BMDC, a wholly-owned subsidiary of Bursa Malaysia Derivatives Berhad (BMD), eliminates credit risk between clearing participants by becoming a counterparty to each contract which is bought or sold by a clearing participant ("CP") and giving an undertaking to perform its obligations under such a contract. The performance of this function provides confidence to the market in the financial performance of the contracts. It also serves to ensure the safety and soundness of the clearing and settlement system as a whole.
Upon the creation of market contracts executed on the BMD, the contracts will be presented electronically to BMDC for registration. Immediately upon the registration of each market contract, two new contracts i.e. open contracts are created in place of and on identical terms with each market contract. BMDC becomes the buyer to the CP acting as the seller under one open contract and the seller to the CP acting as the buyer under the other open contract. This process, known as novation, is provided for in the BMDC Rule 610.
BMDC, as a counterparty to all open contracts, undertakes to its CPs who are party to those contracts that it will perform its financial obligations under the contract. This undertaking is backed by BMDC's risk management policies as well as funds held for such purpose. BMDC's financial undertaking is provided to CPs acting as a principal in respect of the relevant open contract. As a corollary to the undertaking provided by BMDC, each CP is liable as a principal for the performance of its obligations under all contracts to which it is a party. BMDC does not assume or incur any liability to any client of a CP or other third party; neither can BMDC take any action against a client for the performance of an open contract in its own capacity under the BMDC Rules 103.
BMDC, while assuming the counterparty risk through the process of novation, maintains a minimum standard of entry to ensure that only the financially sound institutions are granted participantship. This minimum standard allows BMDC to assess its counterparty and plays the role as the first line of defence in the financial safeguard system. There are two categories of participantship, namely General Clearing Participant (GCP) and Direct Clearing Participant (DCP).
Each GCP must at all time maintain its Adjusted Net Capital (ANC) at the higher of RM500,000; or 10% of the total amount paid by the CP to the Clearing House. ANC is computed as: Permitted Assets less Additional Deductions less Total Liabilities
Each DCP must at all times maintain Net Tangible Asset (NTA) of not less than RM5 million, or a corporate guarantee of not less than RM5 million. DCP is also required to lodge a DCP Deposit and maintains at all time the higher of RM500,000; or 10% of the total amount paid by the DCP to the Clearing House. NTA is computed as: Tangible Assets less Total Liabilities
Further detail of the Clearing Participantship Standard is provided for in the BMDC Rules 200.
BMDC upholds financial integrity through its risk management policies. In addressing and managing credit and market risk, BMDC has in place the following policies:
BMDC is of the view that in managing risk a proper balance should be struck between the need for adequate safeguards and the need to encourage trading and increase liquidity in the market. As such, BMDC's risk management methodology, especially in relation to performance bond, is constantly reviewed to ensure that its requirements are neither inadequate nor excessive. The risk management function is carried out on a daily basis by BMDC and is inherent in its clearing and settlement process. This involves the collection of performance bond, mark-to-market and intra-day margining.
Performance bond requirements are good faith deposits to guarantee the performance of the open contracts and are often referred to as "margin". The collection of margin on all open positions held by a CP is fundamental to the operations of BMDC to protect itself against losses arising from a CP's default. The level of margin is determined based on the derived maximum potential risk exposure over a one-day period. It takes in to consideration of the historical price volatility covering short and long term period, current and anticipated market conditions, and other risk factors.
BMDC adopts a gross margining concept where each client account of a CP is margined separately. The total margin for a CP is the sum of the margins for all the individual client's accounts of the CP. The proprietary position of a CP is margined on a net position.
The following is the list of Approved Collaterals for Initial Margin:
Any update on the Margin Rates and Approved Collateral will be communicated from time to time via the Clearing Circulars.
BMDC will determine the Daily Settlement Price for each open contract in accordance with its procedures. The determination of Daily Settlement Price will take into considerations the relevant trade information including the bids, offers and traded prices quoted on the Exchange and any other information deemed relevant by the Clearing House. The methodology outlined below serves as a general principle in determining settlement price.
All open contracts are valued daily against the Daily Settlement Price determined by BMDC at the end of each trading day and the resulting gains or losses are posted to each CP's account. The losses must be paid in cash to the Clearing House before the start of trading on the next business day. The gains, if available, can be withdrawn upon request by the CP on the next business day.
The Clearing House monitors CP's trading activities and intra-day price movement closely to assess its potential exposure. In periods of extreme market volatility, BMDC can activate the mark-to-market process during the trading day for trades executed up to that point in time. Having two or more mark-to-market and settlement sessions in one trading day effectively changes the duration of BMDC's exposure from one day to segments of a day. The losses have to be paid to BMDC within one hour of the intra-day margin call being made. New positions entered into up to that point in the trading day will also have a margin obligation which has to be settled within the hour.
All participants are required to separate their client positions and funds from their own account, in accordance with Section 118 of the Capital Market and Service Act . This requirement is designed to protect clients in the event of the insolvency or financial instability of the clearing participant through which they conduct business.
BMDC has recourse to contingency funds maintained by it in the form of Security Deposit and contributions made to the Clearing Fund.
Security Deposit (BMDC Rule 206A) Each CP must maintain a Security Deposit of RM1 million lodged with BMDC in the form of cash or Letters of Credit. The Security Deposit lodged by a CP will be used by BMDC in the event of default to cover any amount owing by that CP to BMDC.
Clearing Fund (BMDC Rules - Chapter 4) BMDC maintains a Clearing Fund for the purpose of making good any loss suffered by it as a result of the failure or omission by any CP to perform any of its obligations under the BMDC Rules or if any financial institution or clearing house organisation fails to perform any obligation to BMDC when due because of insolvency, indefinite suspension of operation or suspension of payments or any similar event.
A CP's contribution to the Clearing Fund must be in the form of cash consisting of a fixed contribution of RM1 million and a variable contribution as determined by the Clearing House. BMDC closely monitors the size of Clearing Fund on a daily basis by stress test using a series of historical worst case scenarios and may call for additional contributions to provide further additional resources to the Clearing Fund.
In the absence of default by a CP, the Clearing Fund may be availed of by BMDC to cover any losses suffered by it due to the default of a financial institution or another clearing house. This is to ensure that systemic stability is not threatened by reason of any situation affecting BMDC which is outside of its control. If the losses suffered by BMDC results from a default of a CP, that CP's margins, excess cash and collateral, Security Deposit and Clearing Fund contribution will be claimed upon first. In the unlikely event that these is insufficient to cover the losses, BMDC can resort to the Clearing Fund contributions of other CPs on a proportionate basis. CPs are liable to contribute an additional 100% of their existing contributions in the Clearing Fund if BMDC suffers losses exceeding the amount available in the Clearing Fund.
Recognising the ever challenging environment in today's market, BMDC monitors the positions and financial conditions of CPs in a proactive manner. In the event of high concentration of open positions with any CP which may lead potential increase market exposure, BMDC may call for payment of additional funds as additional security against the non-performance of obligations by such CP. BMDC is also constantly monitoring the financial liquidity status of CP should the need arises where CPs are required to pay additional funds during volatile market conditions.
Risk management policies adopted by BMDC are designed to minimise the likelihood of a default by a CP. However, in the event of disciplinary and default situations, BMDC is authorised to take actions pursuant to Chapter 9 and 10 of the BMDC Rules.