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PHARMACEUTICALS AND LIFE SCIENCES
Break out session: Client clearing
explained
MIG Seminar
Financial Services Team
Norton Rose LLP
April 2013
EU: client clearing in EMIR
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CCPs and clearing members must offer both:
– Omnibus client segregation: Separate records / accounts distinguishing between clearing
member's assets and positions and assets and positions of its clients
– Individual client segregation: Separate records / accounts distinguishing between assets
and positions of each client of clearing member and any excess margin posted to CCP
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CCPs must allow clearing members to open further accounts
Requirement to distinguish involves recording in separate accounts, not netting
across accounts and not exposing assets in one account to losses in another
CCPs and clearing members must disclose levels of protection and costs - must
be reasonable commercial terms
CCPs must commit to trigger procedure for porting - if clearing member defaults
and client requests, transfer client positions and assets to another clearing
member that has agreed to step in - omnibus and individual accounts
CCPs can actively manage their risks by liquidating positions and assets if this
cannot be done within a pre-defined timeframe
Client collateral can only be used to cover positions held for relevant client
account and any surplus on a clearing member default should be returned to
client or, if not possible, to clearing member for relevant client account
Neutrality on principal to principal versus agent model: domestic issues are
separate
Client clearing
CCP
Cleared contract,
CCP rules, collateral
Clearing Member
Alternative Clearing
Member
Back off contracts,
clearing agreement,
security interest in
favour of the client,
collateral
Client
OTC Counterparty
OTC derivative trade,
non-clearing master
agreement
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Porting of positions
and assets takes
place on clearing
member default
Account structures – Omnibus and Individual
Segregation
Omnibus Segregation
Clearing Member
(books + records)
CCP (books +
records)
Client 1
Client 2
Client 3
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Clients 1, 2 +3
Clients, 1, 2 + 3
Omnibus segregation
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Records and accounts kept at CCP which distinguish the assets
and positions of the clients within the omnibus account from
assets and positions within either the clearing member’s house
account or any other client account
Positions can be netted within an omnibus account but not across
accounts
Assets covering positions in an omnibus account are not exposed
to losses on positions recorded in any other account but within the
account, one client’s assets may be used to cover another client’s
positions – so fellow client risk will exist
Excess collateral can be held at the clearing member level
Individual Segregation
Clearing Member
(books + records)
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CCP (books +
records)
Client 1
Client 1
Client 1
Client 2
Client 2
Client 2
Client 3
Client 3
Client 3
Individual Segregation
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Positions and assets distinguished from the positions and assets
of any other client and the clearing member’s house account
Positions within the account can be netted but positions cannot be
netted across accounts
Assets covering positions recorded in the account cannot be used
to cover losses connected to positions recorded in any other
account, so no fellow client risk
Any collateral called by the clearing member which is in excess of
that called by the CCP must be passed to the CCP and not held
by the clearing member
Legal documentation in Client Clearing
structures
A typical client clearing documentation map
CCP
Trust Deed
CCP Rules
Cleared Transaction
Security Trustee
Clearing Member
Security interest
Client Clearing
Agreement
Clearing Master
Agreement and
collateral document
Transaction
Execution standard terms
Client
Non-clearing Master Agreement
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OTC derivative
counterparty
Impact of default – Omnibus Accounts
Omnibus segregation
Party
Is the Client exposed to
losses arising from that
party’s default?
How does the exposure arise?
Clearing Member
 (to the extent any excess
collateral is posted to the
Clearing Member by the
Client: a big caveat on
protection)
Clearing Members may hold excess collateral
posted by Clients who have selected omnibus
segregation. Such excess collateral will not
be part of the porting process at the CCP.
Other Clients of the
Clearing Member
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If another Client in the same omnibus account
defaults, the loss may have to be borne by all
of the Clients in that account.
CCP

Clearing Members are likely to make their
obligations to Clients conditional on CCP
performing its obligations (in both BAU and
default situation).
CCP default is a risk for Clients.
