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CME Group Proposes New Clearing Member Category for Proprietary Trading Firms

bzwirb's picture
Commentary by Bob Zwirb

The Chicago Mercantile Exchange Group ("CME") proposed changes to its rules that would create a new category of direct clearing member called a "Direct Funding Participant" ("DFP"). Under the proposed category, a firm could clear trades solely for its own account, as long as obligations to CME's clearinghouse that arose from the firm's DFP activity were guaranteed by at least one other clearing member that was registered with the CFTC as a futures commission merchant (a "DFP Guarantor"). The changes will become effective on the earlier of September 23, 2016 or the receipt of regulatory approval.

Under the proposed arrangement, a DFP would post collateral to and settle all payments with the clearinghouse without the intermediation of a future commission merchant ("FCM") or the DFP Guarantor. A DFP would be permitted to clear trades only for itself and not for any third parties, including any affiliated entities. A DFP Guarantor would be responsible for indemnifying CME against any losses associated with the default of its DFP (including any losses, costs and expenses incurred by CME, the Board of Trade of the City of Chicago, the New York Mercantile Exchange, and Commodity Exchange, Inc., in managing the default of such DFP). CME would have authority to draw any amounts unpaid by its DFP automatically from the DFP Guarantor's house account.

According to CME, the proposed arrangement would provide key benefits:

  • The DFP's collateral would not be exposed to the risk of pro rata loss allocation that it might have faced if the DFP were the customer of an FCM.

  • Since the DFP's performance bond would not pass through the DFP Guarantor, the DFP Guarantor would not face the potential increase to its regulatory leverage capital requirements that might have occurred if the DFP Guarantor had received the cash performance bond directly from its cleared derivatives customer in its capacity as an FCM.

Further, direct settlements between the DFP and the CME's clearinghouse have the benefits of (i) removing a link in the settlement chain between the CME's clearinghouse and the ultimate customer, thereby minimizing the number of opportunities for settlement bank failure or transit risk to occur, and (ii) diffusing the concentration of settlement flows, which would ensure a settlement failure with a clearing member that is a DFP Guarantor was smaller than it might have been if the DFP had remained a customer of the DFP Guarantor (in its capacity as an FCM). However, there also would be additional margin requirements for the DFP, and additional capital requirements for the DFP Guarantor to account for the activity of its DFP.


Direct access blurs the line increasingly between customers and clearing members, necessitating the creation of hybrid categories and new rules for both types of participants. The primary selling point of the CME's proposed arrangement – that it would reduce the risk of pro rata loss allocation in the event of an FCM default or insolvency – appears to be advantageous to traders that have direct access to the exchange. However, that proposed arrangement does not eliminate the same risk when the DFP fails to meet a payment obligation. In that case, the DFP Guarantor could request the conversion of the DFP into a regular customer whose assets could be subject to such loss allocation. Additionally, the proposed arrangement would not shield DFPs from pro rata loss allocation in the event of a clearinghouse default or insolvency – an eventuality that would be true in any case but caught the attention of regulators only recently.

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