OTC Clear has established a default management process which is aimed at reducing and neutralizing the overall risk arising from the occurrence of default event with respect to one or more Defaulting Clearing Members and applicable affiliates/clients. Once a default event is triggered, OTC Clear will perform the following procedures, to the extent practical:
The objective of hedging is to mitigate, to the extent commercially practicable, any risk or economic exposure to OTC Clear and Non-Defaulting Clearing Members which arises as a result of the occurrence of an event of default.
Once the risk of the defaulted portfolio is substantially reduced by hedging, OTC Clear will commence an auction process as soon as reasonably practicable. OTC Clear will in consultation with the Default Management Group, construct various Auction Portfolios in respect of the contracts relating to a Defaulting Clearing Member. The Auction Portfolios will be offered to Non-Defaulting Clearing Members to bid on. The Successful Bidder(s) will take up the Auction Portfolios and assume the obligations and liabilities of the trades pertaining to the Defaulting Clearing Members.
In an event of default, OTC Clear will be required to meet the payment obligations of the Defaulting Clearing Member, and financial resources held by OTC Clear will be applied towards the losses arising from such default.
OTC Clear defines the priority of resources utilization. As shown in the diagram below, losses incurred in an event of default will first be covered by the Defaulting Clearing Member’s Margin Balance and its Rates & FX Guarantee Fund Contribution. When all the financial resources from the Defaulting Clearing Member are exhausted, the default losses will be satisfied by OTC Clear's 1st tranche Contribution and thereafter the balance of Non-Defaulting Clearing Members’ Rates and FX Contributions.
OTC Clear Risk Waterfall
The adequacy of the Rates and FX Guarantee Fund will be validated daily and the fund will be resized monthly. In addition, OTC Clear has the right to re-size the Rates and FX Guarantee Fund on an ad hoc basis.
For details on the risk waterfall and loss attribution process, please refer to Chapter 15 of the Clearing Rules.