NG Clearing acts as a counterparty for every single trade by ‘interposing’ between the buyer and the seller and guarantee settlement of all transactions with certainty. Considering the critical role performed by the Company to enshrine the confidence of the market participants, it assumes a ‘Market Infrastructure’ status.
A sound risk management framework is at the core of every Market Infrastructure which performs the role of a central counterparty (CCP). As an integral part of the risk management framework, the Company has implemented a state-of-art, robust risk management system in line with developed international markets, which shall be deployed in the Nigerian Securities market for the first time for the quantification, monitoring, and mitigation of counterparty credit risks.
Risk containment measures hinges on embedded components of the risk management framework, which includes, prudent capital adequacy requirements of members, stringent margin requirements, position limits based on capital, real time monitoring of margin requirements & positions limits and automatically triggered trading restrictions on breach or high utilization of these limits.
Based on the complex nature of derivative contract, a highly sophisticated value-at-risk methodology shall be employed to estimate the maximum amount expected to be lost on a contract over a given time horizon, at a pre-defined confidence level. Further, considering the availability of multiple derivative contracts with same underlying or correlated underlying, a portfolio based margining model shall be used to estimate the worst-case loss on a portfolio comprising of various such derivative contracts over a defined time interval. Such a portfolio-based margin system uses risk arrays to simulate the portfolio gains/losses under various predefined scenarios of price movements or volatility movements. Highest expected loss on portfolio is considered for determining the margin requirements.
Our focus is to look at counterparty risk in the context of other financial risk. A CCP manages counterparty risks by managing the following risk types:
- Market Risk: It arises from the short-term movement of market prices. It can be a linear risk arising from an exposure to movement of underlying variables such as stock prices, interest rates, FX rates, commodity prices etc. it can also non-linear risk in that it arises from the exposure of market volatility as might arise in a hedged position. Market risk forms a component of counterparty risk.
- Credit Risk: Is the risk that a debtor may be unable or unwilling to make payment or fulfil contractual obligation;
- Liquidity Risk: A CCP faces both asset liquidity risk which is the risk that a transaction cannot be executed at market prices due to illiquidity of the underlying and Funding liquidity risk which is the inability to fund contractual payments or collateral requirements, potentially forcing an early liquidation of assets and crystallization of losses
- Operational Risk: This is the risk arising from people, systems, internal and external event.
NG Clearing Risk Management Overview
Our risk Management measures include capital adequacy requirements of members, monitoring of member performance and track record, stringent margin requirements, position limits based on capital, online monitoring of member positions and automatic disablement from trading when limits are breached.
Initial and ongoing assessment of members’ capital adequacy and other onboarding requirements. Members are always required to be well capitalized for the quantum of risk they carry through their exposure.
All clearing members are required to maintain an initial margin in highly liquid financial assets, mostly cash as collateral in support of their exposure
Total exposure of the member across all open positions are validated against collateral held by the member to ensure sufficiency of initial margin at any given point in time all through trading hours.
While crystallized mark to market losses are deducted from the collateral of the member, All open positions are marked to market with the closing price for the day and the same is collected from the member.
A corpus, designated as settlement guarantee fund, is set up to guarantee settlement of trades. This could be deployed in the event of one or more member(s) default. In line with IOSCO’s skin in the game recommendation, the Company also contributes towards the guarantee fund.
NG Clearing runs both back-testing and stress testing periodically using extreme but plausible market scenarios and what-if strategies to confirm with high degree of certainty the sufficiency of its default management resources.