Risk Management Methodology
Monitoring of NYPC Clearing Members
Each Clearing Member will be required to provide to NYPC monthly and audited annual financial reports to enable NYPC to evaluate its financial status. A Clearing Member may be required to provide additional reports in such form and at such times as NYPC may require.
The Clearinghouse will review the financial reports provided by each Clearing Member to confirm that such Clearing Member continues to meet the minimum regulatory capital requirements. Clearing Members will be monitored for compliance with eligibility requirements as well as for material events, such as regulatory actions or changes in executive management. NYPC may, in its discretion, prescribe additional capital requirements with respect to any Clearing Member to safeguard the financial integrity of the clearinghouse.
NYPC will monitor Clearing Member positions and payment obligations throughout the trading day as part of its monitoring processes. This will include the review of hourly snapshots of Clearing Member positions and a determination of potential exposures, which information will be made available to Clearing Members throughout the day.
NYPC’s Margin Calculation and Risk Methodology
Each Clearing Member will be required to deposit Original Margin with NYPC twice each business day in connection with contracts cleared by NYPC that remain open. In addition, Clearing Members will be required to make Variation Margin payments to NYPC on the basis of the mark-to-market of open positions twice each business day.
Original Margin is collected to ensure Clearing Members can meet their Variation Margin obligations for the next cycle (intraday or end of day), and to protect NYPC in the event that a Clearing Member defaults on its obligation to pay a Variation Margin obligation. Original Margin requirements will be calculated using a full valuation historic simulation Value at Risk methodology (“VaR methodology”). The VaR methodology is intended to predict the maximum loss at a specified confidence level in any given portfolio over a specified timeframe. This prediction is accomplished by using historical information from the past 250 business days for futures positions and the past 252 business days for cash securities positions, including prices, spreads, and market variables, such as Treasury zero-coupon yield curves and London Interbank Offered Rate (LIBOR) curves. This information is used to calculate a P&L for each instrument in a given portfolio in the event of such an adverse market move, taking into account the specific characteristics of such instrument. P&Ls will be calculated for futures contracts using a one-day time horizon. (The P&L for cash Treasury and other interest rate securities that are cleared by FICC will be calculated using a three-day horizon.) The individual P&Ls for each instrument in a portfolio are then aggregated so that a VaR for the entire portfolio can be estimated. Because a P&L is calculated for each instrument individually within a portfolio, correlations within a portfolio will be reflected in the final VaR estimate.
The VaR estimate will be calculated in all cases to a 99% confidence level. The Clearinghouse intends to back test its VaR estimates monthly at a summary level and quarterly at a more detailed level to ensure that previous calculations accurately reflected actual market risk and to ensure that its 99% confidence level remains accurate.
VaR calculations and additional Original Margin calls will be made each morning and again on an intra-day basis whenever a Clearing Member’s existing Original Margin deposits are insufficient. The Clearinghouse retains the ability to apply increased Original Margin requirements should a Clearing Member hold a concentrated position in a particular product or if the Clearinghouse deems the assessment of increased margin necessary based on existing market conditions or on the results of regularly performed stress tests. This will serve to protect the Clearinghouse from the increased risk in the event of a default by a Clearing Member with a concentrated position and create a disincentive for Clearing Members to hold concentrated positions or to engage in behavior in violation of the Rules.
Guaranty Fund
To protect against additional risks under extreme but plausible market conditions, NYPC maintains a guaranty fund comprised of contributions made by Clearing Members and a $50,000,000 guaranty provided by NYSE Euronext to NYPC. On a daily basis, the Clearinghouse will compare the Guaranty Fund requirements of each Clearing Member to its deposits in the Guaranty Fund. On at least a quarterly basis, each Clearing Member will be required to deposit additional resources into the Guaranty Fund if the Clearing Member’s deposit is less than the amount it is required to maintain on deposit with the Clearinghouse.
The Guaranty Fund will be stress tested on a monthly basis. The stress tests will be selected by calculating the aggregate interest rate move across different terms over the past 10 years, with the largest 50 results being used to identify the days to be used in the stress test and to calculate the assumed profit or loss (“P&L”) on a given portfolio. The calculated P&L will then be compared to Guaranty Fund requirements. The Clearinghouse will re-evaluate its stress testing models, parameters and scenarios no less frequently than annually.
These three layers of protection—Membership Evaluation and Monitoring, Margin Setting and Collections and Guaranty Fund Contributions—make up the core of the risk management process for NYPC. Both the Chief Risk Officer and the Risk Committee of the NYPC Board of Directors closely monitor these areas to ensure that the clearinghouse is adequately protected in the event of a default.