Clearing Member Facing a Client Margin Shortfall
A clearing member (CM) of a domestic exchange clears interest rate futures for a proprietary trading client. The client is long 5,000 contracts of the 10-year IRF, with a notional of ₹2 lakh each. After a sharp yield spike, the exchange raises initial margin from 2.0% to 3.5% of notional and the client's mark-to-market loss reaches ₹1.9 crore. The client has paid only ₹1.1 crore of the ₹3.4 crore total call by the T+1 deadline and says its bank transfer will arrive next morning. The CM's risk team notes that the client's position is now 18% of the CM's total client open interest and that the CM itself has a ₹60 lakh intraday exposure to the client. The CM's agreement allows close-out on a margin shortfall, but the relationship manager wants to wait one day to avoid losing the client. The exchange's settlement guarantee covers cleared trades, not client obligations to the member.
1. What should the clearing member do on T+1, and in what order?
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The CM should not wait for the promised transfer. Under exchange clearing rules, the CM must meet its obligation to the clearing corporation; client shortfalls are the CM's responsibility. The sequence: immediately value the client's position and confirm the ₹2.3 crore shortfall; issue a formal margin call and notice of close-out; close out enough of the client's 5,000 long contracts to eliminate the shortfall and the ₹60 lakh exposure, not necessarily the whole position; deposit the required margin with the clearing corporation from its own funds if necessary; report the client default to the exchange and preserve records. Waiting one day is a credit decision, not a clearing decision: the CM would be lending to the client without collateral. The relationship manager's preference cannot override the risk limit. If the client's transfer arrives later, the CM can reinstate the position only after the account is fully margined.
2. If the client defaults, who bears the loss, and can the CM use collateral posted by other clients?
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The CM bears the loss on the client's obligation to the CM, because the exchange or clearing corporation guarantee runs to the clearing member's cleared trades, not to the member's client. The client's collateral is applied first; any shortfall is a claim against the client, but if unsecured it is a credit loss for the CM. The CM cannot use other clients' collateral: client funds must be segregated, and using one client's margin for another is a serious regulatory breach. The CM can use its own capital, and may draw on any default fund or insurance arrangement only as the rules permit. It should also check whether the client's position can be ported to another clearing member with the client's consent. The practical lesson is that concentration limits and upfront margining are the first line of defence; the clearing guarantee is not a substitute for client credit assessment.
3. What controls should the CM change to prevent a repeat?
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Set a client-level position limit as a percentage of the CM's client open interest; the 18% concentration was too high. Require upfront margin before accepting orders and stress-test the client's portfolio against a yield shock larger than the exchange's margin scenario. The CM should monitor intraday mark-to-market and stop accepting new orders once a call is unpaid. It should diversify its client base, review the credit line and require a standing authority to close out. Operationally, reconcile client collateral daily and ensure that the risk team, not the relationship manager, has the final say on a margin shortfall. Finally, document the default procedure and conduct a mock close-out so the sequence is not invented during a crisis.