SINGAPORE – Public consultations are being sought over proposed changes for the Central Depository’s (CDP) margining framework and clearing fund.

The CDP provides clearing services, assuming the role of seller to buyers, and buyer to sellers.

When a clearing member defaults on its obligations to the CDP, any loss will first be met with margins collected from the defaulter.

If the loss exceeds the defaulter’s margins, the clearing fund will be used to mutualise the loss. These measures help to mitigate the impact that a default could have on the rest of the financial system.

Three changes have been proposed to the margining framework to make the margin required of each clearing member more aligned with its level of risk to the system. This would reduce the likelihood of using the clearing fund in the event of a default.

The first proposed change is to offer differentiated margin rates for groups of securities with different risk profiles.

The CDP charges all securities based on a single margin rate, which is based on the weighted volatility of the FTSE Straits Times Index (STI), FTSE Straits Times (ST) Mid-Cap Index and the FTSE ST Small Cap Index.

Under the proposed change, securities would be categorised into three groups with differentiated margin rates. Group One comprises the STI’s constituents and highly liquid blue-chip counters, while Group Three comprises all structured products, such as daily leverage certificates and structured warrants. All remaining securities fall into Group Two.

The second proposed change is to introduce margin offsets for greater efficiency. These would be offered only to Group One securities, to take into account the diversification effects of a portfolio containing both buys and sells.

Margin offsets would be “calibrated conservatively so that margins remain sufficient to a high degree of confidence”, said the Singapore Exchange Regulation (SGX RegCo).

Another proposed change is to reduce the extent and speed that margin requirements could increase during volatile periods.

The dynamic margin buffer as it is known “appropriately balances competing concerns for stable margins, coverage of risk and cost to the membership”, noted SGX RegCo.

Meanwhile, four other changes have been proposed to the clearing fund.

The first is to refine the approach for determining the size of the clearing fund, and the contributions of each clearing member.

SGX RegCo said that “traded value is not sufficiently risk-sensitive, and may not be a good reflection of CDP’s potential losses in a default”.

To mitigate this, CDP has proposed sizing the clearing fund based on stress test losses arising from the simultaneous default of the top clearing member and its affiliates, and the two financially weakest clearing members over the preceding 12 months.

A clearing fund floor has also been proposed, to give stability to the clearing fund size.

The second proposed change is to apportion the sum of contributions among clearing members, up to a maximum of 75 per cent of the clearing fund, on a pro-rata basis, based on their stress test results. This is to allow for “a more equitable allocation of risk and clearing fund contributions among clearing members”, said SGX RegCo.

The third proposed change to the clearing fund is to de-prioritise the use of contingent contributions, which are unfunded contributions deposited by clearing members only when the CDP calls for them.

Under the proposed change, funded contributions from both clearing members and CDP would be utilised before unfunded contributions. Contingent contributions would also be fixed at an amount equal to each clearing member’s funded contribution.

Lastly, CDP has proposed to introduce a cap on the amount of contributions that can be used for each default by a clearing member.

This cap would be based on the total of the clearing member’s funded and contingent contributions.

The CDP would no longer require defaulters to deposit additional contributions over and beyond the funded and contingent contributions to top up for any contributions used.

Instead, any losses remaining after the clearing fund is exhausted would be borne by the CDP.

The public consultation will close on Dec 5. THE BUSINESS TIMES