²⁶ These efforts have been intensified since the Barings episode in February 1995. On 15th March 1996, 49 exchanges from 18 countries signed an "International Information Sharing Agreement and Memorandum of Understanding". To facilitate and augment the exchange agreement, on the same date regulators from 14 jurisdictions signed a "Declaration on Cooperation and Supervision of International Futures Exchanges and Clearing Organisations". By September 1996, six more exchanges and one more regulator had signed on.

²⁷ Most exchanges in the G-10 countries employ electronic trading systems, which obviate the post-execution matching of trade data. Nonetheless, even with electronic trading systems, clearing members often need to submit information on the allocation of trades to accounts and the resulting open positions.

²⁸ Clearing houses typically require their members to separate their house positions from their client positions and compute margin requirements separately. Furthermore, margin requirements for house and clients often differ in terms of the amounts required and the types of collateral accepted. These arrangements are described in greater detail in Annex 3, but in order to limit the complexity of the discussion and analysis, in what follows differences in the treatment of house and client positions, margins and funds are largely ignored.

²⁹ The term "initial" margin was chosen to describe this practice to achieve consistency with a recent report on margin requirements by IOSCO's Technical Committee (see Technical Committee of the International Organization of Securities Commissions (1996c)). However, it should be emphasised that this requirement must be met not only initially but as of every periodic margin settlement thereafter. In some countries what here is termed initial margin is referred to as "original" margin.

³⁰ The only exception involves futures contracts traded on the London Metal Exchange, which are cleared by the London Clearing House. The approach to margining LME futures contracts is sometimes referred to as "non-cash clearing", in contrast to the more common "cash clearing", that is, a variation margin approach. It should be noted that the non-cash clearing approach to margins is similar to options-style margining (described below), in that cumulative losses on open positions are collateralised (or guaranteed by third parties) rather than settled.

³¹ Annex 5 illustrates the mechanics of the two types of margining system.

³² Because counterparty credit exposures on exchange-traded derivatives are determined by changes in market prices between settlements, the measurement of counterparty credit risks shares many common elements with the measurement of market price risk. Margin requirements are similar to the "value-at-risk" (VAR) estimates employed in market risk measurement in that the confidence limit, often 95 or 99%, and the time horizon, often one day, are critical parameters.

³³ Many clearing houses use methodologies developed by the Chicago Mercantile Exchange (SPAN) or by the Options Clearing Corporation (TIMS) or variants of one of these methodologies.

³⁴ Such haircuts may need to be quite large if the value of the collateral is related to the value of the positions which it is supporting in such a way that the collateral's value would tend to decline at the same time that the value of the positions decreases. For example, if a short position in a futures contract or a put option were supported by collateral in the form of the underlying asset, a very substantial haircut would need to be applied.

³⁵ However, many exchanges have introduced evening or night-time trading sessions, so further trading may have occurred since initial and variation margin requirements were last determined.

³⁶ Price limits preclude trading at prices outside the range specified by the limits. Many exchanges impose price limits on some or all of their contracts. From the standpoint of managing counterparty risks, price limits are, at best, a mixed blessing. On the one hand, by limiting potential price changes, they limit the size of variation settlements, and thereby limit potential liquidity pressures on the clearing house in the event of defaults by clearing firms. On the other hand, to the extent that market fundamentals imply prices outside the price limits, the clearing house may be exposed to additional credit losses, because variation settlement at the price limit allows some clearing members to satisfy margin requirements with payments that are less than the true economic losses on their positions.
For this reason, some clearing houses reserve the right to base variation settlements on prices other than closing prices when price limits have halted trading. Of course, when variation settlements are based on other prices, potential liquidity pressures are not limited.

³⁷ See Committee on Payment and Settlement Systems (1992).

³⁸ As discussed in Annex 4, timely determination of open positions can be more difficult in gross margining systems because of the need to capture information on the effects of trades on gross open positions within the client account.

³⁹ As will be discussed below, some clearing houses rely more on their own supplemental resources.

⁴⁰ In this context, one day means one trading day.

⁴¹ In at least one case, however, open positions can be closed out by assigning the contracts to non-defaulting clearing members at off-market prices determined by the clearing house. In effect, such a procedure would constitute an assessment on the non-defaulting clearing members to which the contracts are assigned.

⁴² Of course such "cross-hedges" would involve some degree, perhaps a significant degree, of basis risk.

⁴³ However, if the clearing member's failure was caused by defaults by one or more of its clients, client positions and margins may also be liquidated.

⁴⁴ A recent report by the Technical Committee of the International Organization of Securities Commissions identified best practices for the treatment of positions, funds and assets. It concluded that: client positions of the defaulting firm at the market will preferably be transferred swiftly to other firms to avoid financial harm to clients, and to avoid spreading the damage from the default; in cases where the nature of the positions makes transfer impracticable, or in cases such as where the client has not completed the necessary documentation for the transfer or the applicable regulation does not allow for transfers, client positions may be liquidated in the market as swiftly as practicable, taking the potential market effect into account. See Technical Committee of the International Organization of Securities Commissions (1996a), p. 24.

⁴⁵ As noted, some clearing houses routinely conduct an additional intraday settlement on the afternoon of day T, while most other clearing houses have the authority to do so.

⁴⁶ As has been frequently observed in the context of securities settlements, "time [that is, delay] equals risk".

⁴⁷ By underscoring the potential losses to non-defaulting clearing members from a clearing member's default, the existence of such loss-sharing arrangements creates incentives for the clearing members to ensure that the clearing house imposes stringent membership requirements and margin requirements.