Patent Publication Number: US-2011066569-A1

Title: Allocation of a credit default swap portfolio

Description:
FIELD 
     The present embodiments relate to allocation of a credit default swap portfolio. 
     BACKGROUND 
     Exchanges provide market access through clearing firms, such as futures commission merchants (FCM). Clearing firms are organizations that work with an exchange&#39;s clearing house to handle confirmation, delivery, and settlement of transactions, such as orders to buy and/or sell future contracts or options on futures. Clearing firms ensure that executed trades are settled within a specified period of time and are generally independent intermediaries that specialize in clearing trades for brokers/dealers through the exchange-run clearing house. Clearing firms may be member firms of the exchange&#39;s clearing house and may be authorized to clear trades for its broker/dealer customers who are exchange members but not necessarily members of the exchanges clearing house. 
     In the event that a clearing member defaults, i.e., is bankrupt or insolvent, the exchange&#39;s clearing house may attempt to sell the defaulting member&#39;s portfolio of credit default swaps in order to allocate risk. A credit default swap is a swap designed to transfer the credit exposure between parties. For example, the buyer of a credit swap receives credit protection (i.e., bought protection), whereas the seller of the swap guarantees the credit worthiness of the product (i.e., write protection). Other clearing members may choose to purchase all, some, or none of the defaulting member&#39;s portfolio of credit default swaps. 
     The credit default swaps that are not purchased, i.e., the illiquid credit default swaps, need to be distributed or absorbed in order to ensure market security. 
    
    
     
       BRIEF DESCRIPTION OF THE DRAWINGS 
         FIG. 1  illustrates one embodiment of an exchange system; 
         FIG. 2  illustrates one embodiment of a exchange computer system; 
         FIG. 3  illustrates one embodiment of a total portfolio margin of a defaulting clearing member; 
         FIG. 4  illustrates one embodiment of weights for each clearing firm; 
         FIG. 5  illustrates one embodiment of an aggregate margin; 
         FIG. 6  illustrates one embodiment of an allocated margin; 
         FIG. 7  illustrates one embodiment of a method for determining an allocated margin; 
         FIG. 8  illustrates one embodiment of a method for determining a margin weight; and 
         FIG. 9  illustrates one embodiment of a method for determining an operating income weight. 
     
    
    
