If following a clearing member default a client’s derivatives are terminated by the clearing house, then instead of being able to claim for the cost of being put in the position that the client would have been in had the clearing member not defaulted, the client is obliged to accept a clearing house valuation that does not take the client’s circumstances into account. This creates a significant risk of unrecoverable losses for clients, a result that is not needed for the proper functioning of the derivatives market and which may add to the inevitable market stress should a major derivatives clearing member default.
This situation should be remedied by restoring within the industry standard documents the client’s right to claim for its full losses. Until this is the case, users of the clearing documents should seek to incorporate the client’s normal contractual right to claim for losses on a negotiated bilateral basis.
This article was originally published in the Alternative Investment Management Association’s AIMA Journal.