CME Default Management

April 2015

CME Group Inc.
CME’s Default Management Process (DMP) has benefited from an experience over several decades of successfully managing defauldealers/clearing members such as Bearings, Drexel Burnham & LaBrothers, Refco, and MF Global. Below are some of the critical les• Importance of a wider base of market participants for successful auc• Importance of detailed customer information to port large number of 

timely fashion 

• Importance of default management drills

- Removes operational risk and increases focus on hedging and auction

• Coordination with other CCPs

Managing Defaults
When a Clearing Member (“CM”) defaults, the house portfolio of the defaultand any of its defaulted customers need to be liquidated. Here are key steps Default Management Procedure (“DMP”): • DMPs should be designed to reflect the market structure of the cleared produc

well thought out strategies and tools while still allowing for enough flexibility annimble and effective in the face of ever unpredictable distressed market condit

- For listed derivatives where in general the market is liquid and has transparent central o

should use the markets and engage a broad set of market participants on a voluntary bportfolio

- For OTC markets the market structure has not evolved to a large central market. Instea

liquidity some on SEFs and others still transacted bilaterally. To account for these chanDMP should be more structured, where a CCP should use the expertise of seasoned trappropriate hedging and auction strategies. The auction participation is generally an obmembers. However, we believe buy side should not be excluded from auction participa

• For OTC markets, it is imperative to execute macro level hedges to reduce lar

defaulted portfolio(s) as soon as practicable

• Once the risk of the defaulted portfolio has been neutralized or sufficiently redu

auction it off.

- CCP should develop and implement a number of auction styles that correspond to a pa

category, and the risk of the portfolio and the market conditions.

• Defaulted CM’s collateral should be liquidated, as needed, to meet DM costs a• The process of porting non-defaulted customers to healthy CMs should start s

Best Practices of Default Management Proce
CME believes that CCPs cooperation is one of the critical elementefficient, scalable and effective DMP• CME has reached out to other CCPs to discuss possible ways to coo• Several initiatives have been identified

- Joint default management exercises. - Coordination of traders secondment across CCPs- Finding a solution to risk offsetting transactions across CCPs with respect 

Coordination with other CCPs
• Creation of hypothetical defaulted portfolio• Generation of simulated market data sets for all days of the drill• Incorporation of simulated market data into CME systems for valuati• Production of risk reports for ADMC traders and firms• Production of hedge calculation worksheets for ADMC traders• Developing and testing the new auction platform• Multiple conference calls, and individual communication with all firms 

participants on using the platform, for creating users, file download, 

• Mock auctions for firms to test the auction platform for all its features• Set up and testing of war room resources at New York and London o• Coordination of a pre-drill valuation exercise with the firms• CME Internal dry runs• Distribution of drill process timelines, scope, clarifications, and updat

Default Management Drills – Preparation for 
• CME conducts DM drills across all asset classes twice a year to test 

enhance

- DM procedures- DM systems- Communication with CMs- Participation of CMs in hedging and auction phase- Bidding incentives

• DM Drills – Resources

- War rooms equipped with laptops, telephones, internet, teleconferencing, s

Bloomberg, and Reuters are set up at New York and London offices

• DM Drills – Hedging Phase

- On Day 1 of the default, CME staff executes initial macro level hedges to re

portfolio

- ADMC traders are seconded to the secured CME offices in London and Ne- Detailed risk reports are presented to the traders- ADMC formulate their hedging strategy and recommend further hedges- CME staff books the hedges into CME systems and re-run the risk reports- The hedged portfolio details are distributed to all firms using CME’s web ba

Auction Platform” and via FTP

CME Default Management Drills (IRS & CDS)
• DM Drills – Auction Phase

- On Day 2, CME conducts an intermediate conference call with non-default

address any outstanding technical issues

- On Day 3 or 4, Auctions are conducted on CME Auction Platform- This platform provides a very efficient, secure, and automated means of co- Bidders from the CMs submit their bids using CME Auction Platform- Winners are determined and award notifications are sent by the Auction Pl- Clearing member firms are informed of the hypothetical impact of their bids 

GF utilization

• DM Drills – Cost of DM calculations

- Throughout the drill, CME staff keeps track of the costs mentioned below to 

costs

- Hedging cost- Variation Margin cost- Auction cost - The total cost of default management is then compared with the collateral o

margin) and the liquidation assumptions of the margin model.

Default Management Drills (IRS & CDS) - Co