Even though it seems the clearing mandate is still so far away from implementation, many buy side firms are undertaking in-depth reviews of the specificities of Eurex Clearing’s segregation offerings. The continued delays within Europe have hindered clearing in general, however this has given buy side clients valuable time to really delve into the detail and here in this article, we hope to highlight some of those key considerations.

Choosing a Segregation Model at Eurex Clearing – key selection criteria

(see interactive tool at the bottom)

By Byron Baldwin

Even though it seems the clearing mandate is still so far away from implementation, many buy side firms are undertaking in-depth reviews of the specificities of Eurex Clearing’s segregation offerings. The continued delays within Europe have hindered clearing in general, however this has given buy side clients valuable time to really delve into the detail and here in this article, we hope to highlight some of those key considerations.

Depending upon client type, what a CCP is able to return in the event of a Clearing Member default is of vital importance, an asset manager simply posting cash as collateral will be happy to receive cash back, not so however for a pension fund who would be short on asset, requiring replacement. A pension fund needs to be assured that any non-cash assets provided as margin, will not be liquidated and returned as cash.

EMIR article 39 requires Clearing Houses and their Members to offer segregation of assets to provide protection to portfolios and their underlying collateral. However just a few paragraphs in EMIR cover segregation. CCPs are required to offer individual and Omnibus segregation at a minimum, but each CCPs segregation offering differs and provides varying advantages and disadvantages.

Eurex Clearing began developing its range of segregation services during the crisis and offers three main account structures for Registered Customers, one of which provides a unique solution which could be a crucial aid during a default. (See “Interim Participant” later).

The segregation models encapsulate combinations of the key factors such as Fellow Customer Risk, Asset Tagging, Portability in Default, and Net or Gross Margin. What follows is an overview of the key decision criteria.

There are important aspects of each account which clients should consider when making their segregation decisions. Figure 2 summarises key aspects of the various accounts.

Key considerations for a clients segregation strategy

1. Disclosure

In the original ‘futures model’ funds were almost never disclosed, their access being provided by a Clearing Member with all activities taking place within their Clearing Member’s main account. EMIR has changed this by requiring Clearing Members to offer all clients segregated accounts across listed as well as OTC derivatives. As a result listed derivative clients are also re-evaluating

their segregation strategies with some moving away from the undisclosed status. This is particularly true of those clients wishing to achieve cross margining against their OTC products. In order for cross margining to work both OTC and ETD derivatives have to be in the same account, at the same clearing broker.

To become a ‘Registered Customer’ clients are required to sign a tripartite agreement with their Clearing Member and Eurex Clearing, thus fully disclosed. This disclosure is required for the highest level of protection, an Individual Segregation Account (ISA), where that individual fund has its own account without any exposure to any other fund.

2. Margin Calculation

Individual Segregation offers a model where a single fund (or single legal entity) records positions and Eurex Clearing calculate’s margin on those positions only.

Multiple Omnibus (MOSA) offers a way to group together a collection of funds or legal entities, perhaps all under the control of a single fund manager, where each fund has it own discrete margin calculation, but also the operational efficiency of a single collateral pool. Clients in a multiple omnibus segregated account may agree with their Clearing Member to pass through collateral to effectively achieve asset protection.

A Standard Omnibus (OSA) account also provides recording of positions as required, but combines all the positions into a single net margin amount, potentially offering margin reductions. Holding your positions in an account where the margin calculation is net of all positions from all funds in the omnibus account may reduce margin requirements, but makes porting in default less likely.

3. Fellow Customer Risk

The level of fellow customer risk varies across the three account types with clients in an ISA account having no fellow customer risk exposure.

The MOSA account offers clients the opportunity to group different legal entities together in an omnibus structure, fellow customer risk in this case is limited within the group. Clearing Members may also offer this facility to clients of a specific type, e.g. two insurance companies that have similar risk profiles but it should be remembered that fellow customer risk is evident.

The OSA account is by design the segregation type within which the most exposure to fellow customers is prevalent.

