Magazine article Modern Trader

Clearing the Air

Magazine article Modern Trader

Clearing the Air

Article excerpt

When exchange clearing members come under stress, the clearinghouse gets active, so we talked to Kim Taylor, managing director and president of CME Clearing House Division, to see what steps were taken once Lehman Brothers Holdings declared bankruptcy on Sept. 15.

The first thing Taylor points out is that Lehman's regulated clearing member entity didn't declare bankruptcy. "The broker dealer/FCM did not declare bankruptcy until it was put in a package in a sale to Barclays," Taylor says. "We had a clearing member who continued to be in good standing with us in terms of meeting all of its obligations. Their regulatory capital provisions, their customer segregated funds protections enabled the regulated entity to function in an orderly way during the period when you would expect the business to be wound down or sold. That process worked all week. And by the end of the week, Barclays had agreed to purchase certain assets of the regulated entity including the futures customer [accounts]."

In situations of stress the clearinghouse is also a clearing-house of information. "We make sure that there is information about the status of the broker dealer because the clearing member of the CME remained in good standing. But we do acknowledge that the clearing member is operating in a state where its parent is impaired and so you have to anticipate that it might not be able to operate on a long-term basis," Taylor says, though she adds that Refco's regulated entity operated for six weeks in this condition.

The regulated entity has capital requirements driven by the extent of exposure to its customers. It must have sufficient capital to meet the needs of its business. It also requires, in the case of futures, that dollar for dollar, any money provided to the firm from futures--or any money the FCM owes customers based on open positions, be on hand.

"That segregated funds protection is a very important, [it] helps customers in the regulated markets have a better outcome, in a situation like with Lehman, than customers in the non-regulated markets," Taylor says, adding that if you had money with a Lehman customer trading OTC derivatives without the benefit of daily mark to market, those customers are expected to take quite a significant loss on those deposits because they are general creditors of Lehman.

She says that futures customers either had the opportunity to transfer funds to another clearing member or have the positions and money moved by the clearinghouse.

She says when a parent of a clearing member goes bankrupt the regulatory community and the Designated Self Regulatory Organization (CME Group in this case) keep a very close eye on the balances of the firm to ensure that customer funds leave with the customers. They also were aware of the larger crisis and had their ears to the pavement. …

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