Since huge numbers and volumes of trades are executed at the organized public markets for which JSCC assumes obligations, if settlement of those transactions were not completed, the impact would be highly significant.
From this viewpoint, settlement guarantees (i.e. even when a defaulting Clearing Participant does not complete the settlement, clearing institution surely completes the settlement with other counterparties) are essential in order to maintain the stable and credible market. Therefore settlement guarantees, along with the fairness and efficiency of transactions, form the basis for assuring the overall quality of the market.
As a clearing institution, JSCC provides settlement guarantee and completes settlement as a counterpart (i.e. a party in charge of fulfilling an obligation and enforcing a claim), to Clearing Participants for trades of which JSCC has assumed obligations; hence, even in participant's default, JSCC is obliged to complete the settlement with the other Clearing Participants.
Thus, JSCC has a clearing guarantee system in place, based on the principle of self-responsibility, where a defaulting Clearing Participant is primarily responsible for contributing its asset to compensate the losses and if by any possibility losses are remaining, it shall be compensated by requiring joint guarantee among the other Clearing Participants.
Schemes for disposing losses resulting from a default
In the event of a Clearing Participant's default, JSCC suspends the scheduled delivery of securities and payment of funds to the defaulting participant. At the same time, in order to fix the amount of losses arising from the default, JSCC executes the trades to offset the Unsettled Contracts of that participant, as well as selling the securities which was supposed to be delivered.
The losses resulting from Clearing Participant's default shall be compensated in the following order:
1st layer: Deposits of the defaulting Clearing Participant (clearing funds, etc)(See Note 1)
2nd layer: Loss compensation by each stock exchange
(default compensation reserve fund, etc.)
（See Note 2）
3rd layer: Shareholder’s equity of JSCC
4th layer: Mutual guarantee among Clearing Participants (See Note 3)
Loss compensation by deposits (self-responsibility)
JSCC has introduced deposit-type clearing fund system, which is generally adopted by clearing institutions around the world. Under this arrangement, each Clearing Participant is required to deposit clearing fund with the JSCC to secure fulfillment of its settlement obligations.
The required amount of the clearing fund to be deposited shall be calculated for each Clearing Participant using the formula determined by JSCC, which is based on the historical value of the participant's open position and its price fluctuation. Any losses resulting from a Clearing Participant's default shall be firstly compensated by the clearing fund deposited by that defaulting Clearing Participant, hence, in principle to the extent of the clearing fund deposited by defaulting participant, the losses by no means causes any damage to the other Clearing Participants.
Loss compensation by each exchange
Since the required amount of clearing fund to be deposited is calculated based on historical data and performance, it is difficult to cover the potential losses completely. Therefore, in case the loss is not covered by the defaulting Clearing Participant's clearing fund, JSCC has concluded contract with each stock exchange to compensate possible losses arising from Clearing Participant's default. Under this contract, each exchange shall compensate the loss which is arising from the transactions of which JSCC has assumed obligations to the extent of each exchange’s reserves, such as loss compensation reserve (*).
(*) Default compensation reserve fund, etc. refers to “default compensation reserve” in Osaka Securities Exchange, “default compensation reserve funds” in Tokyo Stock Exchange, Nagoya Stock Exchange, Fukuoka Stock exchange and Sapporo Securities Exchange.
Mutual guarantee among Clearing Participants (joint responsibility)
In case losses from a default are not covered by the clearing fund deposited by the defaulting Clearing Participant, the default compensation by each exchange and shareholder’s equity of JSCC, the Mutual guarantee system (Loss Share Rule) is taken place under which the other Clearing Participants jointly compensate the remaining losses.