Cleared derivatives—treatment of client collateral for leverage ratio purposes

The following Financial Services practice note provides comprehensive and up to date legal information covering:

  • Cleared derivatives—treatment of client collateral for leverage ratio purposes
  • What is clearing of derivatives?
  • What is client collateral?
  • What is leverage?
  • Leverage ratio—Basel III
  • Leverage ratio—EU CRR and UK CRR
  • Leverage ratio—PRA Rulebook
  • Industry concerns

Cleared derivatives—treatment of client collateral for leverage ratio purposes

What is clearing of derivatives?

Clearing is a process which eliminates the normal risk that a party to a derivatives transaction will default.

The main parties involved in the clearing process are:

  1. a financial institution known as a clearing house, a central counterparty or a CCP, and

  2. other financial institutions, usually banks or brokers, which enter into a clearing agreement with the clearing house—these institutions are known as clearing members of the clearing house or simply clearing firms

In cleared transactions:

  1. all transactions are entered into by clearing members, which may do this for their own accounts or for the accounts of their clients, and

  2. the clearing house interposes itself between the clearing members who have entered into the transaction, becoming a party to every transaction—each party therefore is exposed to the risk of the clearing house but not to the risk of the other party

The way in which the clearing house is interposed between the clearing members depends on whether the clearing house uses:

  1. the principal model—in this case the clearing members (Clearing Member A and Clearing Member B) enter in to a derivative contract which is immediately split and novated into two separate and matching derivative contracts, one between the clearing house and Clearing Member A, the other between the clearing house and Clearing Member B

  2. the

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