RBA: Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties Standard 8: Settlement Finality
A central counterparty should ensure clear and certain final settlement, at a minimum by the end of the value date. Where necessary or preferable, a central counterparty should facilitate final settlement intraday or in real time.
8.1 A central counterparty's rules and procedures should clearly define the point at which settlement is final.
CME sets out in its contracts with its settlement banks the conditions under which settlement obligations are deemed final and irrevocable. These contracts state that settlement is final and irrevocable once the settlement instruction is accepted by the settlement bank. CME has stated that the provisions of the contracts relating to settlement finality are harmonised across all its settlement bank agreements. For the end-of-day settlement cycle, settlement banks have 1.5 hours to accept settlement instructions from the time at which they are communicated to the bank (see CCP Standard 8.2). For intraday and ad hoc settlement cycles, instructions must be accepted within one hour. CME has no exposure to its settlement banks in the course of settlement because its participants remain liable for the payment until it is received by CME (see CCP Standard 9).
CME does not currently use non-US settlement banks; however, its US-based settlement banks sometimes involve their foreign branches in providing settlement services. To the extent that CME were to begin using non-US settlement banks, CME would seek to mitigate any legal risks that may arise by including choice of law provisions in all settlement bank agreements, to ensure that US law governs the agreement. CME would also assess the legal risks presented by a non-US settlement bank, to gain comfort that the agreement would be enforceable and the choice of law would be effective (see CCP Standards 1.6 and 9.3). CME would not use a non-US settlement bank if the laws of the foreign jurisdiction might materially impede CME's ability to enforce its rules, or otherwise interfere.
CME has provided the Bank with a legal opinion stating that the default of a participant should not affect the finality of settlements executed by a settlement bank on behalf of that participant because US bankruptcy law provides ‘safe harbours’ for DCOs (and other financial participants in certain circumstances). These safe harbours prevent an insolvency trustee from clawing back margin payments made in connection with certain financial contracts (see CCP Standard 1.5). These provisions are intended to minimise the displacement caused in financial markets by a major bankruptcy. CME has provided the Bank with legal opinions regarding the application of the safe harbours contained in US bankruptcy law in the event of the insolvency of US-based and Australian-based clearing participants.
In addition, under Australian law, the PSNA seeks to ensure the finality of settlement for netting markets. CME has applied to the Minister to be approved as a netting market and has provided the Bank with a legal opinion regarding the application of the PSNA with respect to CME in the event of the external administration of an Australian clearing participant.
8.2 A central counterparty should ensure final settlement no later than the end of the value date, and preferably intraday or in real time, to reduce settlement risk.
CME conducts two regular settlement cycles per day – one end-of-day cycle and one intraday cycle. Only US dollar-denominated obligations related to Base products are routinely included in the intraday cycle. CME retains the right to conduct additional, ad hoc settlement cycles for any product type as necessary (see CCP Standard 9.2).
End-of-day cycles are conducted, and settlement information provided to participants, by midnight Chicago time. Settlement instructions for end-of-day cycles are sent to the participant's settlement bank by 6.00 am Chicago time the next day either by fax or by SWIFT message; CME is in the process of replacing fax confirmation with SWIFT messages for all settlement banks. Settlement banks have until 7.30 am Chicago time to accept the instruction, or notify CME of an error in the instruction. For intraday settlement cycles, settlement information is provided to participants and their settlement banks by 1.00 pm Chicago time; settlement banks have until 2.00 pm Chicago time to respond. The longer gap between receiving settlement information and issuing settlement instructions for the end-of-day cycles is to allow clearing participants that clear swaps for customers to comply with their client funds segregation obligations (as noted above, swaps are not typically included in the intraday cycle) (see CCP Standard 13).
For ad hoc settlement cycles, CME will first notify settlement banks of the cycle and then send the payment instructions; settlement banks have one hour from receiving notification of the cycle to accept the payment instruction.
8.3 A central counterparty should clearly define the point after which unsettled payments, transfer instructions or other obligations may not be revoked by a participant.
CME's contracts with its settlement banks provide that settlements are final and irrevocable once the settlement bank communicates acceptance of the payment instruction to CME. However, CME's settlement bank agreements provide for specific instances where a settlement instruction can be amended or revoked in order to correct operational errors. Erroneous settlement instructions are amended or revoked with coordination between CME, the relevant settlement bank and the affected clearing participant. CME has stated that all adjustments are documented.