Companion·Question

How does client clearing work in Japan, and how does JSCC handle segregation and default management?

Codex No. 1 · Derivatives Clearing: A Comprehensive Guide

Japan clears its OTC derivatives at one house. The Financial Instruments and Exchange Act was amended in 2010 to introduce a comprehensive regulatory framework for them, and covered transactions must in principle be cleared at JSCC — the only domestic clearing house for OTC derivatives, and an integrated one: equities, bonds, exchange-traded derivatives, interest rate swaps and credit default swaps, and commodity derivatives all clear inside it. Clients that are not clearing participants reach it the way clients reach any CCP, through a clearing broker.

On segregation and default management, Japan is not a separate species. JSCC’s yen interest rate swap clearing adopts an ISA-type model, and its default waterfall runs in the same direction as any CCP built to the PFMI. The part that is genuinely different sits underneath both: customer assets are held through a trust scheme, which ring-fences them in law not only from a default by the clearing participant, but from a default by JSCC itself.

Drawn from a book written from the clearing broker's side of the trade, for the people who run it — operations, risk, treasury and collateral, at brokers and on the buy side alike.

The MapOne house, one trust, and porting first

The category is ordinary. The trust underneath it is not.

The mandate

The clearing mandate was introduced under the Financial Instruments and Exchange Act, at Article 156-62 and related provisions. Covered transactions must, in principle, be cleared at JSCC, which is the only domestic clearing house for OTC derivatives. That single-venue structure is the first thing to understand about the Japanese market: there is no domestic choice of CCP for the products in scope.

Where Japan really does differ

Electronic trading mandates

The United States, through SEFs, and Europe, through the derivatives trading obligation, impose execution mandates on the great majority of trades. Japan covers only major banks meeting criteria such as OTC derivatives outstanding of JPY 1 trillion or more. The book calls this a clear difference in stringency.

Supervisory structure

The United States runs a dual-agency system and Europe a tiered one. Japan’s is essentially unified, commodities excepted — which changes who a firm answers to, and how many of them.

Segregation: an ISA-type model, with a trust on top

For yen interest rate swaps, each customer account is managed individually inside JSCC under an individual segregated account model. One customer’s assets are never commingled with another’s. Then comes the part that has no close counterpart elsewhere: the use of a trust scheme, which the book calls the defining feature of the JSCC model. Customer assets are insulated from the default risk of the clearing participant and legally ring-fenced from a default by JSCC itself — bankruptcy remoteness at a level that is uncommon.

Exchange-traded derivatives work differently. A gross omnibus customer account and an individual customer account are both available, and the clearing participant or the customer selects between them. The model is a choice there, not a given.

How the segregation models compare →

Default management: porting first, then the waterfall

If a clearing participant fails, JSCC’s stated first priority is to port the positions it was clearing for clients, together with the associated margin, to surviving participants. Only what remains is absorbed by the waterfall: the defaulting participant’s initial margin and default fund contribution, then JSCC’s own contribution, then the contributions of the surviving participants, then assessments, and finally variation margin haircutting as the last stage of loss allocation.

The framework is designed and operated in line with the PFMI, and specifically its principle on default management. It is rehearsed rather than assumed: JSCC runs fire drills annually with its clearing participants, and assembles packages of a defaulter’s positions for competitive auction among the survivors. Through the stress of March 2020 it held initial margin of over roughly JPY 1.5 trillion, so that risk was absorbed at the upper steps.

The waterfall, step by step →

Where the book takes this further

Chapter 4, Section 2

The amended Financial Instruments and Exchange Act and the role of JSCC, followed by a comparison across the United States, Europe and Japan — what is the same, and what is not.

Chapter 4, Column D

JSCC itself: how it became the core infrastructure of Japan’s capital markets, and what it still has to solve.

Chapter 5, Section 4

JSCC’s default management framework in detail — porting, the waterfall, the auction, and the annual fire drills.

Chapter 6, Section 3

Segregation models in the Japanese market, set against the futures omnibus, LSOC and ISA models used elsewhere.

What is in each chapter →

The Book

Written by Shun Yanagisawa — Director, Head of Futures, Clearing and FX Prime Brokerage, Markets Sales at Citigroup Global Markets Japan Inc. He is a Representative Director and Vice President of FIA Japan and the Chair of its Operations Committee, and sits on the JSCC Interest Rate Swap Steering Committee and the advisory board of Asia Risk.