Notes to the Consolidated Financial Statements
Years ended December 31, 2008 and 2007 (In thousands of dollars, except per share amounts)
22. Risk management:
(a) Credit risk:
Credit risk is the risk of financial loss to the Company associated with a counterparty’s failure to fulfill its financial obligations and arises principally from the Company’s investments in marketable securities, total return swaps and interest rate swaps, accounts receivable and the clearing and/or brokerage operations of Shorcan, NGX and CDCC.
| (i) | Investments in marketable securities The Company, excluding MX, manages its exposure to credit risk arising from investments in marketable securities by limiting the investment in short-term bond and mortgage funds to a maximum of 70% of the investment portfolio. Corporate bonds must have a minimum credit rating of BBB by DBRS Limited. Mortgages may not comprise more than 40% of the portfolio and must be either multi-residential conventional first mortgages or multi-residential government guaranteed mortgages. The Company does not have any investments in non-bank asset-backed commercial paper. MX manages its exposure to credit risk arising from investments in marketable securities by limiting total short term investment in bonds to a maximum of 30% in Schedule “A” Canadian chartered banks (“Bank bonds”) with the balance in Federal and Provincial bonds, while limiting total medium term investment in corporate bonds to a maximum of 35% with the balance in Federal and Provincial bonds. Corporate bonds must have a minimum credit rating of AAA by DBRS Limited. At December 31, 2008, MX did not have any investments in non-bank asset-backed commercial paper. |
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| (ii) | Total Return Swaps The Company limits its exposure to credit risk on TRSs by contracting with a major Canadian chartered bank |
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| (iii) | Interest rate swaps The Company limits its exposure to credit risk on the interest rate swaps by contracting with a major Canadian chartered bank. |
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| (iv) | Accounts receivable The Company’s exposure to credit risk resulting from uncollectable accounts is influenced by the individual characteristics of its customers, many of whom are banks and financial institutions. There is no concentration of credit risk attributable to transactions with a single customer. In addition, customers that fail to maintain their account in good standing risk loss of listing or trading privileges. |
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| (v) | Clearing and/or brokerage operations The Company is exposed to credit risk in the event that customers, in the case of Shorcan, or contracting parties, in the case of NGX, or clearing members, in the case of CDCC, fail to settle on the contracted settlement date. Shorcan’s risk is limited by its status as an agent, in that it does not purchase or sell securities for its own account. As agent, in the event of a failed trade, Shorcan has the right to withdraw its normal policy of anonymity and advise the two counterparties to settle directly. NGX requires each contracting party to provide sufficient collateral, in the form of cash or letters of credit, to exceed its outstanding credit exposure as determined by NGX in accordance with its margining methodology. The cash collateral deposits and letters of credit are held by a major Canadian chartered bank. This collateral may be accessed by NGX in the event of default by a contracting party. NGX measures total potential exposure for both credit and market risk for each contracting party on a real-time basis as the aggregate of: |
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As a result of these calculations of contracting party exposure at December 31, 2008, NGX held cash collateral deposits of $716,484 (December 31, 2007 – $273,612) and letters of credit of $2,366,318 (December 31, 2007 – $2,230,928). These amounts are not included in the Company’s consolidated balance sheet.
CDCC is exposed to the risk of default of its clearing members. CDCC is the central counterparty and guarantor of all transactions carried out on MX’s markets and on the OTC market, when the transaction is cleared through CDCC. It primarily supports the risk of one or more counterparties, meeting strict financial and regulatory criteria, defaulting on their obligations, in which case the obligations of that counterparty would become the responsibility of CDCC. This risk is greater if market conditions are unfavourable at the time of the default.
CDCC’s principal risk management practice is the collection of risk-based margin deposits in the form of cash, letters of credit, equities and liquid government securities. Should a clearing member fail to meet a daily margin call or otherwise not honour their obligations under open futures and options contracts, margin deposits would be available to apply against the costs incurred to liquidate the clearing member’s positions.
CDCC’s margining system is complemented by a stress reporting system. This process evaluates the financial strength of a clearing member to meet margin requirements that might result from a sudden adverse change in the market. Clearing members who fail to meet the criteria are required to deposit a stress margin.
CDCC also maintains a clearing fund through deposits of cash and securities from all clearing members. The aggregate level of clearing funds required from all clearing members must cover the worst loss that CDCC could face if one counterparty is failing under various extreme but plausible market conditions. Each clearing member contributes to the clearing fund in proportion to its margin requirements. If, by a clearing member’s default, further funding is necessary to complete a liquidation, CDCC has the right to require other clearing members to contribute additional amounts equal to their previous contribution to the clearing fund.
CDCC’s margin collateral deposits and clearing fund deposits are held by approved depositories under irrevocable agreements. This collateral may be accessed by CDCC in the event of default by a clearing member. As a result of these calculations of clearing member exposure at December 31, 2008, CDCC held margin collateral deposits of $4,502,024, and clearing fund deposits of $201,478, primarily in collateral securities. These amounts are not included in the Company’s consolidated balance sheet.
| (vi) | Guarantees NGX maintains an unsecured clearing backstop fund of U.S. $100,000. The Company is the guarantor, on an unsecured basis, of this fund. CDCC maintains $30,000 in revolving standby credit facilities in the event of default by a clearing member of CDCC. Borrowings under these facilities would be required to be collateralized. Neither facility has been drawn upon at December 31, 2008.
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