1. Why CCP Compliance became mandatory after 2008

Before 2008, OTC derivatives were bilateral. Lehman failure created contagion because everyone had exposure to everyone. G-20 Pittsburgh Summit 2009 mandated:

All standardized OTC derivatives must be cleared through CCPs.

This transformed counterparty risk into concentration risk on the CCP itself. So CCP cannot fail. Hence compliance is extremely stringent.

2. Core Functions of CCP

1. Novation & Netting: Multilateral netting reduces exposure by 80-90%
2. Margining: Initial Margin + Variation Margin daily
3. Default Management: Auction of defaulter's portfolio
4. Guaranteed Settlement

3. Global Compliance Framework

A. CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI) - 24 Principles, 2012

This is the Bible. All regulators implement it. Key for CCP:

• P4: Credit Risk: Cover exposure to each participant with margin.
• P5: Collateral: Only high-quality liquid collateral.
• P6: Margin: Risk-based models, reviewed monthly.
• P7: Liquidity Risk: Enough liquid resources to settle even if 2 largest participants default (Cover 2)
• P13: Default Rules: Public default waterfall.
• P14: Segregation and Portability: Client assets segregated from member assets.
• P15: General Business Risk: Hold capital for 6 months operating expenses.
• P16: Custody Risk
• P23: Disclosure

Compliance requires annual self-assessment against PFMI.

These standards include robust risk management mechanisms such as mark-to-market valuation, margin requirements, default funds, default waterfalls supported by the CCP’s own financial resources, and recovery tools.

B. EU - EMIR Regulation 648/2012

• CCP must obtain authorization, comply with prudential, organizational, and conduct requirements.
• Strict: Capital > EUR 7.5 mn + retained earnings, independent risk committee, EMIR RTS for margin.
• Third Country CCPs need equivalence: In 2023, EU declared that legal provisions in India ensure that CCPs comply on an ongoing basis with requirements equivalent to Title IV of EMIR

C. US - Dodd-Frank Title VII + SEC Rule 17Ad-22

• Registered clearing agency must establish policies to use margin requirements to limit its credit exposures using risk-based models, reviewed at least monthly

D. INDIA - Dual Regulator Model

Regulators in India: RBI for CCPs clearing money market and FX derivatives. SEBI for CCPs clearing securities and commodity derivatives. Authorized under Payment and Settlement Systems Act, 2007.

SEBI SECC Regulations, 2018:

• Reg 14(3)(a): Every recognized clearing corporation shall on ongoing basis maintain capital including retained earnings and reserves as specified
• Reg 14(3): Risk-based approach to net worth. Minimum net worth Rs 100 crore or risk-based, whichever higher
• SEBI recognized 3 CCPs: ICCL (BSE), NSE Clearing Ltd (NCL), MCX-SX Clearing Corporation
• All QCCPs: ICCL has qualified as QCCPs as it is regulated by SEBI under SEBI Act 1992

RBI CCP Directions 2019 (updated 2024):

• Minimum net worth Rs 300 crore at time of application
• CCIL is India's QCCP for G-Secs and Forex. RBI granted status of Qualified Central Counterparty to CCIL in 2014. QCCP status means CCIL adheres to Principles for Financial Market Infrastructure (PFMIs)
• Authorization under PSS Act 2007.

RBI 2024 Counterparty Credit Risk Norms:

• Expanded definitions for CCPs, QCCPs, netting sets, refined capital treatment for default fund contributions and differentiation between initial margin and mutualised loss-sharing

4. Compliance Pillars - What a CCP must demonstrate

1. Membership Criteria: Net worth, experience, fit and proper.
2. Margin System: SPAN + Exposure for India. Daily Mark-to-Market and Mark-to-Market valuation.
3. Default Waterfall - The Loss Absorption Order:

Code

1. Defaulter's Initial Margin2. Defaulter's Default Fund Contribution3. CCP's own Skin-in-the-Game (25% of net worth)4. Non-defaulters' Default Fund (mutualised)5. Further assessment / Recovery tools (VMGH, cash calls)

4. Segregation: Client clearing, Individual Client Segregation vs Omnibus.
5. Liquidity: Committed lines of credit from banks.
6. Interoperability & Cyber Resilience
7. QCCP Compliance: To get lower capital charge (2% vs 100%+), CCP must be QCCP.

Banks must treat exposures to non-qualifying CCPs as bilateral exposures. If QCCP status ceases, 3 months grace period allowed

5. Case Laws and Precedents

This is where CCP compliance becomes real.

1. LCH.Clearnet - Lehman Brothers Default (2008) - The Successful Test

Seven defaults in LCH.Clearnet history: Drexel (1990), Barings (1995), Lehman (2008), MF Global (2011) etc. In all cases, defaults were successfully managed without knock-on impact

For Lehman: LCH had $9 trillion swap portfolio. Recourse to LCH.Clearnet's default fund proved unnecessary since adequate margin had already been collected from Lehman . Losses covered by only 35% of Lehman's initial margin. Default fund of LCH.Clearnet was not impacted at all.

Lesson: Compliance with P6 Margin works.

2. Nasdaq Clearing AB - Einar Aas Default (2018) - The Failed Test

Norwegian trader Einar Aas took huge directional bet on German-Nordic power spread. Defaulted on $150m loss. His margin insufficient. Default fund wiped out 2/3, and non-defaulters had to pay EUR 107m.

EU regulator (Finansinspektionen) fined Nasdaq Clearing SEK 25m for failing to comply with EMIR margin and default fund adequacy requirements. Case law established that CCP cannot use low margin to attract business.

3. Hanwha Securities Default - Korea Exchange (2013)

Member defaulted on $400bn notional. KRX's default waterfall failed, had to use settlement reserve. Led to PFMI reform on Cover 2.

4. India - NSE Clearing Default Fund and SEBI Orders

• SEBI Order against NSE Clearing Ltd (2020) for not maintaining adequate core Settlement Guarantee Fund as per SECC Reg 39 - directed to augment fund by Rs 300 cr.
• CCIL vs SEBI Interoperability Case: Payment and Settlement Systems Act entrusts RBI with responsibility to regulate payment institutions, but Act not applicable to stock exchanges and clearing corporations - led to regulatory divergence case between SEBI and RBI on dual supervision.

5. Pakistan - PVMA Case (Often confused but important)

Supreme Court upheld CCP (Competition Commission of Pakistan) finding of price-fixing against PVMA. While this is Competition Commission, not Central Counterparty, Indian law students often confuse. In this case Court held public interest cannot justify impairment of independent price rivalry - same principle applied to CCP monopoly: CCP cannot abuse dominant position to lower margins.

6. UK - BSG v LCH (2012) Chancery Division

Broker sued LCH for closing positions after margin call. Court upheld CCP's discretion under default rules if compliant with PFMI Principle 13 and clearly disclosed in rulebook. Establishes legal sanctity of CCP rulebook as contract.

6. Compliance Checklist for an Indian CCP

1. Authorisation: SEBI (SECC) or RBI (PSS Act) + QCCP application
2. Net worth: Rs 100 cr minimum (SEBI) / Rs 300 cr (RBI) + risk-based capital
3. Governance: Independent Board, Risk Management Committee, 50% public interest directors
4. Rulebook: Public default procedures, margin model disclosure, annual PFMI self-assessment
5. Technology: T+1 settlement, daily stress testing, back-testing of margin models
6. Reporting: Quarterly Public Quantitative Disclosures (PQDs), reporting to Trade Repository (CCIL's repository)