RBA: Assessment of Chicago Mercantile Exchange Inc. against the Financial Stability Standards for Central Counterparties Standard 14: General Business Risk

CME Group is responsible for determining and overseeing the business strategy, and managing general business risks for the entire corporate group, including CME Clearing Division. CME and CME Group both have capital available to cover business-related losses arising from risks unrelated to the default of a clearing participant (see CCP Standard 14.2). CME is required to maintain sufficient financial resources for, respectively, its DCO operations and DCM operations, as per CFTC regulations. The minimum financial resource requirements are additive in that each of CME's DCO and DCM operations are independently required to maintain sufficient operating capital to address its operating costs for a rolling one-year period.

Business-related risks are identified and monitored at Group-level as part of CME Group's ERM program, which is led by CME's Global CCO and coordinated by CME Group's cross-functional ERM team (see CCP Standard 2.6). The ERM program is designed to facilitate business risk management across the Group by establishing processes to consistently identify, communicate, assess, respond to and monitor all risks faced by CME, across all of its functions.

The ERM program assesses risks across Operational, Strategic (including Regulatory) and Financial areas for CME Group. These take account of:

• Trading. This includes CME Exchange Division's infrastructure, software, operational processes and support services that are essential to ensure continuous operation of CME's trading venues.
• Clearing. This includes the operational processes and systems responsible for clearing, settlements and risk management.
• Product and service offerings. Examines risks relating to CME's product and service offerings, including the potential influence of CME-specific and competitor-related or business-environment-related factors, both domestic and international.
• Personnel. Monitoring of this risk area is designed to ensure CME has adequate resourcing and includes ensuring that it has appropriate organisational programs in place to attract, train and retain talent. It also covers key person risk and succession planning.
• Compliance, legal and regulation. Includes CME's surveillance and investigations of exchange activity, as well as risks relating to litigations and regulatory change.
• Physical and information security. Monitors CME's capabilities in identifying, assessing, treating and preventing cyber and physical threats to its physical infrastructure and personnel.
• Recoverability. Covers CME's responses to operational risks and Business Continuity plan (see CCP Standard 16).
• Project execution. Monitors potential risks with project delivery across projects related to strategic, operational and regulatory plans and requirements.
• Credit and liquidity. Monitors risks that may affect CME Group's credit, or its ability to meet business-related expenses.
• Financial reporting. Monitors risks related to CME Group's reporting requirements as a publicly listed company.

Key risks identified by the ERM program are presented to the Board and Audit Committee in the quarterly Enterprise Risk Profile Report. The report classifies risks by their area (listed above) and rates the risks by their likelihood and potential impact. Changes in ratings are documented, and the rationale and background for the change explained.

In addition to the ongoing monitoring of business-related risks through the ERM processes, CME Group has an annual strategic and planning process, an annual budget process and a five-year financial plan. These plans and processes are combined to monitor and understand CME and CME Group's ability to meet business plans, and to protect against business risks including adverse business conditions or poor execution of business strategy. As part of this process, CME estimates its revenues and expenses based on internally estimated market, economic and volatility projections; estimates are cross-referenced against external analyst reports that cover the industry and domestic and global economy. CME uses sensitivity methodologies to assess its ability to cover its expenses during adverse business conditions and market contractions.

CME has established an Opportunity Review Committee (ORC) to consider any new initiative that would require significant investment (i.e. greater than US$2 million). The ORC has processes in place to develop the initiative and, at checkpoints along the way, determine if further allocation of resources is necessary to develop that initiative into a project. Following the development of a business case, it is presented to management or (depending on the size and scope of the project) the Board for a decision. In a project's implementation phase, the ORC provides advice and guidance, and monitors the project's status, working jointly with the Enterprise Solutions Division (see CCP Standard 16.4).

The ORC is responsible for communicating the status of potential projects to relevant areas of the management team, while CME's Enterprise Solutions Division is responsible for communications regarding projects in execution. The Enterprise Solutions Division also manages cross-functional projects related to business initiatives such as mergers and acquisitions, and expansions into new business areas (see CCP Standard 16.4). CME Clearing Division is responsible for managing and prioritising risk- and operations-related projects, including by ensuring adequate resource availability.

