The nascent Japan Government Bond Clearing Corporation (“JGBCC”) has began to map out how losses incurred by counterparties going under would be handled.
The first line of defence will be the collateral pledged by the bankrupt counterparty. If this is insufficient, each of the counterparty participants who have traded with the bankrupt participant will compensate the remaining loss on a pro-rata basis according to the trading amount of each counterparty participant.
The third line of defence will be to suspend settlement of trades by counterparties who refuse to pay up, and the application of collateral they have pledged to the loss. If the clearing funds of the counterparties still do not completely compensate the loss, these participants shall remain liable to pay compensation, on pain of being sued by the JGBCC.
Where a loss is not completely covered by these various steps, the JGBCC will utilize the 25% of the retaining surplus (or more than 25% if authorized by the Board of Directors).
Thereafter, the cash portion of the clearing funds provided by all the participants of JGBCC (subject to an upper limit of yen 100 million) will be used. If the funds are still short, each netting (or clearing) participant will be obliged to subscribe additional clearing funds.
Ultimately, the JGBCC will simply request all the participants to compensate the remaining loss in proportion to the amount of the clearing funds each participant provides.