Risk Management

Overview

Muqassa maintains an integrated and comprehensive risk management system and ensures that its risk management framework identifies, measures, monitors and manages the risks that it bears from Clearing Members as well as other key institutions.

Muqassa has a low risk appetite for financial, liquidity, operational, market and credit concentration risk. This appetite helps drive the setting of conservative values when deciding on key measures such as the Default Fund Cover or Investment Duration.

Muqassa’s risk management policies, procedures, systems and controls have been developed to adhere to the CMA’s Securities Central Counterparties Regulation as well as align to both CPMI-IOSCO’s Principles for Financial Market Infrastructures (PFMIs) and international best practices.

Credit Risk Management

As a CCP, Muqassa stands in the middle of a transaction assuming the previous bilateral counterparty credit risk between the two counterparties. Muqassa needs to ensure that minimum standards, as directed within the Clearing Rules and Procedures, are met. This serves two purposes, (1) Muqassa can be confident that the potential Clearing Member is less likely to default on its obligations and (2) provides confidence to other Clearing Members that their mutualised Upfront Default Fund Contributions are less likely to be used for sub-standard Clearing Members.

One of these entry requirements and as part of Clearing Member onboarding is the requirement for the counterparty to be given an Internal Credit Score (“ICS”). Muqassa’s Credit Risk Assessment Framework (CRAF) will be used to assess, quantify and monitor the level of credit risk that it is materially exposed to from each counter party that it is exposed to.

There are three general types of counterparties as a source of credit risk:

  • Clearing Members
  • Service Providers & Financial Infrastructures
  • Investment Counter parties.

Each of the counterparties listed above, as part of onboarding, will be assigned an ICS on a scale of one to six, where one corresponds to the highest level of creditworthiness. There is a range of inputs to the ICS including both qualitative as well as quantitative factors and the rating framework broadly follows the CAMELS rating methodology. In addition, global Credit Rating Agency assessments of a counterparty is also take into account.

On an annual basis, the counterparty will have a full credit assessment conducted on them in which the latest financial reports will be assessed to form a base score. On a quarterly basis, the score can deviate by +/- 1.0 based on CreditWatch.

CreditWatch is a proactive counterparty analysis tool which is used to assess possible deviations in the creditworthiness of a counterparty throughout the year and to the next full credit assessment. Current inputs into CreditWatch is Bloomberg data as well as other qualitative factors; however, as new markets are launched it can be developed to take into account factors such as settlement fails, margin breaches, etc.

The ICS directly determines the internal Risk Limit as well as the Trading Limit applicable to Clearing Members and is based on a percentage of equity, i.e. the stronger, in terms of creditworthiness of the Clearing Member the higher percentage they will get in terms of a Risk Limit.

It is important to note that should there be a strong deterioration in the creditworthiness of the counterparty, as determined by the internal Credit Rating Methodology, then the counterparty may be placed on the WatchList, which could involve actions such as the counterparty being subject to closer monitoring through to ultimately the off-boarding of that counterparty.

CRAF is subject to external validation in line with the internal Model Validation Policy & Plan. 

General Risk Management

Collateral

Currently, Muqassa routinely accepts SAR cash to meet Margin and Upfront Default Fund requirements. Clearing Members Cash Collateral is placed within an account at the Central Bank, SAMA, in order to maximise the safety of Clearing Member’s assets.

In the event that Muqassa decides to accept different forms of Collateral it will always adhere to the higher-level principles that any Collateral accepted will bare low market, liquidity and credit risk. In addition, non-cash collateral will be subject to haircut to take into account market risk. Information on Collateral acceptability is and will be clearly communicated to Clearing Members and the data on these will be contained within the Quarterly Quantitative Disclosures that are available on Muqassa’s website.

Liquidity

Muqassa’s liquidity requirement against resources is assessed with credit stress-testing and is conducted daily. The aim is to ensure that Muqassa has, at all times, adequate liquidity to be able to settle its payment obligations on time with a high degree of confidence by taking into account a wide range of potential stress scenarios.

The key parameters specific to each market is disclosed within our Quarterly Quantitative Disclosure, which is available on Muqassa’s website.

 

QCCP Status

Capital Market Authority (CMA) has licensed Muqassa on January 12th, 2020 to conduct clearing services in the Saudi Capital Market as the first Qualified Center Counterparty (QCCP) in Saudi Arabia, to clear securities traded in the exchange along with other products in the Saudi Capital Market.

