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Derivatives Clearing

Why have clients lost the right to claim for their losses?

The standard documents in use for OTC and exchange-traded derivatives central clearing in Europe oblige clients to surrender their standard contractual right to claim for compensation should their clearing member default. If following a clearing member default a client’s derivatives are terminated by the clearing house acting as the central counterparty (the "CCP"), then instead of being able to claim for the cost of being put in the position that the client would have been in had the clearing member not defaulted, the client is obliged to accept a CCP valuation that does not take the client’s circumstances into account. This creates a significant risk of unrecoverable losses for clients, a result that is not needed for the proper functioning of the derivatives market, and which may add to the inevitable market stress should a major derivatives clearing member default. This situation should be remedied by restoring within the industry-standard documents the client’s right to claim for its full losses.

Background

In response to the requirements imposed by the European Market Infrastructure Regulation1 (EMIR) with regard to the trading and clearing of derivatives, Europe-based clearing members and their derivatives clients are re-documenting their relationships. In this they have been assisted by two industry-standard English law documents published in 2013, the FOA Clearing Module2 (the “Module”) published by FIA (published under the prior name of FIA's European arm, the Futures and Options Association), which deals with clearing exchange-traded derivatives (ETDs) and OTC derivatives; and the ISDA/FOA Client Cleared OTC Derivatives Addendum3 (the “Addendum”) as jointly published by the International Swaps and Derivatives Association and FIA, which covers clearing of OTC derivatives, but not ETDs. The clearing documents were published after a lengthy drafting process involving market participants.

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