4. Type of Collateral Protection

For an ISA each security is implicitly recorded against that account, belonging to the single fund or legal entity within the ISA. In the event of collateral being returned following a Clearing Members default it will be returned directly to the registered customer rather than via the Clearing Member’s insolvency administrator.

For a Multiple OSA, the default choice is to hold assets in a single collateral pool. With the agreement of your Clearing Member, clients can obtain asset protection. In a Standard OSA where the margin is net across all fund positions, it is not possible to record an asset against a specific fund, so only a funds share of the value of the assets can be protected should an account be liquidated in a default. In the event of collateral being returned following a Clearing Members default it will be released to the insolvency administrator.

The most important consideration here is for clients to determine what they want to receive back in the event of a Clearing Member default.

5. Options in a default

In an ISA account clients have three options in the event of a default;

i) Port to an alternative Clearing Member
ii) Request that positions are closed out and all collaterals are returned directly to the Registered Customer
iii) Act directly with Eurex Clearing as an interim participant. This enable clients to exchange margins directly for a minimum of five business days, allowing clients time to consider their options and, or, negotiate porting with their alternative Clearing Member(s).

In the MOSA account clients are able to port to an alternative Clearing Member with the agreement of the other group constituents and the Clearing Member. In the absence of such an agreement then a difference claim will be calculated with the subsequent actions taken (See ‘Overview on the consequences of an insolvency under Eurex Clearing’s Models’).

In practice porting the OSA account may be unlikely because all clients may be unable to agree to transfer to a single alternative Clearing Member within porting timelines. In the event that porting is unsuccessful then a difference claim will be calculated with the subsequent actions taken (See ‘Overview on the consequences of an insolvency under Eurex Clearing’s Models’).

6. Probability of porting in a default

In the event that your Clearing Member is declared to be ‘in default’, this triggers procedures to ‘port’ client portfolios to another Clearing Member. In order to achieve successful porting, a fund must firstly have pre-arranged alternative Clearing Members who are willing to accept their portfolio. Porting an ISA has the least dependency on any other client and has the most likely chance of success.

An Omnibus account however relies upon the consent of all clients in that account to move positions and collateral to the alternative Clearing Member, as well as the acceptance by the alternative Clearing Member of all of those client positions and collaterals greatly reducing the likelihood of successful porting.

The MOSA account works similarly to the OSA except that the decision to move positions and collateral to the alternative Clearing Member is solely that of the group constituents, increasing the likelihood of successful porting.

7. Capital weighting

An Individually Segregated Account (ISA) benefits from a 2% risk weighting to exposures when the positions are segregated from the Clearing Member and other funds.

Any account which isn’t an ISA (such as an Omnibus Segregated Account) receives a 4% risk weighting to exposures (Subject to legal opinions). For the 2% weighting the following conditions should be met.

i. The funds positions and assets are segregated from other funds and the Clearing Member

ii. The CCP is a Qualifying CCP, authorised under EMIR

iii. Rules and procedures to ensure portability must be in place iv. A legal opinion must be in place to show that should the Clearing Member or another fund default, no loss will occur to your portfolio

The above considerations can be used with the chart below to guide clients towards the right account model for their businesses, ranging from maximum protection of specific portfolios and assets in an ISA to the typical futures model in a Standard Omnibus account. Eurex always works with its Clearing Members and Registered Customers to help make these choices. It is also worth mentioning that all account segregation options are free of charge at Eurex, giving clients maximum freedom of choice.

Eurex Clearing are always happy to walk clients through the Default Management Process. We hope this will help them to fully understand the variables allowing them to put in place the right procedures for such a circumstance.

We recognise that the move to central clearing is a wholesale change for the OTC market and we aim to ensure that our clients are as well informed as they can be, such that their clearing strategy will be optimum.

It is vitally important that the right choices are made and even more important that client’s assets, and those of their clients are as well protected as can be.

An interactive 'Account Chooser' tool is available to use alongside this article, which will assist with choosing the most suitable account type.

Click here to try it out and if necessary send an enquiry to Eurex

This article was first published in edition 4 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to receive the latest hard copy editions as they become available.