As part of gaining the status of a Qualifying Central Counterparty (“QCCP”), Muqassa will release all the required data to enable Clearing Members to calculate their capital requirement for exposures to Muqassa within the Quarterly Quantitative Disclosures which is available on Muqassa’s website.

In addition, and as part of being a QCCP is that Muqassa should demonstrate on-going compliance with the CPMI-IOSCO Principles for Financial Market Infrastructure. This is also available on Muqassa’s website.

 

 

Trading Limit

Trading limits are part of pre-trade risk management and designed to limit potential exposure on a trading level. These limits are required to prevent any given exchange member from having a (risk-weighted) value of trades and orders above a certain limit.

Effectively, Muqassa can limit the exposure of General Clearing Members (“GCMs”) and Direct Clearing Members (“DCMs”) by assigning a trading limit. Flexibility is provided to GCMs and DCMs to set a lower limit than the limit assigned by Muqassa. In addition, the functionality allows a GCM to cap the exposure of its NCMs by assigning a trading limit on each of its NCMs. Note that the cumulative total of the GCM limit and the limits of each of its NCMs must not exceed the limit assigned by Muqassa on the GCM itself. 

The trading system calculates utilization in SAR for each exchange member and triggers an alert to Muqassa if the pre-defined threshold has been breached. In addition, upon reaching the applicable limits, exchange members’ incoming orders will be rejected and receives alerts when limit has been breached.

In addition, the trading limit will be a counterparty limit, e.g. if one GCM is clearing in both the Cash and Derivatives markets, they will have to proportion out the trading limit provided by Muqassa in a percentage that they see fit.

 

Margining

Muqassa shall collect Margins that are based on the risks in the cleared portfolios (market risk, liquidity risk, etc.) and not on the credit risk of the Clearing Member.  More precisely, margins will cover the current exposure (Variation Margin) and expected future close-out (“Initial Margin”) cost of the portfolios.

With regard to Initial Margin (“IM”), Muqassa has adopted Nasdaq’s Delta Hedge methodology which is highly compatible with CME SPAN® in that it uses the same set of parameters to estimate portfolio risk.  The key components of the IM methodology are:

  • Type of Model: Simple historical Value at Risk (“VaR”) model used in calculating historical risk per instrument / instrument group.
  • Margin Period of Risk (“MPoR”): minimum 2 days.
  • Confidence Interval: minimum 99%.
  • Lookback period: 10 years.
  • Anti-Procyclicality Coefficient (“APC”) – 25% buffer on margin calculations.

In addition, Additional Margin may also apply; however, this is market specific, and can include add-ons such a concentration margin, margin for rolled-over trades, add-on for breach of risk limit etc.

Specifically, for the Cash Market, stocks are divided into tiers based on pre-defined set of criteria. Each tier has a number of stocks that share similar attributes in terms of market cap, traded value, and standard deviation of returns.

Gross margining is adopted by Muqassa, whereby each client account of a clearing member is margined separately. Margin will be evaluated continuously intraday, in the event that there is a collateral deficiency then an Intra-Day Margin Call (IDMC) will be issued. The Clearing Member will have to remedy the deficit as notified from time to time.

IM coverage is backtested on a daily basis by comparing it with the actual realised profits and losses.

The IM will be validated on an annual basis by independent external experts.

The market specific margin attributes are captured within our Quarterly Quantitative Disclosure available in the Disclosures section.

Stress Testing

Stress-testing is performed daily to ensure that the financial resources are sufficient to cover risk exposures under extreme but plausible market condition, and more precisely looks at “tail-risk”. In conducting stress testing and to consider ‘extreme but plausible’, Muqassa analyses both historical scenarios as well as hypothetical scenarios. The results of the stress testing form the basis for Stress testing.