CME calculates 12-month-ahead expected revenue and operating costs for each month across major expense categories to ensure it has adequate financial resources (see CCP Standard 14.2). This analysis is undertaken monthly for short-term forecasts and quarterly for longer-term, three-year forecasts.

CME Group publishes a quarterly 10-Q report as part of its requirements under Securities and Exchange Commission rules. This document contains unaudited financial reports, including consolidated balance sheets, consolidated statements of income and consolidated statements of cash flows.

CME holds insurance to cover a number of business risk areas, including general liability, property, management liability, workers' compensation and employers' liability insurance.

CME holds capital sufficient to cover 12 months of projected operating expenses. CME recalculates this amount monthly and reports the amount to the CFTC quarterly. Of these resources, CME holds an amount sufficient to cover six months of operating expenses in cash or highly liquid securities. Capital held to cover operating expenses is invested in accordance with CME's Investment Policy (see CCP Standard 15). CME calculates operational expenses using projected expenses across major expenditure areas (e.g. compensation and benefits, communications infrastructure, occupancy and building operations). These projections are based on CME's financial plan and annual budget, and are adjusted to reflect changes in CME's business environment or the assumptions underlying the financial plan or budget.

Based on this analysis, CME's 12-month projected operating costs, as at the end of June 2014, were US$489 million, and six-month projected operating costs were US$242 million. As at end June 2014, CME had total assets funded by equity equal to US$1.2 billion of which US$480 million was held in cash and a further US$48 million in highly marketable securities; US$300 million of this capital and cash is CME's contribution across the three default waterfalls, and is not available to address business losses.^[1]

CME is in the process of developing a RWP which will, among other things, identify recovery and wind-down scenarios, estimate the length of time to achieve an orderly wind-down, and identify tools and resources available to achieve recovery or orderly wind down. The utilisation of a specific tool and/or resources to enable recovery or orderly wind down will depend on the facts and circumstances at the time of the triggering event(s) (see CCP Standard 14.5).

CME is preparing a plan for recovery and orderly wind-down to comply with CCP Standard 14.3, and has been granted an extension until 31 December 2014 by the CFTC to finalise the plan. The Bank will expect to conduct a review of these plans once this work has been completed.

CME currently has access to sufficient liquid net assets, funded by equity, equal to at least six months of current operating expenses (see CCP Standard 14.2).

CME invests its capital in high-quality assets, in accordance with CME's Investment Policy (see CCP Standard 15). CME ensures it holds cash (which, under its Investment Policy, can be held at central banks and creditworthy commercial banks; see CCP Standard 15) or highly liquid securities, funded by equity, sufficient to meet projected six-month operating costs; this amount is recalculated quarterly.

Assets held to cover business risk are not commingled with the financial resources held to cover the default of a participant, including the capital CME contributes to the Guaranty Funds. To ensure separation of margin and Guaranty Funds from assets to cover business risks, CME has accounting, reconciliation and financial services for the former undertaken by a division within CME Clearing, while a division at CME Group is responsible for those assets used to cover business risks.

In addition, CME has a formal credit line with CME Group – currently US$400 million – which can be drawn solely to cover general operational expenses of CME and its subsidiaries. However, because this line is not an asset funded by equity, it is not an eligible loss-absorbing resource for the purpose of CCP Standard 14.2 or 14.3.

CME currently has available net equity in excess of 2.5 times CME's projected six-month operating costs. In the event additional liquidity is required, CME Group maintains a universal shelf registration statement, approved by the Board, with the SEC. This registration allows CME Group to access the public debt or public equity markets quickly and could be utilised to raise equity to contribute to CME. As a wholly owned subsidiary of CME Group, CME could receive a contribution to its equity from its parent, CME Group Inc. CME Group could fund up to a pre-determined amount of capital for CME without additional Board approval. The Board of CME Group, which is identical to the Board of CME, would also have to authorise further increased investment in CME (see CCP Standard 2).

The Bank expects CME to formally document these plans to raise additional equity in its recovery and wind-down plan. As discussed in CCP Standard 14.2, CME expects to finalise its recovery and wind-down plan by 31 December 2014.