Segregation and Bankruptcy

Slide 1

FCM 1.20 Account Segregation – Operations Considerations

FIA Segregation Sub-committee meeting with CFTC

Washington, 15 September 2010

Agenda

Agenda

♦Introduction & Overview 2:00 - 2:10

♦Key areas of consideration (1) 2:10 – 2:45

    –Account Structures

    –Omnibus accounts

    –Reconciliations

♦Key areas of consideration (2) 2:45 – 3:20

    –Cash Flows with Clearing House

    –Cash Flows with Customers

♦Summary Considerations – Operations and Systemic Risk 3:20 – 3:35

♦Current Financial Safeguards 3:35 – 3:45

♦Wrap Up 3:45 – 4:00

Direct Accounts: Current State

Direct Accounts: Current State

Assets Held

Externally

US FCM

FCM Overall Segregation Environment

3rd Party

customer

Clearing House

Assets

Liabilities

FCM Omni Client Clearing Account (Margin & Positions)

Clearing House Omni

Securities

Cash

Positions

1

1

FCM Agents

Customer Seg Account

Bank Account

FCM Settlement Account

Bank Account

Trust Account

Investment Account

1 customer with 1 CCP

Fed & DTCC Box

Collateral Account

Number of Reconciliations

Incremental per customer

Incremental per CCP

8

0

3

Reconciliations

P/L Account

Commission& Fees

3 customers with 2 CCPs

Number of Reconciliations

11

2

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Direct Accounts – CCP & FCM Segregation: Possible Future State

Direct Accounts – CCP & FCM Segregation: Possible Future State

Assets Held

Externally

FCM Overall Segregation Environment

Assets

Liabilities

3rd Party

customer

Clearing House

Customer Clearing A/C (Margin & Positions)

Clearing House Omni

Assets

Securities

Cash

Customer A/c’s

Positions

FCM Agents

FCM customer Segregation Environment

Customer Trust A/c

Customer Seg A/c

Customer Bank Account

Customer A/c by CCP (positions & cash)

Customer Margin A/C

1

Customer Investment Account

Customer Fed Box

Customer DTCC Box

Customer Collateral Account

Customer Commission A/c

Clearing House

Securities

FCM Clearing A/C

FCM Clearing Account

Cash

Positions

FCM Agents

FCM Bank Account

1 customer with 1 CCP

14

FCM Investment Account

FCM Settlement Account

FCM Investment Account

7

FCM Collateral Account

Number of Reconciliations

Incremental per customer

Incremental per CCP

6

FCM Fed Box

FCM DTCC Box

3 customers with 2 CCPs

Number of Reconciliations

34

Reconciliations

P/L Account

Commission& Fees

3

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Slide 9

Direct Accounts – CCP Segregation Only: Possible Future State

Assets Held

Externally

US FCM

FCM Overall Segregation Environment

3rd Party

customer

Clearing House

Customer Clearing A/C (Margin & Positions)

Clearing House Omni

Assets

Liabilities

Securities

Cash

Customer A/c’s

Positions

Customer A/c by CCP (positions & cash)

FCM customer Segregation Environment

Customer Margin A/C

1

Customer Commission A/c

Clearing House

FCM Clearing A/C

FCM Clearing Account

FCM Agents

FCM Bank Account

1 customer with 1 CCP

FCM Investment Account

FCM Settlement Account

FCM Investment Account

10

FCM Collateral Account

Number of Reconciliations

Incremental per customer

Incremental per CCP

3

6

FCM Fed Box

FCM DTCC Box

3 customer with 2 CCPs

Number of Reconciliations

22

Reconciliations

P/L Account

Commission& Fees

4

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Omnibus Accounts: Current State

Omnibus Accounts: Current State

Assets Held

Externally

US FCM

FCM Overall Segregation Environment

•Legal Relationship between FCM and non member FCM

•No look through to underlying customers

3rd Party

customer

Clearing House

Assets

Liabilities

FCM Clearing

Clearing House Omni

Securities

•Legal Relationship between non member FCM and customer

Cash

Positions

FCM Agents

Non member FCM

Customer Seg

Bank Account

Customer Omni

(Non member FCM)

