Futures and Index Options (HKCC) 
29/09/2017 
 

The Hong Kong Futures Exchange (HKFE), a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Limited (HKEX), provides and regulates a marketplace where futures and options are traded. The HKFE Clearing Corporation Limited (HKCC), another HKEX subsidiary, clears and guarantees all HKFE trades through its facilities; and sets minimum margin levels for all HKFE products. It becomes the central counterparty to every validly executed trades through the process of novation.

The System

Risk management is the primary function of HKCC safeguard system. The System is to provide the highest level of safety and the early detection of unsound financial practices. Its purpose is to protect all HKCC Participants and their customers against the consequences of a default by a participant in the clearing structure. The system is constantly being reviewed and modified to reflect the most advanced risk management techniques.

 

The Safeguards

Clearing Participantship Standard

Participantship standard is the first line of defense in the risk management system.  There are two categories of the clearing participantship, namely, Individual Clearing Participantship and General Clearing Participantship.  The clearing participantship is only open to the HKFE Participants.

Individual Clearing Participants should have minimum liquid capital of HK$5 million and General Clearing Participants should have at least liquid capital of HK$20 million.  In addition to the financial requirement, HKCC also considers the other factors including (1) the company background, (2) financial conditions, (3) the experience of the company’s directors and key personnel and (4) the risk management system employed by the company.

Clearing System

The Derivatives Clearing and Settlement System (DCASS) is an integrated clearing and settlement system for the derivative markets covering futures and options products of HKEX.  It is a fully electronic and automated clearing and settlement system capable of supporting many types of derivatives products.  It also provides a seamless interface for derivatives trading and clearing, which reduces cost through common hardware, software and communication links. DCASS enables Participants to establish and maintain positions in either the house or the client accounts. 

Margining System

Margin requirements are good faith deposits to guarantee the performance of the contracts. Clearing House and Client margin levels for all products traded in HKFE are established with reference to historical price volatilities, current and anticipated market conditions, and other relevant information. HKCC calculate the margin requirements of their participants at the end of each trading day using PRiME, (Portfolio Risk Margining System of HKEX), a SPAN[1] compatible margining algorithm that underpins the margining engine of DCASS.  PRiME determines the margin requirements based on its assessment of the maximum potential risk exposure of a portfolio over a one-day period under different realistically simulated market scenarios.  It takes into consideration of the major risk factors, such as the movement in the prices and volatilities of underlying assets, the time until expiration and the risk-free interest rate when assessing the potential loss (risk) of the portfolio’s value. Margin levels are routinely reviewed and will be revised should market conditions change.

HKCC performs regular backtesting to evaluate the margin coverage and regular sensitivity analysis to test the sensitivity of the margin model coverage. The latest results as of March 2017 reveal that the model performance is satisfactory. The margin coverage for major products and all Clearing Participants' portfolios can achieve single-tailed confidence level of at least 99%. 

 

Daily Mark-To-Market

HKCC reduces its risk through the mark-to-the-market process at the close of Markets each trading day for each contract.  All open positions are revaluated daily, on the basis of their respective closing prices and any resulting losses should be settled by Clearing Participants before the opening of Markets on the next day.  Collections from Clearing Participants are processed by the Direct Margin Debiting System (“DMDS”) through which HKCC instructs its settlement banks to direct debit the Clearing Participant’s bank account.  Money settlement conducted by settlement banks should be confirmed before 9:15 a.m. to assure that all open positions are fully margined before the opening of Markets.

Mandatory Intra-day Variation Adjustment and Margin Call

Following the market open of T Session on each Business Day, HKCC conducts a mandatory Intra-day Variation Adjustment and Margin call on markets with a T+1 Session (and any other markets whose underlying instrument is the same as or similar to the underlying instrument of any such markets) on Clearing Participants.  The calculation is based on the prevailing open positions as at 8:45 a.m. and the Calculated Opening Prices of the relevant markets in the T Session.  The mandatory call includes both margin and variation adjustment (i.e. Mark-To-Market) to ensure that all positions, including trades transacted during the preceding T+1 Session, are fully margined and reduce the risk of HKCC from the preceding T+1 Session during which intra-day call is not available.  HKCC will collect any shortfall amounts that exceed HK$2 million by DMDS and Clearing Participants will receive notification calls from HKCC on their settlement amounts by 10:00 a.m.  All money settlement amounts should be met by Clearing Participants within two hours after the notification or by noon on the same business day.