     DETAILED DESCRIPTION 
     The present embodiments relate to allocation of a credit default swap portfolio. The portfolio may be allocated when a clearing firm defaults, i.e., goes bankrupt. The credit default swap portfolio may be allocated to non-defaulting clearing firms based on the size of the non-defaulting firm&#39;s portfolio, for example, relative to the portfolios of all the clearing firms. As a result, the risk of absorbing the defaulting portfolio may be absorbed among the non-defaulting firms in such a way that the distribution of the risk is fair and equitable to the non-defaulting firms. 
     As used herein, a credit default swap (CDS) transfers the credit exposure (read risk) of fixed income products between parties. A credit default swap is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults. The buyer of a credit swap receives credit protection. The seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap. The buyer of a credit swap will be entitled to the par value of the bond by the seller of the swap, for example, if the bond defaults in its coupon payments. 
     In one aspect, a method for allocating margin of a defaulting firm is provided. The method may include determining, using a computer exchange system, a total weight for a non-defaulting clearing firm. The non-defaulting clearing firm may maintain credit default swap portfolios. The method may further include determining an aggregated margin and determining an allocated margin of the margin of the defaulting firm for the non-defaulting clearing firm as a function of the total weight and aggregated margin. 
     In a second aspect, an exchange system is provided. The exchange system includes a processor and a memory coupled with the processor. The memory includes instructions that are operable to be executed to determine a total weight for a non-defaulting clearing firm, the non-defaulting clearing firm maintaining credit default swap portfolios; determine, using the computer exchange system, an aggregated margin; and determine an allocated margin of the margin of the defaulting firm for the non-defaulting clearing firm as a function of the total weight and aggregated margin. 
     In a third aspect, a system for allocating margin for a credit default swap portfolio is provided. The system includes a means for determining a total weight for a non-defaulting clearing firm, the non-defaulting clearing firm maintaining credit default swap portfolios; a means for determining an aggregated margin; and a means for determining an allocated margin of the margin of the defaulting firm for the non-defaulting clearing firm as a function of the total weight and aggregated margin. 
     In a fourth aspect, a method for allocating margin of a credit default swap portfolio is provided. The method includes identifying a credit default swap portfolio maintained by a defaulting clearing firm, determining a defaulting margin for the portfolio, the defaulting margin being determined using a margin model, and allocating the defaulting margin to one or more non-defaulting clearing firms based on account margins for each of the non-defaulting clearing firms. 
       FIG. 1  illustrates an exchange system  100 . The exchange system  100  includes an exchange computer system  10  and one or more clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26 . The exchange system  100  may include additional, different, or fewer components. Clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  may be futures commission merchants (FCM) or other organizations that work with the exchange&#39;s clearing house to handle confirmation, delivery, and settlement of transactions, such as orders to buy and/or sell future contracts or options on futures. Clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  ensure that executed trades are settled within a specified period of time and are generally independent intermediaries that specialize in clearing trades for brokers/dealers through the exchange-run clearing house. Clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  may be member firms of the exchange&#39;s clearing house and so are authorized to clear trades for its broker/dealer customers who are exchange members but not necessarily members of the exchanges clearing house. 
     Clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  may provide credit protection to customers. Credit protection may include write protection and/or bought protection. As used herein, write protection relates to the guarantee of protection against a credit event, such as a default. Bought protection relates to the buying of protection against a default event. The credit protection may be included in a credit default swap portfolio, as discussed below. 
     The clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  may own, operate, manage, control, or monitor one or more accounts  12   a,    12   b,    14   a,    16   a,    18   a,    20   a,    20   b,    22   a,    24   a,    24   b,    26   a,    26   b.  The one or more accounts may include house accounts  12   b,    14   a,    16   a,    20   b    24   a,    26   b;  customer accounts  12   a,    18   a,    20   a,    22   a,    24   a,    26   a;  or a combination thereof. The house accounts may include the clearing firm&#39;s credit default swap portfolio, for example, traded by the clearing firm. As shown in  FIG. 1 , the house accounts are illustrated with an “H.” The one or more accounts may be customer accounts  12   a,    18   a,    20   a,    22   a,    24   a,    26   a.  The customer accounts may include customer&#39;s credit default swap portfolio, for example, traded by customers. The clearing firm may provide market access to the customers. The customer accounts are illustrated with a “C.” 
     Clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26  may default when the clearing firm is unwilling or unable to pay a clearing firm debt, fails to pay back a loan, or does not satisfy a legal obligation. For example, clearing firm  18   a  may default when a customer is declared bankrupt. The customer may be a majority of the clearing firm&#39;s  18   a  business. Without the customer, the clearing firm  18   a  may be unable to satisfy legal obligations. 
     In one illustration, which will be referred to herein as the “illustration above,” clearing firm  26  defaults, i.e., is bankrupt or insolvent. At the time of default, clearing firm  26  may own a credit default swap portfolio having write protection and/or bought protection. The exchange computer system  10  may be used to allocate the credit default swap portfolio to the non-defaulting clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 . 