Non member FCM Omni

3A

3A

3B

3B

3C

3C

FCM Settlement Account

Bank Account

Trust Account

Investment Account

1 customer with 1 CCP

Fed & DTCC Box

Collateral Account

8

0

0

3

Reconciliations

P/L Account

Commission& Fees

Number of Reconciliations

Incremental per omnibus FCM

Incremental per omnibus customer

Incremental per CCP

3 omnibus customers with 2 CCPs

Number of Reconciliations

11

5

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Slide 13

Omnibus Accounts – CCP & FCM Segregation: Possible Future State

Assets Held Externally

US FCM

FCM Overall Segregation Environment

Clearing House

Customer3A Clearing A/C

Recs *3

Assets

Liabilities

FCM customer 3A Segregation Environment

•Tri party legal Relationship between FCM, non member FCM and underlying customer

3rd Party

customer

Customer 3A Clearing Account

Bank Accounts

Customer 3A Investment Account

Customer Bank 3A Account

Customer3A Bank Account

Omni / 3A Positions A/c by CCP

Customer 3A Investment Account

Liabilities

Customer 3A Fed Box

Customer 3A DTCC Box

Customer 3A Collateral Account

Omni/ 3A Customer Margin A/C

Clearing House

Customer 3B Clearing A/C

Recs *3

Customer 3B Clearing Account

Bank Accounts

Customer3B Bank Account

Omni / 3B Positions A/c by CCP

Liabilities

Non member FCM

Customer 3B Investment Account

Customer 3B Bank Account

Customer 3B Investment Account

FCM customer 3B Segregation Environment

Customer 3B Collateral Account

Omni/ 3B Customer Margin A/C

Broker Omni

3A

3A

3B

3B

Customer 3B Fed Box

Customer 3B DTCC Box

3C

3C

Clearing House

Customer 3C Clearing A/C

Recs *3

Customer 3C Clearing Account

Bank Accounts

Customer3C Bank Account

Omni / 3C Positions A/c by CCP

Liabilities

Customer 3C Investment Account

Customer3C Bank Account

Customer 3C Investment Account

FCM customer 3C Segregation Environment

Customer 3C Collateral Account

Omni/ 3C Customer Margin A/C

1 Omni A/c with 3 customers, 1 CCP

Customer 3C Fed Box

Customer3C DTCC Box

Number of Reconciliations

Incremental per omnibus FCM

Incremental per omnibus customer

Incremental per CCP

28

7

Clearing House

FCM Clearing A/C

Recs *3

FCM Clearing Account

7

Bank Accounts

FCM Bank Account

Omni Commission A/c

FCM Investment Account

12

FCM Investment Account

FCM Bank Account

FCM Collateral Account

1 Omni A/c with 10 customers, 2 CCP

FCM Fed Box

FCM DTCC Box

Number of Reconciliations

89

Reconciliations

P/L Account

Commission& Fees

6

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Slide 15

Start of Day Margin Processing Timelines - Today

Scenario: Two customers, two CCPs, customer 1 pays on T+1, customer 2 pays on T+2

T+1

T+2

05:00

07:00

12:00

15:00

18:00

eod

05:00

07:00

12:00

15:00

18:00

CCPs call margin from FCM

FCM Pays margin to CCP A for both customers

FCM advances own funds to cover customer exposure

FCM Pays margin to CCP B for both customers

FCM advances own funds to cover customer exposure

FCMs verify calls with customers

Managed at CCP level across customers

Customer 1 pays single margin amount for both CCPs

Customer 2 pays single margin amount for both CCPs

Managed at customer level across CCPs

Note: This diagram shows the funding flows to the client following the CCP call on T+1. The first CCP margin funding run to the FCM is on an intraday trade date basis

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Slide 17

Start of Day Processing Timelines – Possible Future State (1)

Scenario: Two customers, two CCPs, each call is $50, customer 1 pays on T+1, customer 2 pays on T+2

T+1

T+2

05:00

07:00

12:00

15:00

18:00

eod

05:00

07:00

12:00

15:00

18:00

CCPs call margin from FCM

FCM Pays margin to CCP A for both customers

FCM advances own funds to cover customer exposure

FCM Pays margin to CCP B for both customers

FCM advances own funds to cover customer exposure

FCMs verify calls with customers

Customer 1 pays margin amount for CCP A

customer 2 pays margin amount for CCP A

Customer 1 pays margin amount for CCP B

Customer 2 pays margin amount for CCP B

CCP records:

