On January 30, 2020, Japan Securities Clearing Corporation (JSCC) announced the revision of the Loss Compensation Framework for Listed Derivatives, scheduled to be implemented in July 2020.
The major point of the revision is the setting of a cap on the cash call for Clearing Participants (Special Clearing Charge), which is one of the financial resources (Loss Compensation Financial Resources*1) to cover losses that may arise in association with the liquidation of positions and collateral of a defaulter, upon a Clearing Participant’s default. Moreover, a resolution scheme will be established to allow an early termination of position in any required issue/quantity (Partial Tear-up*2) when the Loss Compensation Financial Resources are unlikely to be sufficient to cover losses arising from a Clearing Participant’s default.
*1 Loss Compensation Financial Resources comprise of pre-funded financial resources, including various collaterals such as Margin and Clearing Fund, which Clearing Participants deposit ordinarily in accordance with the status of held positions and other conditions, CCP’s reserves (so-called Skin-in-the-Game) and loss compensation from market operators, as well as ex post facto assessments from Clearing Participants (Special Clearing Charge).
*2 Partial Tear-up specifically refers to the following two actions:
(i) To make an early termination of the positions held by the defaulter which remains unliquidated (Subject Positions); and
(ii) For those Clearing Participants holding offsetting positions to the Subject Positions (Offsetting Positions), to first allocate the relevant Subject Positions on a pro-rata basis according to the quantity of the Offsetting Positions held by the relevant Clearing Participants (Allocated Positions), and to then make an early termination of the Offsetting Positions and the Allocated Positions.
As a background to this revision, amongst the recent trend in international regulations and discussions related to recovery and default management at CCPs, it is considered important to be able to predict the amount of ex post facto assessment that a Clearing Participant may be required to contribute at the time of a Clearing Participant’s default, especially for Listed Derivatives trading which has a relatively high exposure level. In light of the Clearing Participants’ demands for the revision, JSCC established a Working Group (WG) in September 2019 (comprised of 15 domestic and foreign Clearing Participants as WG members, and also inviting the Financial Services Agency, the Bank of Japan, FIA and FIA Japan as observers) and had intensive discussions over several months. The revision of the framework is a direct result of the WG discussions.
In parallel to this revision, JSCC also adopted more conservative practices*3for various collateral calculation methods (Margin and Clearing Fund) for Listed Derivatives, which are broadly adopted by major overseas CCPs from the viewpoint of strengthening pre-funded financial resources and to suppress the Clearing Participants’ burden upon a Clearing Participant’s default, as well as to comprehensively reinforce JSCC’s risk management framework.
*3 Some of the major points are: (1) Margin - as an assumption for calculation, the holding period (price fluctuation risk) will change to 2 days (currently 1 day), and the lookback period will be extended to 5 years (currently up to 2 years); and (2) Clearing Fund – the assumed default scenario will change from “simultaneous default of top 1 firm + 5 firms with lowest financial strength” to “simultaneous default of top 2 firms.”
Masaki Shizuka, Director and Senior Executive Vice President of JSCC, made the following comments: “These revisions, including setting a cap on the Special Clearing Charge, will make it easier for Clearing Participants to predict their potential contribution upon a Clearing Participant’s default. Moreover, to make the margin calculation method more conservative, margins will be raised to a certain level, and together with the reinforcement of the Defaulter-Pay principle (i.e. the concept of covering losses arising from a default with the defaulter’s contributions), Clearing Participants’ contributions arising from a Clearing Participant’s default will be subdued in comparison to what they are under the current Loss Compensation Framework. Through these efforts, we expect to maintain international confidence from market participants and that many domestic and international Clearing Participants will continue to feel comfortable participating in JSCC.”