     The exchange computer system  10  may be owned, managed, controlled, monitored, programmed, sold, or used by an exchange. The exchanges may be a regulated or unregulated exchange or other electronic trading service making use of electronic trading systems. For example, the exchange may include the Chicago Board of Trade (CBOT), the Chicago Mercantile Exchange (CME), the Bolsa de Mercadorias e Futoros in Brazil (BMF), the London International Financial Futures Exchange, the New York Mercantile Exchange (NYMEX), the Kansas City Board of Trade (KCBT), MATIF (in Paris, France), the London Metal Exchange (LME), the Tokyo International Financial Futures Exchange, the Tokyo Commodity Exchange for Industry (TOCOM), the Meff Renta Variable (in Spain), the Dubai Mercantile Exchange (DME), and the Intercontinental Exchange (ICE). 
       FIG. 2  illustrates one embodiment of an exchange computer system  10 . The exchange computer system  10  may include an input  200 , a processor  210 , a memory  220 , and an output  230 . The processor  210  may be coupled with the input  200 , memory  220 , and/or output  230 . As used herein, “coupled with” may include directly connected or indirectly connected through one or more intermediary components. Intermediary components may include hardware and/or software components. 
     The input  200  may be a user input, network interface, external storage, or other input device for providing data to the system  100 . For example, the input  200  is a mouse, keyboard, track ball, touch screen, joystick, touch pad, buttons, knobs, sliders, combinations thereof, or other now known or later developed user input device. The user input may operate as part of a user interface. For example, one or more buttons are displayed on the output  230 . The user input is used to control a pointer for selection and activation of the functions associated with the buttons. Alternatively, hard coded or fixed buttons may be used. As another example, the input  200  is a hard-wired or wireless network interface. A universal asynchronous receiver/transmitter (UART), a parallel digital interface, a software interface, Ethernet, or any combination of known or later developed software and hardware interfaces may be used. The network interface may be linked to various types of networks, including a local area network (LAN), a wide area network (WAN), an intranet, a virtual private network (VPN), and the Internet. The input  200  may be used to access, receive, or otherwise obtain data stored in memory  220 . 
     The input  200  is an interface to receive data. The data may include margin data. Margin data may include data relating to the margin of one or more defaulting and/or non-defaulting clearing firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 ,  26 . As used herein, margin relates to collateral that the clearing firms deposit with the exchange to cover the credit risk of the counterparty. Collateral may be in the form of cash or securities and may be maintained in a margin account. The margin data may include the margin of one or more clearing firms or data that may be used to determine the portfolio margin of a defaulting clearing firm or non-defaulting clearing firm. For example, the margin data may include the data needed to apply a margin model, such as the ISDA margin model or a multi-factor margin model, to obtain the portfolio margin of one or more clearing firms. The multi-factor margin model may be the multi-factor margin model presented in U.S. application Ser. No. ______ [Attorney Docket No. 4672-735] ______, which was filed on ______, and is incorporated in entirety by reference. 
     The processor  210  may be operable to determine a portfolio margin of the defaulting firm using margin data obtained via the input  200 . The portfolio margin of the defaulting firm may be referred to as the defaulting margin. In the illustration above, as shown in  FIG. 3 , the portfolio margin of clearing firm  26   a , which may be referred to as the defaulting margin  300 , may be $900.00. The defaulting margin  300  may be determined by applying a margin model. 
     As shown in  FIG. 4 , the processor  210  may be operable to determine a total weight  400  for each non-defaulting clearing firm  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 . The total weight  400  may be determined based on a margin weight  410  and open interest weight  420 . As used herein, the margin weight  410  is the clearing firm&#39;s margin relative to all or some of the margin of all the non-defaulting firms  12 ,  14 ,  16 ,  18 ,  20 ,  22 ,  24 . The open interest weight  420  is the clearing firm&#39;s open interest relative to the entire open interest of all the firms. Open interest may be an outstanding position that is not closed. The position may be a buy position or sell position. 
     The margin weight  410  may be determined based on a margin requirement  430  and margin weighting  440 . The margin requirement  430  may be the margin required to maintain that account. For example, in order to maintain the customer account  12   a,  the clearing firm  12  may be required to maintain $400 in a margin account with the exchange. The margin requirement  430  may be determined based on the credit default swap portfolio (e.g., the size of the CDS portfolio) and a margin model. The account weight  440  may be a qualitative or quantitative weight. The account weight  440  may be determined relative to the other accounts. For example, as shown in  FIG. 4 , the account weight  440  may be determined based on whether the account is a house account or customer account. In order to give more weight to a house account, the house account weight may be “2” and the customer account weight may be “1.” In other embodiments, this may be switched. Alternatively, the house account weight may be the same as the customer account weight. The account weight  440  may be set by an exchange, clearing firm, or other operator. 
     Once the margin requirement  430  and account weight  440  for each clearing firm account is determined, the processor  210  may determine the weighted margin  450 . The weighted margin  450  may be determined based on the margin requirement  430  and account weight  440  for each clearing firm. The weighted margin  450  may be determined using Equation 1. 
         WM  450=( MR   1   *AW   1 )+( MR   2   *AW   2 ) . . . ( MR   n   *Aw   n )   Equation 1
 