Intra-day Margin Call

During periods of high market volatility, HKCC conducts intra-day mark-to-the-market calculations on real-time open positions using the prevailing market prices.  Clearing Participants who suffer losses as a result of the intra-day calculation will receive a call from the HKCC.  All intra-day margin calls should be met by Clearing Participants within one hour after the notification.  On the other hand, if an intra-day mark-to-the-market calculation is made at or before 12:30p.m., Participants will receive payments from the HKCC if they make profits arising from the intra-day calculation.  Generally, a margin erosion of 25% in any Market will automatically trigger the intra-day margin call in that Market and/or any other Market whose underlying instrument is the same as or similar to the underlying instrument of that Market. Apart from the ad-hoc intra-day margin call which is triggered by market volatility, HKCC conducts a routine intra-day assessment on each HKCC Participant’s Capital Based Position Limits (“CBPL”) after the close of the morning trading session and issues intra-day margin calls to HKCC Participants who are in breach of their CBPL. With the capacity to conduct intra-day margin calls, HKCC is not forced to wait until the settlement on the next day and margins for those contracts whose prices have changed significantly can be restored immediately.

Capital Based Position Limit

HKCC assigns gross and net position limits to each Clearing Participant on the basis of its apportioned Liquid Capital (“LC”).  It is a measure which seeks to ensure that the risk exposures of participant commensurate with their financial strength in terms of LC. Should an HKCC Participant's total Gross and/or Net position exposure exceed the assigned limits, the Participant can extend the limit by increasing its liquid capital. In addition, during the T+1 session where banking service is not available, HKCC performs monitoring of HKCC Participants’ net CBPL based on the latest market prices and positions on an hourly basis to ensure HKCC Participants’ exposures are within the limits.

Additional Margin on Concentrated Positions

To minimize the risk arising from the over-concentration of open Futures and Options positions on one Participant, HKCC has the authority to impose additional margins on individual Participants.  If the projected aggregate loss (less any Clearing House margin) based on the Reserve Fund stress assumptions arising from such open Futures and Options positions (“Net Projected Loss”) held by a Participant in any product group^ is greater than 30% of total Net Projected Loss of all Participants and the total Net Projected Loss of the product group exceeds of HK$500 million, HKCC will increase the margin level by 20% or more# (depends on its concentration level in that particular product group) on that Participant.

 

^List of Product Groups

Product Group

Products

Hang Seng Index (HSI) Futures & Hang Seng China Enterprises Index (HSCEI) Futures Product Group

  • HSI Futures
  • HSI Options
  • Flexible HSI Options
  • Mini-HSI Futures
  • Mini-HSI Options
  • HSCEI Futures
  • HSCEI Options
  • Flexible HSCEI Options
  • Mini-HSCEI Futures
  • Mini-HSCEI Options

CES China 120 Index Futures Product Group

  • CES China 120 Index Futures

HSI Volatility Index Futures Product Group

  • HSI Volatility Index Futures

HSI Dividend Point Index Futures Product Group

  • HSI Dividend Point Index Futures

HSCEI Dividend Point Index Futures Product Group

  • HSCEI Dividend Point Index Futures
CES Gaming Top 10 Index Futures Product Group
  • CES Gaming Top 10 Index Futures
Hang Seng Mainland Oil & Gas Index Futures Product Group
  • Hang Seng Mainland Oil & Gas Index Futures
Hang Seng Mainland Banks Index Futures Product Group
  • Hang Seng Mainland Banks Index Futures
Hang Seng Mainland Healthcare Index Futures Product Group
  • Hang Seng Mainland Healthcare Index Futures
Hang Seng Mainland Properties Index Futures Product Group
  • Hang Seng Mainland Properties Index Futures
Hang Seng IT Hardware Index Futures Product Group
  • Hang Seng IT Hardware Index Futures
Hang Seng Software & Service Index Futures Product Group
  • Hang Seng Software & Service Index Futures

London Aluminium Mini Futures Product Group

  • London Aluminium Mini Futures

London Copper Mini Futures Product Group

  • London Copper Mini Futures

London Zinc Mini Futures Product Group

  • London Zinc Mini Futures
London Nickel Mini Futures Product Group
  • London Nickel Mini Futures
London Tin Mini Futures Product Group
  • London Tin Mini Futures
London Lead Mini Futures Product Group
  • London Lead Mini

