Assessment of Chicago Mercantile Exchange Inc. – March 2017 1. Regulatory Priorities
CME is a Chicago-based CCP that provides clearing services for a number of products from its US operations.[1] CME operates three clearing services: an over-the-counter (OTC) Interest Rate Swap (IRS) clearing service; a ‘Base’ clearing service; and an OTC Credit Default Swap (CDS) clearing service. The Base service accounts for the majority of CME's total clearing activity and covers exchange-traded interest rate futures and options on futures, foreign exchange (FX), equity, soft commodity, energy and metal futures, and certain OTC FX forwards and commodity swaps. CME maintains separate default resources (i.e. default waterfalls) for each clearing service. Further background on CME's risk management is set out in Appendix B.2.
In Australia, CME holds a CS facility licence, which permits it to offer clearing services to Australian-based institutions as direct clearing participants for OTC interest rate derivatives (IRD) and non-Australian dollar-denominated IRD traded on the CME market or the Chicago Board of Trade (CBOT) market, for which CME permits portfolio margining with OTC IRD.[2]
Given the nature and scope of CME's current activities in Australia, the Bank does not consider it necessary at this stage to conduct a detailed assessment of CME against all of the CCP Standards. The Bank instead conducts and publishes a narrower annual assessment, focusing on CME's progress towards addressing key issues.
This section summarises actions taken by CME over 2016 to meet the Bank's regulatory priorities set out in the 2014/15 Assessment of Chicago Mercantile Exchange Inc. that was published in March 2016 (the March 2016 Assessment). This section also summarises the Bank's supervisory focus for the 2017 assessment period.
1.1 Progress against 2016 Regulatory Priorities
CME was granted a CS facility licence in September 2014. In assessing CME's licence application, the Bank conducted an initial assessment of CME's observance of the CCP Standards.[3] As part of this, the Bank determined a set of initial regulatory priorities for CME, reflecting expectations set out in the CCP Standards and by the Council of Financial Regulators (CFR) in July 2012 in its policy Ensuring Appropriate Influence for Australian Regulators over Cross-border Clearing and Settlement Facilities (CFR Regulatory Influence Policy).[4]
The Bank's 2016 regulatory priorities for CME, set out in the March 2016 Assessment, effectively carried over the Bank's initial regulatory priorities for CME.[5] Four of these priorities relate specifically to the provision of services to the Australian market, to ensure that CME's governance and operational arrangements promote stability in the Australian financial system. CME does not yet have any direct Australian-based clearing participants, and its clearing of Australian dollar-denominated OTC IRD remains relatively low. The Bank therefore has not expected that CME should make substantial progress against regulatory priorities specifically related to the provision of services to the Australian market over the assessment period. The remaining regulatory priorities are areas in which the Bank considers that CME should, as a matter of priority, make changes to its policies or make further progress on work that is already ongoing, in order to enhance its observance of the CCP Standards.
These priorities, and CME's progress towards them, are summarised in Table 1 and discussed in more detail in section 2.
| Standard | Priority | Comment |
|---|---|---|
| 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. | On hold. The Bank will engage with CME on these priorities in the event that there is material direct Australian participation in CME, or should there be a significant increase in CME's provision of services in Australian-related products. |
| 5. Collateral 6. Margin |
The Bank expects CME to ensure that local market practices are appropriately accommodated. | |
| 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. | |
| 16. Operational risk | The Bank expects CME to provide adequate operational support arrangements to Australian participants, particularly during Australian market hours. | |
| General Regulatory Priorities | ||
| 3. Framework for the comprehensive management of risks 14. General business risk |
CME should complete its work to implement its recovery and wind-down plans. The Bank will expect to conduct a review of these plans once this work has been completed, and to engage with CME regarding how its recovery and wind-down plans meet the requirements of the CCP Standards and the guidance on recovery planning set out by CPMI-IOSCO. | Mostly addressed. Expected to be fully addressed in 2017. CME has developed or enhanced its recovery and wind-down plans for each of its clearing services. Rule changes for the Base clearing service were implemented at the end of the assessment period. In 2017, CME will, where applicable, make conforming changes to the end of waterfall rules for its OTC IRS and CDS services. |
| 2. Governance 4. Credit risk 6. Margin 7. Liquidity risk |
The Bank expects CME to share the reports from the validations that it finalises during the next assessment period and to engage with the Bank on the results. The Bank will monitor CME's application and the ongoing adequacy of the Model Validation Framework, including the governance process. | Fully addressed. CME completed validations for the Standard Portfolio Analysis of Risk (SPAN) and Collateral Haircut Model during the assessment period and CME has shared these reports with the Bank. CME has also updated its governance arrangements, introducing board-level approval of the Model Validation Framework on an annual basis and of all substantive changes. |
| 5. Collateral | The Bank will continue to monitor CME's acceptance of letters of credit as collateral, including the extent of exemptions granted. | Fully addressed. CME's Collateral Policy sets a cap on the use of letters of credit as collateral. During the assessment period, CME granted no additional exemptions to these caps to clearing participants. As at end December 2016, three clearing participants held exemptions. |