     In Equation 1, MR 1  is the margin requirement for a first account and AW 1  is the account weight for the first account. For example, in  FIG. 4 , the margin requirement  430  for account  12   a  may be  400  and the account weight  440  for account  12   a  is “1.” The weighted margin for account  12   a  may be determined by multiplying “ 400 ” and “1.” The weighted margin  450  may be determined by summing the weighted margins for each of the clearing firm accounts. 
     The margin weight  410  may be determined for each account may be determined based on the weighted margin  450  and the weighted margins for each of the accounts. For example, as discussed above, the weighted margin for account  12   a  is “400” and the weighted margin  450  is “4330.” The processor  210  may determine the percentage of the weighted margin  450  of the weighted margin for account  12   a.  In this example, “400” is 9.2% of “4330.” The margin weight for account  12   a  is 9.2%. The processor  210  may determine the margin weight for each of the accounts. 
     The open interest weight  420  may be determined based on the open interest of each clearing firm  460  and the open interest weighting  470 . The open interest  460  may be the open interest for an account. Open interest may be an outstanding position that is not closed. The position may be a buy position or sell position. The open interest may be gross notional open interest. Gross notional of open interest is the sum of the credit default swap open interest for a particular firm without netting any positions. For example, as shown in  FIG. 4 , the open interest for account  12   a  may be 40,000,000,000 buying protection or selling protection. The account weight  470  may be a qualitative or quantitative weight. The account weight  470  may be determined relative to the other accounts. For example, as shown in  FIG. 4 , the account weight  470  may be determined based on whether the account is a house account or customer account. In order to give more weight to a house account, the house account weight may be “2” and the customer account weight may be “1.” In other embodiments, this may be switched. Alternatively, the house account weight may be the same as the customer account weight. The account weight  470  may be set by an exchange, clearing firm, or other operator. 
     The processor  210  may determine the weighted open interest  480 . The weighted open interest  480  may be determined based on the open interest  460  and account weight  470 . For example, the weighted open interest  480  may be determined using Equation 2. 
         WOI  480=( OI   1   *AW   1 )+( OI   2   *AW   2 ) . . . (i OI n   *OI   n )   Equation 2
 