One-Month Hong Kong Interbank Offered Rate (HIBOR) Futures Product Group

  • One-month HIBOR Futures

Three-Month HIBOR Futures Product Group

  • Three-Month HIBOR Futures

5-Year China Ministry of Finance Treasury Bond Futures Product Group

  • 5-Year MOF T-Bond Futures

Individual Hong Kong Stock Futures Product Group

  • Individual Hong Kong Stock Futures

IBOVESPA Futures Product Group

  • IBOVESPA Futures

MICEX Index Futures Product Group

  • MICEX Index Futures

S&P BSE SENSEX Index Futures Product Group

  • S&P BSE SENSEX Index Futures

FTSE/JSE Top40 Futures Product Group

  • FTSE/JSE Top40 Futures

US Dollar vs Renminbi (Hong Kong) Currency Futures Product Group

  • US Dollar vs Renminbi (Hong Kong)(“USD/CNH”) Futures
  • US Dollar vs Renminbi (Hong Kong)(“USD/CNH”) Options
  • Renminbi (Hong Kong) vs US Dollars (“CNH/USD”) Futures
Euro vs Renminbi (Hong Kong)(“Euro/CNH”) Futures Product Group
  • Euro vs Renminbi (Hong Kong)(“Euro/CNH”) Futures
Japanese Yen vs Renminbi (Hong Kong)(“JPY/CNH”) Futures Product Group
  • Japanese Yen vs Renminbi (Hong Kong)(“JPY/CNH”) Futures
Australian Dollars vs Renminbi (Hong Kong)(“AUD/CNH”) Futures Product Group
  • Australian Dollars vs Renminbi (Hong Kong)(“AUD/CNH”) Futures
USD and CNH Gold Futures Product Group
  • USD Gold Futures
  • CNH Gold Futures

#Tiered Margin Rate

A CP’s Market Share of Net Projected Loss

Additional Margin Rate

Above 30% and at or below 40%

20%

Above 40% and at or below 50%

25%

Above 50% and at or below 60%

30%

Above 60% and at or below 80%

40%

Above 80%

   50%##

##Applicable on the sixth consecutive Business Days and onwards, before which 40% would be applied, to allow 5 days for CPs to transfer or close out concentrated positions and/or arrange funding.

 

Holiday Margin Arrangement

HKCC has put in place a set of holiday margin arrangements to mitigate the potential market risk on the reopening of the Hong Kong markets after the holiday break arising from significant overseas market movements during the holiday period. Currently, when there is one calendar day, excluding Saturdays and Sundays, in the Hong Kong holiday period, HKCC makes a mandatory intra-day call of variation adjustment on its participants on the trade day prior to the holiday period to mitigate the potential market risk. When there are more than one calendar day, excluding Saturdays and Sundays, in the Hong Kong holiday period, in addition to the mandatory intra-day call of variation adjustment, HKCC also raises the margin levels for some major products based on the historical price movement with reference to the number of calendar days, excluding Saturdays and Sundays, in the holiday period and collects the margin requirements of open positions based on such increased margin levels from the participants before the holiday.

Reserve Fund

HKCC has established a Reserve Fund for the purpose of meeting its obligations as the counterparty in circumstances that the losses arising from one or more Clearing Participants’ default cannot be fully covered by the defaulting Participant’s margin. The resources available to the Reserve Fund comprise HKCC Participant’s Deposits, HKCC Participant Additional Deposits (HPAD), interest income earned on the cash deposits of the Reserve Fund, Clearing House resources appropriated to the Reserve Fund and other resources as arranged by HKCC from time to time.

In addition to establishing the Reserve Fund, HKCC has put in place a Contingent Advance Capital (CAC) arrangement (under the financial support from HKEX) to provide additional funding in the event that the resources of the Reserve Fund are insufficient to meet its liabilities arising from a Participant default situation.  To the extent any amount available under the CAC is utilized, HKCC will exercise its power under the Rules to recover the utilized amount from HKCC Participants.

The adequacy of the Reserve Fund is assessed on a daily basis by conducting stress testing and HKCC will require participants to pay such amounts by way of HPAD for the purpose of providing further additional resources to the Reserve Fund.

Key stress testing assumptions are:

  • Market movement assumptions: ±20% applied to key markets* including HSI futures and options and HSCEI futures and options
*The price movement assumptions for HKCC products: 
 (a) Equity products: ±17% to ±56% 
 (b) Currency products: ±4% to ±9%
 (c) Interest Rate and Fixed Income products: ±2% to ±30%
 (d) Metal products: ±12% to ±18% 
  • Counterparty default assumptions:  default of the single largest Participant plus the fifth largest Participant

 

Level of HPAD required = [(Projected Loss from stress testing – Defaulting participants’ Margin and collateral**) ÷ 90% – Basic Elements of Reserve Fund***] ÷ 2

** Collateral includes clearing house margin and surplus funds

*** Denotes the existing aggregate value of the Reserve Fund less the total HPAD

HKCC will re-calculate the requirements for HPAD of each Participant on the 1st business day of every month and ad hoc recalculation may be made from time to time.