| 7. Liquidity risk | The Bank expects CME to share the reports from the validations that it conducts of its liquidity stress testing model and any further validations of the Liquidity Risk Management Framework (LRMF), and to engage with the Bank on the results. The Bank expects to continue to engage with CME regarding its management and governance of liquidity risk more broadly, including how the board oversees the management of liquidity risk. | Mostly addressed. Expected to be fully addressed in 2017. CME has engaged with the Bank regarding its management and governance of liquidity risk. CME has made improvements to the governance arrangements for liquidity risk, including introducing a requirement for the LRMF to be reviewed and approved by the board-level Clearing House Oversight Committee at least annually before it is sent to the board. CME is currently conducting an independent review of the LRMF. The Bank expects CME to share the report from this review once it is finalised and engage with the Bank on the results. |
| 15. Custody and investment risks | The Bank expects CME to continue to reduce the size and concentration of its unsecured investments of cash collateral with non-government obligors. The Bank expects to engage further with CME as it implements these changes and will continue to monitor CME's cash collateral investments. The Bank will also engage CME to understand the governance arrangements regarding its investment exposures in more detail, including what oversight the board has of these exposures. | Mostly addressed. Ongoing monitoring in 2017. During the assessment period, CME has worked towards expanding its number of investment counterparties, including opening accounts at central banks. CME's governance arrangements include consideration of unsecured exposures. Going forward, the Bank will monitor the outcome of these developments on the size and concentration of its unsecured investments of cash collateral with non-government obligors. |
| 19. Financial Market Infrastructure (FMI) links | The Bank will continue to monitor CME's links, with a view to revisiting
this issue if there is a material increase in exposures. The Bank expects to be
notified by CME of any such increase in exposures. In such an event, the Bank
will also seek to engage with other relevant regulators. The Bank expects CME to provide accurate and timely data regarding its exposures across its links with other CCPs. The Bank expects that CME will not permit letters of credit as acceptable collateral for any future links. |
Fully addressed. CME now provides the Bank with data on the exposures across its links with other CCPs on a regular basis. Exposures across these links remain relatively small compared with CME's overall exposure. CME continues to accept letters of credit to cover exposures across its link with Singapore Exchange Limited (SGX) but has not accepted letters of credit for any other of its links. CME has not entered into any further links with other CCPs during the period. |
1.2 2017 Supervisory Focus
The Bank is not setting regulatory priorities for CME for 2017. The Bank's supervisory focus for 2017 will be to assess the outcome of the work planned or recently completed by CME to fully address the 2016 priorities. Specifically, the Bank will:
- review CME's enhancements to its recovery and wind-down plans
- review the results of the planned independent review of CME's LRMF once it is completed
- monitor the size and concentration of CME's unsecured investments of cash collateral with non-government obligors.
Some of this work will also overlap with the follow-up targeted review currently being conducted by CPMI and IOSCO (see section 2.3.1 for further details).
During the assessment period, CPMI and IOSCO also finalised the Cyber Resilience Guidance and consulted on draft CCP Resilience and Recovery Guidance (for more information on the reports, see section 2.3.2). Over the coming year, the Bank expects CME to consider any implications these reports have for CME.
In the event that CME has material direct Australian participation, or should there be a significant increase in CME's provision of services in Australian-related products, the Bank will expect that CME should:
- ensure that Australian representation in governance arrangements appropriately reflects the scale and nature of Australian participation
- ensure that local market practices are appropriately accommodated
- ensure that there is appropriate representation of Australian membership and regulators in default management
- provide adequate operational support arrangements to Australian participants, particularly during Australian market hours.
However, as the Bank does not currently anticipate this to occur in the near to medium term, these will not be a supervisory focus for 2017.
Footnotes
CME Group also operates a separate European clearing house, CME Clearing Europe Limited. CME and CME Clearing Europe Limited are legally separate entities; each CCP is separately capitalised and operates its own guaranty funds. [1]
The scope of CME's CS facility licence covers its Base clearing service and its OTC IRS clearing service (which encompasses all OTC IRD products). CME's CS facility licence does not permit it to offer CDS clearing in Australia and this Assessment therefore does not cover CME's CDS service. [2]
See RBA (2014), ‘Initial Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties’, September. Available at <http://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/assessments/chicago-mercantile-exchange/2014/pdf/cme-assess-2014-09.pdf>. [3]
The CFR Regulatory Influence Policy sets out a graduated framework that imposes additional requirements on cross border facilities proportional to the facility's activities in the Australian financial system. Available at <http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/cross-border-clearing>. [4]
See RBA (2016), ‘2014/15 Assessment of Chicago Mercantile Exchange Inc.’, March. Available at <http://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/assessments/chicago-mercantile-exchange/2016/pdf/cme-assessment-2016-03.pdf>. [5]