     In Equation 1, OI 1  is the open interest for the first account and AW 1  is the account weight for the first account. For example, in  FIG. 4 , the open interest  460  for account  12   a  may be 40,000,000,000 and the account weight  470  for account  12   a  is “1.” The weighted open interest for account  12   a  may be determined by multiplying “40,000,000,000” and “1.” The weighted margin  480  may be determined by summing the weighted margins for each of the clearing firm accounts. In this example, the weighted open interest  480  may be “324,433,300,000.” 
     The open interest weight  420  may be determined based on the weighted open interest  480  and the weighted margins for each of the accounts. For example, as discussed above, the weighted margin for account  12   a  is “40,000,000,000” and the weighted open interest  480  is “324,433,300,000.” The processor  210  may determine the percentage of the weighted margin  480  of the weighted margin for account  12   a.  In this example, “40,000,000,000” is 12.3% of “324,433,300,000.” The open interest weight  420  for account  12   a  is 9.2%. The processor  210  may determine the open interest weight for each of the accounts. 
     The average weight  490  may be the average of the margin weight  410  and the open interest weight  420 . For example, the average of the margin weight  410  and the operating income weight  420  may be determined using Equation 3. 
         AW  490=[ MW  410+ OI  Weight 420]/2   Equation 3
 
     The total weight  400  for each non-defaulting clearing firm may be determined using the margin weight  410 , open interest weight  420 , and one or more scaling factors. The scaling factors may be used to scale the margin weight  410  and open interest weight  420 . The scaling factors may be qualitative or quantitative scaling factors. The scaling factors may be used to adjust the margin weight  410  and open interest weight  420  relative to each other. The scaling factors may be set by an exchange, clearing firm, or other operator and may remain constant or change over time. The total weight  400  may be determined using Equation 4. 
         TW  400=(1+ SF )* AW  490   Equation 4
 
     In equation 4, the scaling factor SF is used in order to weight open interest or margin higher to produce the effective weight. The decision of whether to tilt (i.e., scale) the allocation weights more towards open interest than margin or vice versa depends on the risk management team&#39;s decision. The scaling factor SF may be based the depth of the credit default swap order book, the amount of credit default swap margin paid, and the amount of capital and security deposit that the credit default swap clearing firms have. 
     The processor  210  may determine the margin allocated to each clearing firm, which may be referred to as the clearing firm&#39;s allocated margin. The clearing firm&#39;s allocated margin may be determined based on the total weight  400  for the clearing firms and the aggregated margin. As shown in  FIG. 5 , the aggregated margin may be the sum of all the margins after the defaulting firm&#39;s credit default swap portfolio is allocated to all the clearing firms (i.e., is split). In the illustration above, as shown in  FIG. 5 , the aggregate margin  500  for the clearing firm is $1500. As shown in  FIG. 6 , the clearing firm&#39;s allocated margin  600  may be determined based on the aggregate margin  500  and the total weight  400  of  FIG. 4 . Accordingly, the allocated margin  600  for clearing firm  12  may be determined based on the aggregate margin  500  and the total weight  400  for clearing firm  12   a  and the total weight for clearing firm  12   b.  More specifically, the allocated margin  600  for clearing firm  12  may be determined using Equation 5. 
         AM  600= TW   Rx   *AM  500   Equation 5
 
