Clearing is the process of registering bilateral transactions for post-trade processing at a clearing house. Clearing is done through the act of novation where the clearing house becomes the central counterparty to every trade.
Clearing is these days considered an essential part of counterparty risk management by traders in the freight and commodity swaps markets. The costs of clearing are more than accounted for by the knowledge that in the case of default, the Clearing House provides a safety net unavailable to traditional over the counter trading.
- ‘Guaranteed’ delivery by a central counterparty, reducing counterparty risk;
- More transparent valuation through daily margining and daily cash flows;
- Trading with a counterparty, regardless of credit rating;
- Higher efficiency through a single operational process for all contracts;
- Reduced settlement cost through single netted payment with a clearing house and reduced risk exposure.
Choosing a Clearing House
The choice of clearing house available for freight and commodity swaps is growing, reflecting the global growth of these commodities.
Current options for clearing are as follows:
|FFA Options||FFA Options||FFA Options|
|Iron Ore Swaps||Iron Ore Swaps||Iron Ore Swaps||Iron Ore Swaps|
|Iron Ore Options||Iron Ore Options|
|US HRC Options|
|Black Sea Billet|
|US Midwest Scrap|
|HRC Northern Europe||HRC Northern Europe|
|HRC Southern Europe|
|HRC Northern Europe|
|HRC China Domestic|
|Rebar China Domestic||Rebar China Domestic|
|Turkish Scrap Imports||Turkish Scrap Imports|
|Fertilizer Swaps||Fertilizer Swaps|
|Container Swaps||Container Swaps|
Opening a Clearing Account
Select a General Clearing Member (GCM) from a list provided by the Clearing House:
Charges and fees vary between GCMs according to the client’s current operational situation. In order to increase efficiency for our clients, FIS is able to negotiate with some GCMs for account opening. More details can be provided upon account opening.
After the client completes an account opening form and submits supporting documents, the clearing bank will conduct a credit check on the client’s company. Financial statements and other business related documents may be requested by the clearing member from the clearing house.
The client must then arrange margin deposit or other capital to fund the account. The initial margin requirements are as follows:
LCH – http://www.lchclearnet.com/risk_management/ltd/margin_rate_circulars/enclear/default.asp
SGX – http://www.sgx.com/wps/portal/sgxweb/home/products/asiaclear/freight/ffa
NOS – http://www.nosclearing.com/margin-curves/category387.html
The client must then inform the GCM of the selected broker (OTC Inter-Dealer Broker) they will use. The client will then sign a brokerage agreement with FIS to authorise FIS as the executing broker for the client. An agreement may have to be signed between the client, FIS and the clearing member to grant FIS the right to transfer trades to the clearing member for clearing. Once confirmation has been received from the GCM of account approval and set-up for OTC Clearing, the client may start trading and ask FIS to register trades for clearing.
The Broker – The Trader – the GCM and the Clearer
Once a trade is confirmed, the trade details will be entered into the exchange’s trade registration system for matching and allocating to GCM clearing accounts. Initial margin is collected by the GCM from the client as a good faith deposit for undertaking the trade.
While the position is still open, clearing members will mark-to-market the position and collect/pay out variation margin to the client’s clearing accounts. On the settlement date, the clearing house calculates the settlement price as the arithmetic average of the specified index on all index days within the month. The final variation margin is then paid out/received by the clearing member from the client to complete the trade.