The following are some of the main components for the Default Fund and its calculation:

  • Default fund size - Cover 2 (Highest stress loss of the largest two participants and their affiliates in preceding 90 days) with a buffer of minimum 10%
  • Recalculated on a monthly basis with the discretion to perform an ad-hoc calculation
  • Default Fund allocated to members based on average Initial margin of members. The Default fund requirement is to be contributed in cash in SAR.
  • Supplemental Default Fund Contribution: 1x

A Stress Test Exposure Limit (“STEL”) may also be used to address any potential uncovered credit loss by setting a limit on each Clearing Member’s stress loss relative to the total Default Fund size from those Clearing Members that bring increased ‘concentration’ risk to the CCP. The limit will represent the amount of stress loss in percentage relative to the Default Fund size. The limits are set in accordance to the ICS as determined by Muqassa.

 

Default Management

In the event that Muqassa, and more specifically the Default Management Committee (“DMC”), determines that a Clearing Member is, or appears to be unable, to meet its obligation in respect of the Clearing Documentation than an Event of Default may be declared and the internal Default Management Procedure (“DMP”), which is in alignment with the Clearing Documentation, for that specific market will be followed. At this point, Muqassa will have an unmatched book and will be exposed to the market risk on the Defaulting Clearing Member’s portfolio.

The main objective of the DMP is to:

  • Manage the risk exposure and impact associated with a defaulting Clearing Member;
  • Minimize and stem the losses arising from the default and liquidity risk associated;
  • Ensure the continuity of critical services for non-defaulting Clearing Members; and
  • Limit the disruption and prevent wider financial market impact.

In summary, and in the Event of Default being declared, the DMC has a number of tools it can utilize to primarily address an un-matched book and is market dependent but can include:

  1. Porting – Transferring positions and/or collaterals of the non-defaulted accounts under the defaulted member to another clearing member
  2. Hedging – Neutralising the overall risk of the defaulter’s portfolio
  3. Closing-Out – via Brokers, where appropriate
  4. Auction – Allocating the positions to the non-defaulting Clearing Members by a tender

The actions of the DMC will be considered a success if Muqassa regains a matched book and any monetary losses are able to be fully allocated to the Default Waterfall, preferably without utilising Non-Defaulting Clearing Member’s Upfront contribution and within the Stressed Period of Risk (“SPOR”)

An unsuccessful outcome would be where there are positions outstanding or the monetary losses that exceed that of the Default Waterfall. At this point, Muqassa may wish to trigger the Recovery & Wind Down Plan (this is currently in development with further details to be released once complete; however more generally the recovery tools are listed within the Clearing Rules under “Additional actions upon an Event of Default”)

 

Default Waterfall

Muqassa has designed the following Default Waterfall that is in line with international best practice:

  • Defaulting Clearing Member’s Margin contribution (including excess).
  • Defaulting Clearing Member’s Default Fund contribution.
  • Muqassa’s contribution to the Default Fund (Skin-in-the-Game).
  • Non-Defaulting Clearing Member’s Upfront contribution to the DF.
  • Non-Defaulting Clearing Member’s Supplemental Default Fund contribution.

Muqassa may elect to have more than one default waterfall and in the event it does, every effort will be made to ensure that cross-contamination between segments is removed, i.e. a default in one segment cannot directly affect another segment in terms of the resources used.

 

Pricing

Price Management details the steps for determination of the margin and collateral prices which will be used within the Intraday and end of day with respect to:

  • Cleared instruments subject to margining
  • Non-cash collateral assets accepted as Collateral, for valuation purposes, if any.

 

Prices are needed to calculate daily margins including variation margins, collateral valuation and compensation for late delivery.

Intraday Pricing

  • Margin price and Collateral price (before haircut) is selected as the latest price out of the Last and the Mid (out of Bid and Ask) prices from Exchange.

 

Muqassa uses last paid prices or average of simultaneously existing bid/ask prices, whichever comes last. Bid/ask prices with larger spreads and one-legged bid/ask prices are not used.

 

  • Theoretical price calculated by Muqassa,
  • Previous day's end of day price

End of Day Pricing

  • The Margin and Collateral Prices are derived according to the above mentioned sequence until price is discovered.  In case of no trade within the day for a specific instrument, theoretical pricing will be applicable.

Theoretical pricing in Fixed Income Market

  • Calculation of theoretical price for the FIs will be via yield curves bootstrapped with selected FIs and/or benchmark instruments for related maturities

Members can see the prices for instruments in the Risk parameter file published intraday and End of day by Muqassa.

Risk Management

Select Date
Risk Parameter File - Derivatives

SPAN® File Placement

Risk Parameter File - Cash

SPAN® File Placement