     In Equation 5, “TW Rx ” is the sum of the total weight for the clearing firm&#39;s accounts. For example, in the illustration above, the TW Rx  for clearing firm  12  is 23% (i.e., 11.1%+11.9%) for clearing firm  12   a  and clearing firm  12   b.  As a result, the allocated margin  600  for clearing firm  12  is $344.21. 
     The allocated margin indicates the amount of the defaulting margin that the clearing firm is responsible for absorbing. The credit default swap positions that equate to the margin are moved from the defaulting firm&#39;s portfolio to the receiving clearing firm&#39;s portfolio. This may be performed automatically (e.g., without user interaction), for example, using the system  100  or manually by an authorized user. 
     Referring back to  FIG. 2 , the memory  220  may be computer readable storage media. The computer readable storage media may include various types of volatile and non-volatile storage media, including, but not limited to, random access memory, read-only memory, programmable read-only memory, electrically programmable read-only memory, electrically erasable read-only memory, flash memory, magnetic tape or disk, optical media and the like. The memory  220  may be a single device or a combination of devices. The memory  220  may be adjacent to, part of, networked with and/or remote from the processor. 
     Data representing instructions, executable by the processors, may be stored in the computer readable storage media. Logic encoded or embedded in one or more tangible media for execution is defined as the instructions that are executable by the programmed processor and that are provided on the computer-readable storage media, memories, or a combination thereof. The one or more processors may be programmed with and execute the instructions. The functions, acts, methods or tasks illustrated in the figures or described herein may be performed by the programmed processor executing the instructions stored in the memory. The functions, acts, methods or tasks are independent of the particular type of instructions set, storage media, processor or processing strategy and may be performed by software, hardware, integrated circuits, firmware, micro-code and the like, operating alone or in combination. The instructions are for implementing the processes, techniques, methods, or acts described herein. 
     The display  230  is a cathode ray tube (CRT), liquid crystal display (LCD), plasma, projector, monitor, printer, or other output device for showing data. The display  16  is operable to display an image. The image may be of an allocated margin image, chart, graph, value, or other allocated margin information. Allocated margin images, charts, graphs, values, or other allocated margin information may be used to represent an allocated margin for a clearing firm or clearing firm account. In an alternative embodiment, the processor  210  may be operable to output an allocated margin image, chart, graph, text, audio, value, or other information to other devices, such as speakers, memory, networks, or other interfaces. 
       FIG. 7  illustrates one embodiment of a method  700  for determining an allocated margin of a credit default swap portfolio. The method  700  may include determining a defaulting margin  710 ; determining a total weight for non-defaulting clearing firm  720 ; and determining an allocated margin for the non-defaulting clearing firm as a function of the total weight and defaulting margin. The non-defaulting clearing firm may include one or more accounts having credit default swap portfolios. The allocated margin may be determined based on the margin and open interest of the one or more accounts. The acts may be performed in the order shown or a different order. For example, act  720  may be performed prior to act  710 . 
     In act  710 , an exchange computer system may determine a defaulting margin using a margin model. The exchange computer system may use information about a defaulting clearing firm&#39;s accounts with the margin model to determine the defaulting margin. Any margin model may be used. Alternatively, determining the defaulting margin may include receiving the defaulting margin, for example, via a network or storage device. The defaulting margin may be transmitted to the exchange computer system. 
     In act  720 , the exchange computer system may determine a total weight for a non-defaulting clearing firm. Determining the total weight may include determining a margin weight and an open interest weight.  FIG. 8  illustrates one embodiment of a method  800  for determining a margin weight. As shown in  FIG. 8 , the method  800  may include determining a margin requirement  810 , account weight  820 , weighted margin  830 , and account margin weighting  840 . The acts may be performed in the order shown or a different order. Determining a margin requirement  810  may include using a margin model. Margin data, for example, about a non-defaulting account, may be used with the margin model to determine the margin requirement. Determining the account weight  820  may include setting a weighting to properly weight the one or more non-defaulting accounts. For example, a house account may be weighted more or less than a customer account. The account weightings may be predetermined or dynamically determined. Determining the weighted margin  830  may include determining a weighted margin for each of the non-defaulting accounts and summing the weighted margins together. Determining the account margin weighting  840  may include determining a percentage of the weighted total margin for each individual, non-defaulting account, which may include dividing the weighted margin for an individual, non-defaulting account by the total weight margin. 
       FIG. 9  illustrates one embodiment of a method  900  for determining an open interest weight. As shown in  FIG. 9 , the method  900  may include determining an open interest  910 , account weight  920 , weighted open interest  930 , and account open interest weighting  840 . The acts may be performed in the order shown or a different order. Determining an open interest  910  may include importing data about the account. Open interest data, for example, about a non-defaulting account, may be used to determine the margin requirement. Determining the account weight  920  may include setting a weighting to properly weight the one or more non-defaulting accounts. For example, a house account may be weighted more or less than a customer account. The account weight determined in act  920  may be the same or different than the account weight determined in act  820 . The account weights may be predetermined or dynamically determined. Determining the weighted open interest  930  may include determining a weighted open interest for each of the non-defaulting accounts and summing (i.e., adding) the weighted open interests. Determining the account margin weighting  940  may include determining a percentage of the weighted total open interest for each individual, non-defaulting account, which may include dividing the weighted margin for an individual, non-defaulting account by the total weight open interest. 
     Referring back to  FIG. 7 , as shown in act  730 , the exchange computer system may determine an allocated margin for the non-defaulting clearing firm as a function of the total weight and aggregated margin. Determining the allocated margin may include transferring or spreading the allocated margin for a non-defaulting clearing firm to the non-defaulting clearing firm&#39;s margin account. Transferring or spreading may include moving, updating, or otherwise making the non-defaulting clearing firm responsible for the allocated margin. Furthermore, determining the allocated margin may include notifying, for example, via email, account statement, etc., that the allocated margin was transferred or spread to the non-defaulting clearing firm&#39;s margin account. 
     Various improvements described herein may be used together or separately. Any form of data mining or searching may be used. Although illustrative embodiments have been described herein with reference to the accompanying drawings, it is to be understood that the invention is not limited to those precise embodiments, and that various other changes and modifications may be affected therein by one skilled in the art without departing from the scope or spirit of the invention.