Clearing Participant in Default
A clearing participant (CP) of Bursa Malaysia Derivatives Clearing Bhd clears for 12 clients. One client, a proprietary trading firm, holds a large short position in FCPO. At 10:30 a.m. the clearing house issues an intraday margin call of RM2.5 million to the CP. The CP has RM1.8 million of its own collateral at the clearing house and an undrawn RM1 million unsecured line from a bank. The defaulting client has RM600,000 of collateral in its own client account. Another client has a long position and RM1.5 million of collateral. The CP asks the clearing house to net the defaulting client's short position against the other client's long position and to use the other client's collateral to cover the shortfall, arguing that all clients are ultimately customers of the CP. The clearing house must decide whether to declare the CP in default.
1. Assess the CP's request to net positions and use another client's collateral.
Read the worked answer
The clearing house's contract is with the CP, not with the CP's clients. Client positions must be kept separate and margined separately unless there is a legally enforceable netting arrangement that the clearing house recognises. A long position of one client cannot be used to offset the short position of another client merely because both are customers of the same CP. The collateral in each client account is held for that client and cannot be used to meet another client's obligation. Using the other client's RM1.5 million would breach client asset segregation and the CP's duties as a holder of client money. The CP must meet the clearing house call from its own resources, including its own collateral and any committed credit line. The CP's argument that 'all clients are ultimately customers' ignores the legal segregation of client accounts and the clearing house's own rules.
2. What default management steps should the clearing house take and in what order?
Read the worked answer
The clearing house should first confirm that the call is due and that the deadline has passed without payment. It should issue a formal notice to the CP and give any short additional cure period required by its rules. If the CP still fails, the clearing house may declare the CP in default. It should then close out or transfer the defaulting positions in an orderly way, apply the CP's own collateral, and draw on any default fund or guarantee arrangements in the order set by its rules. It should assess the resulting shortfall and make any further calls permitted by the rules. Throughout, it should keep other clearing participants informed as required, preserve records and notify the SC and Bursa Malaysia. The objective is to contain systemic risk without using one client's assets to pay another client's debt.
3. What should the CP have done earlier to manage the risk, and what regulatory notifications arise?
Read the worked answer
The CP should have monitored the client's position against its margin and concentration limits, collected margin promptly and stress-tested the account against a plausible price move. It should have maintained enough own liquidity and committed credit to meet intraday calls, rather than relying on an undrawn unsecured line. It should also have kept client collateral segregated and reconciled. Once a default is likely, the CP should notify its board, compliance and the clearing house immediately. If it cannot meet its clearing obligation, it should notify the SC and Bursa Malaysia under the applicable rules and cooperate with the default management process. It should also communicate accurately with affected clients, without disclosing another client's confidential position or collateral.