Clearing

Each Futures and Options Exchange will have a clearing house associated with it. The Sydney Futures Exchange has SFE Clearing Corporation Pty. Limited.

The principal role of a clearing house is to guarantee the performance of contracts. If one counterparty to a contract were to default on a contract, the clearing house would honour that contract to the other counterparty. The existence of a clearing house concentrates all credit risk with a single institution and so eliminates the necessity to monitor the creditworthiness of each counterparty to a contract.

Central counter-party clearing

SFE Clearing Corporation Pty Limited (SFE Clearing) provides a central counter-party (CCP) clearing service for all futures and options contracts traded on the SFE. Central to CCP clearing is the process of "novation", which involves SFE Clearing interposing itself between a buyer and a seller, becoming the central counterparty or principal to all trades.

The process of novation provides a number of benefits for users including:

• surety of payment
• margin netting
• risk management
• liquidity
• elimination of the need to assess the credit of other SFE participants.

SFE participants are able to anonymously deal with all other SFE participants and are not required to revert to their original counterparty in order to close out their original transaction. This enhances market access and promotes liquidity.

Through this process, SFE Clearing remains liable to perform against all contracts to which it is a party, even if either the buyer or seller fails to fulfil its obligations. To ensure the continued financial integrity of both the CCP and the SFE market, SFE Clearing imposes strict financial requirements and criteria on SFE participants.

The financial integrity of SFE clearing

Risk management activities undertaken by SFE Clearing are designed to ensure that the interests of SFE participants and clients are protected and that the integrity of the SFE marketplace is maintained. These activities are primarily focused on two key types of risk: market risk and credit risk.

Market risk represents SFE Clearing's exposure to its SFE's clearing participants irrespective of the performance of individual SFE participants. It encapsulates factors that impact upon the entire market, such as extremely large price movements.

Credit Risk represents SFE Clearing's exposure to a loss arising from actions undertaken by an individual SFE participant and its clients. Such factors may include a deterioration of the capitalisation of a SFE participant, or a SFE participant holding a position that is beyond its financial capacity to absorb a loss arising from that position.

SFE Clearing undertakes a number of activities to manage these risks including the following:

• Margins and surveillance
• Capital Based Position Limits (CBPL)
• The SFE Clearing Guarantee and Capital Reserve
• Admission Criteria and "Net Tangible Assets"

For more information on SFE Clearing visit SFE's website.