China to Nullify Financing Guarantees by Local Governments

[SomeYoungGuy]

Quote from pitz:

Absolutely.

Quote from Renegen:

My understanding is no.

I'm getting mixed signals here.

I understand that in an extreme black swan where international markets crumble crumble, everybody with skin in the game gets burned.

What I'm wondering is let's say I'm trading just a contract or two of commodity X. Is it possible that the other side of my trade could be a Chinese trader who says "oops, lost some money" and breaks the trade? Assume an otherwise normally functioning market.

Seems like this could really shake confidence in any market they play in. It's like sitting down for a poker game, and having to wonder if the other guy is going to welsh on his marker and I get screwed. What are we paying commission to the exchange for?

 

[nutmeg]

It's like sitting down for a poker game, and having to wonder if the other guy is going to welsh on his marker and I get screwed.
---------------

Sorta like AIG paying GS. Thank god our gov't has some sense of decency. (yuk yuk) I suppose it depends on who is getting screwed.

 

[pitz]

Quote from Renegen:

My understanding is no. That's because your futures contracts are held at the CME for example. Your counterparty is the CME.

And just how safe is the CME? If, for instance, the USA had a 'bank holiday' (ala 1930s), with the dollar being devalued by 50% -- what would happen to the CME the next day?

I suggest that the CME would default. In the 1930s, they dealt with this circumstance by confiscating the physical gold, so the CME participants at the time did not have to perform on the contracts (as possession of gold was illegal).

 

[VoodooMMI]

Quote from SomeYoungGuy:

I'm hopelessly naive here, but do I have counterparty risk trading gold and wheat futures sitting here in my underwear? Or is this only a worry for some dark-pool international trading consortium that I'm not a part of?

If the contracts you are trading are CME Gold (Ticker Symbol GC) and CME Wheat (Ticker Symbol W) then your counterparty risk is negligible. Why, because of the clearing house structure at the CME. See
http://www.cmegroup.com/clearing/cme-clearing-overview/safeguards.html
and
http://www.cmegroup.com/clearing/files/financialsafeguards.pdf

Let's look at an example. If you Buy 1 GC contract through Interactive Brokers (IB) and a speculator in China, let's call him Mao, shorted that contract to you through his futures account at Merrill Lynch (ML), technically he is not your counter party. Instead both Interactive Brokers and Merrill Lynch are members of the clearing house and the clearing house serves as counter party to all trades. In other words, the clearing house serves as seller to all buyers and buyer to all sellers. So, because of your trade, IB is Long 1 GC held in your account at IB. ML is Short 1 GC held in Mao's account at ML. The Clearing House is Short 1 GC vs the Long 1 held at IB. The clearing house is also Long 1 GC vs the Short 1 held at ML.

So, to recap IB is Long 1 GC, ML is Short 1 GC and the clearing house is both Short 1 GC and Long 1 GC (i.e. net flat). So the counter party to the 1 Long contract in your account at IB is the Clearing House. Margin requirements and daily mark-to-market help to minimize overall counter party risk in the GC futures market as a whole.

You have 2 potential concerns (both negligible in the vast majority of cases). The counter party risk you have with the CME clearing house (currently, negligible in my opinion). The other concern is that IB properly credits the 1 Long GC to your account and not someone else's account at IB. Trades can be erroneously booked to the wrong account on occasion, so you should verify that what you think your position is corresponds to what your broker thinks your position is. I'd verify your position at least once a day. But in general, that is not a problem either and where it is your broker can rebook the trade properly.

This is my understanding of the underlying functioning of CME exchange traded futures. If I have made any errors, please point them out so that everyone that reads this thread will have correct information. IMO, The clearing house structure is an advantage which minimizes counter party risk over other markets without a Clearing House. Whether a counterparty risk is large or small all depends on who the counterparty is and that counterparty's financial condition. If the CME Clearing House is my counter party, right now I'd say my counter party risk is negligible. As for risk of other counter parties, that is for each trader to assess.