February 1, 2012

Follow-up on Javelin & CME real-time IRS clearing

As a follow-on to the press release by Javelin on 2 second clearing, my story here, I spoke with Javelin, and then CME who lie at the heart of the speed results. The original story was that Javelin were managing to clear trades within 2 seconds, and my many questions revolved around the type of trades, and the method of registration. What I've found from talking to Javelin is this:

  • These were not block trades – the assumption being block trades are exempt from 'real time' processing anyway – given the time it takes to perform the allocations, and the intention of the CFTC rule making (they were IRS BTW)
  • Javelin supports complete affirmation / confirmation, no additional legal steps are needed, so no need to send via MarkitSERV
  • The API from Javelin to CME is direct and real-time

What I've learned from CME, and is more interesting is this:

  • The guarantee (default) fund at CME is around $1bn, larger than at some CCPs
  • CME prefers a large guarantee (default) fund and relatively lower IM, compared to other clearing houses which might prefer larger IM and smaller G/D F.
  • This means CME feels more insulated from default risk, and hence has less emphasis on IM calculations as a means of gatekeeping access to clearing intraday
  • CME has provided to the FCMs and Executing Brokers two methods of performing a check prior to accepting a trade for clearing
  • Type 1: is a live real-time API, where CME will ask both the FCM and EB to decide if the trade is to be accepted for clearing, the decision method is under the control and within the systems of the FCM & EB. Provided both say Yes, the trade gets cleared
  • Type 2: CME takes delegated responsibility to carry out a measurement of the incoming trade, and uses either a PV01, DV01, Gross Notional or Net Notional calculation, compared to thresholds given to CME by the FCM and EB, to automatically (and very quickly) decide whether a trade can be accepted for clearing
  • Type 3: Coming soon, a full margin recalculation approach, being built at the moment
  • Additionally, CME places emphasis on a once a day (at end of day) margin run, and settlement the following morning, rather than on repeated intraday runs. Whilst CME recalculate and monitor liabilities of it's members intraday, there will only be a margin call under exceptional circumstances

This answers the question on why Javelin and CME could announce clearing within 2 seconds – a check on PV01 or notional is easy to build and run quickly, compared to the need to fully recalculate IM across a large number of trades. A counter argument might be that without a full IM calculation you can't be sure the effect of multiple trades on the liabilities / risk of a portfolio – and this goes back to the debate on whether the CCP collects more margin from each member, so that in default, the member suffers most, or whether the guarantee (default) fund is larger, mutualising losses across the whole membership.


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