A clearing house must ensure that it has adequate resources to absorb the losses that result from the default of one or more clearing members. The resources are contributed by the CCP itself as well as by its clearing members. The total resources available to the CCP for this protection is commonly referred to as the Waterfall and shows the order in which the CCP can use these resources. The Nasdaq Clearing waterfall is illustrated below.
In order to avoid having to use any of the resource in the waterfall, the first layer of protection for the clearing house is its membership requirements, its margining methodology, its collateral requirements, and its pro-active risk management.
Defaulted party’s initial margin
If a clearing member is declared in default and there are costs incurred by the clearing house in order to handle the portfolio of the defaulting member, the clearing house will start by using the margin collected from the defaulting member.
Defaulted party’s default fund contribution
If the margin collected from the defaulted member is insufficient to cover the costs associated with the default, the clearing house will use the defaulted party’s default fund contribution.
Nasdaq Clearing Junior Capital
In the event of a counterparty default where the defaulting counterparty’s posted margin and default fund contribution is not sufficient to cover the cost of closing out the portfolio, Nasdaq Clearing’s Junior Capital will absorb the first layer of loss. A specific amount of Junior Capital is dedicated for each market.
Loss Sharing Pool
In the event of a default including OTC-traded interest rate derivatives (so-called Generic Rate Instruments), default losses from such derivatives and other related fixed income contracts remaining after the Junior Capital has been exhausted will be covered by the Loss Sharing Pool, consisting of assets posted by the clearing members active in this market.
Default Fund (Commodities/Financial Market/Seafood Market)
There are separate default funds for each clearing service. Each default fund is limited to counterparty defaults within its own clearing service. The size of each default fund is calculated to withstand a default of either the clearing service’s largest, or of the second and third largest counterparty combined, in an extreme but plausible scenario. Contributions to each of the default funds are only available to cover default losses in that particular market.
Nasdaq Clearing Senior Capital
The size of this layer, Nasdaq Clearing’s Senior Capital, is calculated to be sufficiently large to ensure that, when aggregated with the Junior Capital and Default Funds per clearing service, Nasdaq Clearing will withstand a default of the two largest counterparties, under an extreme but plausible scenario.
Nasdaq Clearing holds an Assessment Power as a final layer in the waterfall. This ultimate layer strengthens the clearing house’s contingent financial resources by committing clearing members to contribute additional capital in the event that prior levels of protection have not been sufficient to cover counterparty default(s). The commitment equals an obligation to provide additional funds up to an amount equal to 100% of each clearing member’s contribution to the Financial Default Fund, the Commodities Default Fund, and the Seafood Default Fund.
Commitments based on the default fund contributions to the financial market are only available to cover default losses in the financial market, commitments based on the default fund contributions to the commodities market are only available to cover default losses in the commodities market, and commitments based on the default fund contributions to the seafood market are only available to cover default losses in the seafood market.
If any of the clearing capital funds (including default funds) are used due to a default of a counterparty, the capital used must be replenished through new contributions by the non-defaulting clearing participants and Nasdaq Clearing. Replenishment of the clearing capital shall follow a procedure similar to the one applied to quarterly contribution procedures, but in a separate replenishment contribution request. Such replenishment shall be effected within two business days after request (including capital provided by Nasdaq Clearing).
Other Regulatory Capital
In addition to capital held to withstand counterparty defaults, Nasdaq Clearing also holds capital to ensure that it is adequately protected from operational, legal, business, and investment risks, so called Non-Default-Losses. In addition to the funds described above, Nasdaq Clearing holds sufficient Operational Capital to ensure an orderly winding-down or restructuring of its operations.
For further details about the default fund and other financial resources of Nasdaq Clearing, please refer to the Resource Center, below.
Regulation requires qualifying central counterparties (QCCPs), such as Nasdaq Clearing, to submit specific data points to assist clearing members in determining their default fund exposures towards Nasdaq Clearing. The Current Exposure Method (CEM) is used to calculate the hypothetical capital of the CCP and the resulting c-factors, that are calculated individually for each default fund, are published in the Excel spreadsheet which can be retrieved in the link below (CRD IV CCP notification, under Resource Center). The c-factors are to be applied to the value of the default fund contribution in order to calculate the hypothetical capital of the clearing member. The spreadsheet is updated each month with end-of-month data.
Standing Settlement Instructions for Default Fund Download Standing Settlement Instructions for Default Fund