HKCC Participants will be required to pay HPAD under either of the following conditions:

  • Under the regular monthly assessment where the existing contributions amount is lower than the required contributions; or
  • Daily risk exposure exceeds 90% of the sum of the existing aggregate value of the Reserve Fund and the maximum amount of funding which may be made available under the HKCC Contingent Advance Capital for one business day

If HPAD is required, HKCC will calculate each Participant’s contribution requirement based on each Participant’s daily average net margin liabilities over the most recent 60 business days. Any HPAD payable by an HKCC Participant will be debited from its House CCMS Collateral Account via the Direct Margin Debiting System by 4:00 p.m. of the 1st business day after the recalculation, unless otherwise specified by the Clearing House.

 

HPAD may be contributed in the form of non-cash collateral such as Exchange Fund Bills and Notes provided prior approval is obtained from the Clearing House.

For more details, please refer to Chapter VII – The Reserve Fund of the Rules of HKCC and Chapter 4 – Reserve Fund Contribution of the Clearing House Procedures of HKCC by the hyperlink below:

http://www.hkex.com.hk/eng/rulesreg/clearrules/hkcc/futrule_accept.htm

Collateral Management

Participants' margin deposits must be in the form of cash, Exchange Fund Bills/Notes, US Treasury Bills/Notes or other acceptable collateral types as prescribed from time to time. If a participant does not have sufficient margin collateral on deposit with HKCC to satisfy the margin requirements calculated, a direct debit instruction will be sent to the participant's designated bank to collect the shortfall.  All margin calls must be met before the stipulated time. 

Segregation of Customer Monies

Participants are also required to separate their customer positions and monies from their own positions. The regulations are designed to protect customers in the event of the insolvency of financial instability of the HKCC Participant through which they conduct business. Based on specific written instructions from a HKCC Participant, HKCC maintains separate accounting of the aggregate positions and monies of the HKCC Participant's customers.

Monitoring Client Exposure

Although HKCC’s direct exposure is to its Clearing Participants, if a Participant holds large positions for a client who subsequently defaults, this could affect the solvency of the Clearing Participant concerned.  For this reason, HKFE sets a position reporting level for each Market at the client level.  For example, if a client maintains more than 500 open contracts in the HSI Futures Market, the Participant must report such large open positions to the HKFE. No customer is allowed to hold HSI futures and option positions in excess of 10,000 delta. Based on these information, HKCC can better analyze the risk exposure of Clearing Participants.  Particular attention is paid to those Clearing Participants whose positions are concentrated on a few clients.

HKCC Participant's Default

While the risk management techniques at HKCC are specifically designed to prevent an HKCC Participant from defaulting on its obligations, the Clearing House, by rule and by operational practice, has prepared contingencies to deal with such an event. The following summarizes the steps that would be taken in the event an HKCC Participant failed to meet its financial obligations to HKCC.

The HKCC managed Reserve Fund provides instant liquidity to the market in the event that the HKCC Participant cannot meet margin calls and his margin monies have been exhausted. When an HKCC Participant defaults, customer positions are netted against each other and the HKCC Participant's margin money is applied to any deficits after netting. If the deficit exceeds funds available in the HKCC Participant's margin deposits, the balance will be applied from the Reserve Fund in layers.  In the event that the Reserve Fund is insufficient to cover HKCC’s liabilities even after its resources have been fully depleted as result of the application, HKCC may apply any funding available under the HKCC Contingent Advance Capital towards the satisfaction of its outstanding liabilities.  Under no circumstances will customer segregated margin deposits held by the Clearing House for one HKCC Participant be used to cover either a house or customer default of another HKCC Participant. Customers doing business through an HKCC Participant not involved in a default are insulated from losses incurred by the failure of another HKCC Participant.

 

Conclusion

The safeguard system of the HKCC provides a unique blend of risk management and financial surveillance techniques designed for the protection of the Clearing Participants and its customers. As the Clearing House strives to become more responsive to the demands of a sophisticated financial marketplace, it will continue to improve and strengthen its financial safeguard system. This article has been compiled by the HKCC for general information purposes only. Although every attempt has been made to ensure the accuracy of the information, the HKCC assumes no responsibility for any error or omission. All matters pertaining to rules and procedures herein are made subject to and are superseded by the official HKCC Rules and Procedures.

 



 

[1] SPAN (Standard Portfolio Analysis of Risk) is a registered trademark of the Chicago Mercantile Exchange