What does your clearinghouse DEFCON scale look like today?

Jim Kharouf

Jim Kharouf

Freelance Writer

Talk about timing.

Ten years after the collapse of the global financial market and a decade of rebuilding it, Nasdaq reports that Nasdaq Clearing had to cover for a clearing member default of €114 million on Nasdaq Nordic,  a default so large it took up 68 percent of the default funds from other clearing member firms.

According to reports from the Financial Times and Bloomberg, a trader by the name of Einar Aas (one letter off from a joke here), defaulted on Nasdaq’s power market on September 11, forcing Nasdaq Clearing to tap into clearing member default funds. Aas reportedly was such a big trader he was allowed to clear his own trades.  

In a glass half full world, this is where the industry can say the system backstops worked. But if a €114 million loss blows through almost 70 percent of the default fund, that raises serious questions at a time when global standards boards are looking at setting leverage ratios for clearinghouses and firms. Those entities include the Financial Stability Board which coordinates with Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions. Just last month, they issued a report on central clearing of OTC derivatives, Incentives to centrally clear over-the-counter (OTC) derivatives: A post-implementation evaluation of the effects of the G20 financial regulatory reforms. The report stated “central clearing of standardized OTC derivatives is a pillar of the G20 Leaders’ commitments to reform OTC derivatives markets in response to the financial crisis.”

The Nasdaq Clearing case appears to be in the futures only sector. Yet, one can only imagine what is being discussed, analyzed and debated in this case. Clearinghouses performed well in the midst of the chaos that was marked by the Lehman collapse 10 years ago this week. Much has been made about how well crafted and reliable the clearinghouse model is.

Conference after conference devoted hours of discussion and information to things like “skin-in-the-game” and “default waterfalls” after 2008. This is essentially a DEFCON kind of scenario at the nuclear plant when a disaster needs to be contained. Every exchange clearinghouse has the manual on what to do and from whom to take money to cover a loss. In this case, Nasdaq Clearing appears to have followed the manual and contain the loss. The question here is, what would have happened if Mr. Aas had lost €300 million?

In another near coincidence, the Nasdaq event happened the day before former UBS trader Kweku Adoboli was moved one step closer to deportation for his conviction in 2012 of losing £1.8 billion ($2.3 billion). It’s not a stretch to ask “what if?” The point is massive losses happen. The question is: do global clearing houses have the proper backstops in place to hold these markets together in the worst case scenarios?

Of course, anyone can come up with a scenario beyond the scope of the clearinghouse’s walls, secondary walls and meltdown bunker. Many panels I’ve attended brought up the question themselves. What would happen if the two largest clearing member firms defaulted? The answer usually was, “If that happened, we’d have bigger problems than a failed clearinghouse.” Probably.

The thing the futures industry has always hung its hat on is that in these terrible events, it stood tall, did what it was designed to do and helped carry the markets even when others were closed or worse. The strength of the global futures markets in the face of adversity and chaos is also among its sources of pride.

That track record should be protected with every fiber of every executive of an exchange and clearinghouse or clearing member firm.


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