Counterparty risk management

NOS membership model allows all counterparties that satisfy the minimum requirements in the Rulebook to become clearing members. The counterparties represent all types of business with an interest in the freight, seafood and other commodities market. The member list in the freight market includes large financial institutions, ship-owners, charterers, energy companies, hedge funds and investment companies. The member list in the seafood market includes sea farmers, exporters, producers of fine food and others. To limit the counterparty risk, NOS sets base collateral requirements and exposure limits for all members. All entities that apply for clearing membership and existing clearing members, are reviewed by NOS. In this process, NOS membership committee reviews all information submitted by the client to determine an internal rating, exposure limit and individual base collateral requirement. NOS may also impose other restrictions if necessary. In the review process the following factors are evaluated: financial, legal, operational and miscellaneous factors. The application form states a list of information that the counterparty has to provide to NOS.

Financial

The capital requirement of clearing members is designed to grant membership only to clients that have the capacity to meet their obligations. The counterparty has to submit audited financial statements to NOS. The balance sheet and profit and loss account shall demonstrate the client’s capability to cover margin requirements and daily cash settlements. NOS may request that the member provides NOS with a parent company guarantee as additional security for the performance of the member.
Information regarding the counterparty’s credit facilities may also be requested to prove access to sufficient liquidity sources to fund margins and settlements. NOS calculates a risk capital that forms part of the basis for an internal classification.

Legal

NOS obtains legal opinions on all jurisdictions that it accepts clearing members from. The legal opinions shall establish that the contracts are legally valid and binding, that netting between contracts is valid etc. NOS may impose certain extra conditions to the clearing membership due to legal uncertainties. Such conditions may be that collateral has to be posted as standby letters of credit or certain registration requirements of pledging of the collateral account.

Operational

The experience with derivatives trading at the client’s trading desk, backoffice and risk management is reviewed together with operational capability, size of the organisation, risk management integrity and division of responsibilities between traders, backoffice and risk management.

Miscellaneous

The complexity of the member’s business forms a part of the credit assessment together with information reports from independent third parties, e.g. Infospectrum and Lloyd’s, regarding the counterparty’s management, payment performance and reputation. Other factors taken into consideration are supervision by financial authorities or similar licence requirements from governmental bodies.

Classification

Based on the risk capital and other factors, NOS assigns an internal classification of the counterparty. Each classification group has an exposure limit and the objective is to ensure that the maximum exposure is in line with the financial strength of the member. The individual base collateral requirement of the member is decided according to classification and exposure limit. The exposure limit is reviewed at least annually and on request from the member. Any change in the exposure limit is based on trading activity, frequency and size of margin calls, market share of open interest, in addition to the financial strength of the member.