Project launching otc derivative and repo clearing in kdpw ccp using novation
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Project launching OTC derivative and repo clearing in KDPW_CCP using novation. Project Environment. Adverse impact of the financial crisis Adverse impact of the crisis on the stability of the financial sector Reduced liquidity on the OTC market

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Project launching OTC derivative and repo clearing in KDPW_CCP using novation

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Project launching OTC derivative and repo clearing in KDPW_CCP usingnovation


Project Environment

Adverseimpact of the financialcrisis

  • Adverseimpact of the crisis on the stability of the financialsector

  • Reducedliquidity on the OTC market

  • Increasedvolaility of trade values

  • Risingawareness of creditrisk in the ‘worldafter Lehman’

    New regulations

  • UE: EMIR – Regulation on OTC derivatives, central counterparties and trade repositories –pendingapproval of the EuropeanParliament

  • USA: Dodd-Frank Act - implemented 21/07/2010

  • Basel III, CRD IV – in market consultation


Identifying the Legal Environment

  • EMIR - Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on OTC derivativetransactions, central counterparties and trade repositories.

  • Central clearing of trades

    mandatory clearing via a CCP (central counterparty) of all standard derivativestradedoutside the regulated market

    • Reporting to trade repositories

      mandatoryreporting of alltrades, bothclearedcentrally and bilaterally, to trade repositories

    • Rules for CCPs and trade repositories

      - authorisation and supervision of CCPs

      - capitalrequirements

      - organisationalrequirements

      - precautionaryrequirements (riskguarantee system)

      - interoperability


  • Identifying the Legal Environment

    • BaselCommittee on Banking Supervision

    • ConsultativeDocumentCapitalisation Of Bank Exposures To Central Counterparties

  • Exposures to CCPs in respect of MtM and marginssubject to low (2% riskweight) capitalrequirementsowing to multilateralnetting of liabilities and lossprotectionmechanismsoffered by CCPs

  • Bank exposure to the default fund determined on the basis of the currentfinancialresources of the CCP in relation to hypotheticalcapitalrequirements. CCP hypotheticalcapitaldeterminedunder CEM (CurrentExposure Method).


  • List of Active and Planned CCP Services for OTC Derivatives

    Bank for International Settlement, CGFS Papers No 46


    WhyKDPW_CCP?

    • Experience in clearing: new clearing guarantee model of the clearing house KDPW_CCP spun off from KDPW in July 2011

    • Technical and technological infrastructure and existing communication infrastructure with participants

    • KDPW_CCP’s neutral position as a counterparty to market participants

    • Clearing Model accepted by the Banking Expert Team

    • Relations with PFSA, NBP, market participants

    • KDPW_CCP ability to use collateral in securities, which greatly reduces the cost of collateral

    • Own capital of KDPW_CCP


    Consultations with the Banking Expert Team

    The Banking Expert Team has approved:

    • Clearing model

    • Scope of cleared instruments

    • Instrument valuation model

    • Staged implementation of the project

    • Use of confirmation platforms

    • Risk management

      All banks have been invited to participate in KDPW_CCP consultations;

      64 representatives of 17 banks took part in the consultations.


    Proposed OTC Clearing Model

    • External trading platform

    • MarkitWireSWIFT Accord

    • Trade validation

    • Trade affirmation

    • Trade matching

    Client

    Trading Member A

    Trading Member B

    Client

    • KDPW_CCP

    • Trade clearing

    • Trade repository

    • Clearing risk and position management

    • Clearing guarantee system

    • Processing settlement in third-party systems

    Termination Platform

    (TriOptima)

    Clearing Member A

    Clearing Member B

    PFSA

    • Thomson Reuters

    • market data transfer

    KDPW Member A

    KDPW Member B additionally in payer bank function

    • KDPW (CSD)

    • Cash settlement

    • Collateral in securities

    Payer Bank A

    NBPSettlement in PLN


    KDPW_CCP Clearing Model: KeyFunctionalities

    Third-party trading platform

    MarkitWireSWIFT Accord

    Prowadzenie rozliczeń

    KDPW_CCP

    Risk management

    Acceptingtrades for clearing

    • Defining and calculatingriskparameters

    • HVar

    • Price monitoring

    • Back testing

    • Stresstessting

    • Exposurelimits

    Clearing

    • Formal and substantivecheck of instructions

    • Interpositioning KDPW_CCP as legalcounterparty

    • Calculatinginterestpayments and MtM

    • Contributions to the clearing guarantee system(margins and fund)

    • Sendinginstructions for settlement

    Collateraladministration

    • Securities register

    • Collateralvaluation

    • Earlytermination (Auction) (Tri Optima – automatic termination)

    • Reporting

    • Backloading

    Trade repository


    Collateral Processing Model

    Member

    • CASH

    • Collateralvaluation

    • Determining the haircut

    Credits and debits in respect of contributions to the clearing guarantee fund

    • Acceptingcollateral in securities:

    • Treasurybonds

    • W20 indexshares

    NBPKDPW_CCP settlement in PLN


    Instruments: List Approved with Banks

    Phase 1 – 01 January 2013

    • ForwardRateAgreements

    • InterestRateSwaps

    • OvernightIndexSwaps

    • BasisSwaps

    • Repos

      Phase 2 – 01 January 2014

    • Cross CurrencyInterestRateSwaps

    • Options

    • Other


    ProposedIntroduction of Clearing Novation to Regulations

    • Clearing novationmeansthat the clearing housetakesover the rights and obligations of a counterparty to a trade. Once a trade hasbeenaccepted for clearing, the rights and obligationsarising from the trade expire in the relations between the trade counterparties and arereplaced by newlegal relations.