CCP A, customer 1 = +$50

CCP A, customer 2 = +$50

CCP B, customer 1 = +$50

CCP B, customer 2 = +$50

Total seg amount A = $100

Total seg amount B = $100

Note: This diagram shows the funding flows to the client following the CCP call on T+1. The first CCP margin funding run to the FCM is on an intraday trade date basis

FCM records:

CCP A, customer 1 = $0

CCP A, customer 2 = $0

CCP B, customer 1 = $0

CCP B, customer 2 = $0

Total seg amount A = $0

Total seg amount B = $0

Total FCM own assets = $200

CCP records:

CCP A, customer 1 = +$50

CCP A, customer 2 = +$50

CCP B, customer 1 = +$50

CCP B, customer 2 = +$50

Total seg amount A = $100

Total seg amount B = $100

FCM records:

CCP A, customer 1 = $50

CCP A, customer 2 = $0

CCP B, customer 1 = $50

CCP B, customer 2 = +$0

Total seg amount A = +$50

Total seg amount B = +$50

Total FCM own assets = $100

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Slide 19

Start of Day Processing Timelines – Possible Future State (2)

Scenario: Two customers, two CCPs, each call is $50, customer 1 pays on T+1 and covers in securities, customer 2 pays on T+2 and covers in cash

T+1

T+2

T+3

05:00

12:00

18:00

eod

05:00

12:00

18:00

eod

05:00

12:00

18:00

eod

CCPs call margin from FCM

FCM Pays margin to CCP A for both customers

FCM Pays margin to CCP B for both customers

FCMs verify calls with customers

customer 1 deposits securities for CCP A

customer 2 pays margin amount for CCP A

FCMs calls customer 1 for top up of $20

customer 1 pays margin call for CCP A

customer 1 deposits securities for CCP B

customer 2 pays margin amount for CCP B

Customer 1 pays margin call for CCP B

CCP records:

CCP A, customer 1 = +$50

CCP A, customer 2 = +$50

CCP B, customer 1 = +$50

CCP B, customer 2 = +$50

Total seg amount A = $100

Total seg amount B = $100

FCM records:

CCP A, customer 1 = [email protected] $50

CCP A, customer 2 = $0

CCP B, customer 1 = [email protected] $50

CCP B, customer 2 = +$0

Total seg amount A = +$50

Total seg amount B = +$50

Total FCM own assets = $100

CCP records:

CCP A, customer 1 = +$50

CCP A, customer 2 = +$50

CCP B, customer 1 = +$50

CCP B, customer 2 = +$50

Total seg amount A = $100

Total seg amount B = $100

FCM records:

CCP A, customer 1 = [email protected] $40

CCP A, customer 2 = +$50

CCP B, customer 1 = [email protected] $40

CCP B, customer 2 = +$50

Total seg amount A = +$90

Total seg amount B = +$90

Total FCM own assets = $20

Note: This diagram shows the funding flows to the client following the CCP call on T+1. The first CCP margin funding run to the FCM is on an intraday trade date basis

Diagrams are meant to show key flows and accounts only and are not an exhaustive representation of the clearing environment

Current Financial Safeguards

Current Financial Safeguards

Performance Bonds/Concentration Performance Bonds. Performance bond requirements cover expected price moves of at least 95% to 99% over varying time-frames. Concentration performance bond requirements are imposed when a clearing firm’s potential exposure becomes large relative to its financial resources.

Settlement Cycles. Two full settlement cycles are performed daily, marking open positions to market, collecting and payment variation margin, and resetting performance bond coverage.

Capital Requirements. Clearing members have significant minimum capital requirements (OTC derivatives clearing members’ capital requirements are substantially higher). Institutional customers generally require clearing FCMs to maintain capital well in excess of the CFTC/SRO requirements.

    –The top 10 FCMs (ranked by adjusted net capital) have excess net capital ranging from slightly more than $10 billion to slightly less than $4 billion. The next ten have excess net capital ranging from slightly more than $2 billion to slightly less than $1 billion.

Stress Tests. Daily stress tests are performed on clearing member positions on a portfolio basis and on the individual accounts of the clearing member’s large traders; the clearing member may be required to increase performance bond requirements or reduce or transfer positions.

Reporting Requirements. FCMs calculate daily their segregation requirements and capital and report those numbers to their DSRO as required.

Early Warning Requirements. FCMs and clearing organizations are subject to certain early warning requirements.