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Impact of default – Individual Accounts
Party
Is the Client exposed to
losses arising from that
party’s default?
How does the exposure arise?
Clearing Member
X
Client clearing protections under EMIR
should protect Client against Clearing
Member default.
Other Clients of the Clearing
Member
X
N/A
CCP

Clearing Members are likely to make their
obligations to Clients conditional on CCP
performing its obligations (in both BAU and
default situation).
CCP default is a risk for Clients: “full
segregation” options being looked at to deal
with this
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Documentation checklist
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The types of issues that we would be looking at in the clearing
documentation are:
– What is each document doing – there are usually a number of documents, you
need to understand what each one is doing and your obligations, rights and
risks under each
– Porting mechanism – what are the mechanics of this at each relevant CCP?
What exactly will be ported or returned to the client on the default of the
clearing member? Can the CCP claim any costs and expenses from the client’s
assets? Are there any registration requirements? When does the client need to
appoint an alternative clearing member? Is there a security trustee involved?
– Impact on existing OTC master agreements – how do the documents relating to
cleared OTC derivatives interact with any existing master agreements relating
to non-cleared OTC derivatives? E.g. are there any cross netting and set-off
provisions? How will a default or termination under one of the agreements
impact on the other?
– Termination rights - in what circumstances can the client exercise its rights to
terminate a cleared derivative or the back to back contract? What events at
CCP and clearing member level will trigger termination of the client’s contracts?
What rights does the client have in each case?
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Documentation checklist cont/d
– Liability and indemnity - is the client being asked to accept liability for anything
which is really the clearing member’s responsibility? What indemnities is the
client being asked to give?
– Security, title transfer and the risks for the client - what quality of security is
being provided to the client, on what terms are the securities transferred and
what risks might these arrangements pose for the client?
– Client money – does the client have client money protection? How does the
client money regime interact with the client clearing structure being entered
into?
– Arguably the client money issue makes most difference either in relation to
transfer risk in individual seg account or in relation to moneys held by the
clearing member in the omnibus account
– Structure is more complex as there are different documentation packages
across the various clearing houses with varying degrees of discretion and
mandating of terms
– However, these are the key issues to be asking about
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Indirect client clearing
Indirect clearing: The world of the second tier banks
CCP
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At clearing member’s request, CCP must keep separate records and accounts showing indirect client’s position and assets
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No requirement to offer indirect clearing but if it does then must be on reasonable commercial terms: may include minimum operational terms
for clients who participate
Must give client choice between individual and ominous segregation options for indirect clients in its books and records
Must have procedures to transfer indirect client’s position and assets to a new client or clearing member or liquidate them if original client
defaults: back up client or clearing member mechanism to be included
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Clearing Member
Client
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Indirect client
Must be credit institution, investment firm or equivalent in third country
Must keep records and accounts distinguishing its assets and positions from those of indirect clients
Must offer indirect clients choice of account and disclose risks
Must request clearing member to open segregated account at CCP for indirect clients
Contract with indirect client must be consulted on with clearing member
Must provide sufficient information to clearing member to identify, monitor and manage any risks. In event of default all information to be
provided to clearing member. Politics of this compromise is to balance the interest of the second tier banks who do not wish to lose their client
base against systemic stability issues
Indirect client clearing
CCP
Cleared contract, CCP
rules, provision of
collateral
Clearing Member
Back off contract,
clearing agreement,
CCP mandated
documentation,
provision of collateral
Possible for indirect client to
move into position of client upon
client default (subject to
agreement with clearing
member)
Porting of positions
and assets takes
place on client default
Client
Back off contract, indirect
clearing agreement,
clearing member mandated
documentation provision of
collateral
Indirect Client
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Adopting Client
OTC derivative
counterparty
OTC Oracle: our EMIR online technical resource
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Disclaimer
The purpose of this presentation is to provide information as to
developments in the law. It does not contain a full analysis of the law nor
does it constitute an opinion of Norton Rose LLP on the points of law
discussed.
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