    • Clearing novationwill be used on the organised market and outside the organised market.


    Novation

    • If a counterparty to a trade is a clearing member and hascommitteditself to the clearing house to performobligationsarising from the clearing of itstrades, itisentitled to receiveorliable to provide a benefit resulting from the clearing of the trade vis-a-vis KDPW_CCP.

    Member A

    Trade #1

    Member B

    BUY

    SELL

    KDPW_CCP

    Trade #2

    Trade #2

    SELL

    BUY


    Consequences of Clearing Novation to KDPW_CCP

    • Rights and obligationsarising from the trade expirewhilenewlegal relations arise, to which the clearing houseis a party.

    • The clearing houseisentitled to claim the benefitsarising from the trade with regard to the trade counterparty (ifitis a member) or a memberwhichis a party to clearing.

    • Once a trade hasbeenaccepted for clearing, a memberwhichis a party to clearing and the clearing housemayonlyraiseclaimsarising from the legal relations whichhavereplaced the original trade.

    • A memberwhichis a party to clearing cannotraiseclaimsagainst the clearing housearising from the legalrelationbetween the member and the entitywhichconcluded the trade.

    • Collateralestablished by the entityconcluding the trade subject to clearing by the CCP isexcluded from the liquidationassets of the member.


    LegislativeAmendments

    • As a result of consultationsinitiated by KDPW with market institutions (PFSA, NBP, WSE, Chamber of Brokers, Polish Banks Association, BondSpot, Custodian Banks Council), a draft hasbeensubmitted to the Finance Ministry, requestinganamendment of the Act on Trading in Financial Instruments. Keyamendmentsinclude:

      • Act on Trading in Financial Instruments:

        Art. 45b - amendment of the definition of trade clearing: addition of the clearing house as entitled to receiveorliable to delivercash and non-cashbenefitsarising from concludedtrades;

        Art. 45e - amendmentexcludingcollateralestablished by the entityconcluding the trade outside of organised trading subjectto clearing by the clearing house from the liquidationassets of the member

        Art. 45g-45i -amendmentintroducing clearing novation.

        Art. 50, Art. 68b - amendmentaddingnewfunctionalities in the clearing house and KDPW regulations

        Art.68 - amendmentconcerningguaranteefunds, including establishment of guaranteefunds for tradesconcludedoutside the organised market

      • Harmonisingamendmentsof the Act on Public Offering (Art. 67,90) and the Act on Civil Law TransactionTax (Art. 9).


    KDPW_CCP Clearing Guarantee System

    Participantrequirements

    Price monitoring

    Margins

    Back Testing

    MTM

    Monitoring

    exposures / concentration

    StressTesting

    Default fund

    + additionalmargins

    CCP capital


    State-of-the-art Risk Management System

    • Valuation – instrument valuation model customised to market specificity

    • Calculatingriskbased on HVaR (historicalVaR)

    • 5-day riskcalculationhorizon

    • Confidencelevel – 99.9%

    • 500 days – look back period

    • Default fund – coversstress-test risk

    • Additionalmargins– coverindividualparticipantexposurebetweendefault fund updates

    • Stress-tests – test the adequacy of resourcespooled in the clearing guarantee system

    • Back-tests – test the adequacy of the riskestimation model and itsparameters


    Guarantee System Resources

    • Individualmargins

    • Default fund

    • Additionalmargins

    • KDPW_CCP capital


    Staged Project Implementation

    DONE

    • Establish co-operation with Banking Expert Team

    • Jointly develop OTC trade clearing model

    • Approve standards of OTC instruments covered by phase 1

    • Develop risk management methodology and valuation rules

    • Develop functional and technical specification of the new IT solution

    • Select IT solution vendor

    • Initiate Design Study with selected vendor

    PLANNED

    • Implementation work Jan-Jun 2012

    • Present technical documentation and draft regulations to participants Mar 2012

    • Expected introduction of novation to Polish regulations Apr-Jun 2012

    • Amendment of KDPW_CCP regulationsJan-Jun 2012

    • Signing agreements with participants Dec 2012

    • Testing the system with participants Aug-Nov 2012

    • Increase of KDPW_CCP capitalQ2-3 2012

    • Production rolloutJan 2013

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