the clearing participant to assess its risk management capabilities, risk management systems and reporting. In assessing the clearing participant's compliance with risk management requirements, CME will take into consideration the outcomes from its on-site visit and the participant's response to a risk review questionnaire circulated before the visit.

Suspension and exit of a participant

The CME Rulebook outlines the actions CME can take if a clearing participant no longer meets the relevant participation requirements, including: increased margin; additional capital or other financial requirements; position limits; issuing a notice to cease and desist from the conduct in question; and the liquidation or transfer of positions. These actions would be approved by the CHRC (if relating to a clearing issue) or the Business Conduct Committee^[6] (if relating to an exchange issue), by a majority vote. The Business Conduct Committee may also refer a matter to the Board if it believes the matter might warrant a penalty in excess of its own authority.

If a clearing participant fails to meet participation requirements, or if its continued participation presents an unacceptable risk to CME, the clearing participant may have part, or all, of its participation privileges suspended by the CHRC or the Business Conduct Committee, in accordance with the CME Rulebook. This decision must be approved by a majority vote, and, for such decisions made by the CHRC, is also subject to approval by any two of the following: CEO; COO; Chairman; President; Chairman of the CHRC; and the Clearing President.

The Clearing President also has the power to declare an emergency financial situation where a clearing participant threatens the integrity of CME. The procedures and powers relating to an emergency financial situation are detailed in CCP Standard 4.3.

A suspended or expelled clearing participant would be required to liquidate and/or port its (and its customers') positions. The clearing participant would generally be permitted to manage the wind-down of its positions; however, CME and/or the CHRC reserve the right to impose orders, pursuant to Rule 979. Either CME or the clearing participant, as applicable, would move the participant's positions to another clearing participant, or otherwise liquidate them.

Once a clearing participant has been suspended or expelled, the participant is not entitled to any of the privileges of participation including: access to any trading floors or clearing platforms owned or controlled by CME Group; member trading fees and rates; and any applicable cross-exchange trading privileges. A clearing participant that has been expelled must relinquish its licence to any of the exchanges owned or controlled by CME Group within 30 days of the date of expulsion.

Under certain conditions, suspended clearing participants may appeal a final decision of the CHRC or the Business Conduct Committee to a hearing panel of the Board (the Appellate Board). The Appellate Board may overturn the decision of the CHRC or Business Conduct Committee, by a majority vote, if the decision was concluded to be arbitrary, in excess of the Committee's authority, or based on a clearly erroneous interpretation of the CME Rulebook.