How does NG Clearing ensure stability in the derivatives market?
The derivatives market is very delicate. While it has the potential to open new frontiers for capital gains, liquidity, and capital flow it is also exposed to unique risk elements if not carefully managed. Managing the risk in the derivatives market is one of the core functions of NG Clearing as a Central Counterparty (CCP).
To ensure the market is stable and safe, NG clearing does the following:
- NG Clearing guarantees the trades:
When a derivatives contract is created, NG Clearing comes in between the buyer and the seller through a process called Novation. By doing this even if the seller or buyer does not fulfill their obligation, NG Clearing will ensure the trade is executed.
- NG clearing takes collateral and margins from market participants.
To ensure the trade is executed even if the buyer or the seller defaults (fails to fulfill their obligation). Market participants are required to deposit margins and collateral (which are usually a fraction of the contract value). The margins and collaterals are used to settle obligations when market participants fail to play their part.
- NG Clearing maintains a Default Fund.
The default fund is a pool of financial resources contributed by the CCP (NG Clearing) and Clearing Members. It is meant to serve as a fund of last resort should there be extreme conditions that destabilize the market. The default fund is also managed with a default fund waterfall that stipulates the sequence of the utilization of the fund.
Derivative Terms to Know:
A default fund is a pool of financial resources that serve as a line of defense against extreme conditions that threaten market stability. It is a contribution by NG Clearing and Clearing members.
Default Fund Waterfall
The default waterfall stipulates the sequence of financial resources that a CCP can draw upon to cover the unsatisfied financial obligations of a defaulted clearing member. At the top of the waterfall are the margin and default fund contributions of the defaulting clearing member.