Examining another Clearing Service Rulebook

Clearing Service rulebooks are complex and lengthy documents. In this article I use Google Gemini to examine the CME Rulebook, which has more than 250 chapters, each with many pages of text.

May 15, 2025

Background

In Capital Markets, Clearing Service providers such as CME Group or DTCC, publish rulebooks that specify in immense details the rules they operate by. These documents are generally public and are important documents for member firms to understand the detailed rules of the clearing service.

Chicago Mercantile Exchange or CME as it is widely known, is one of the world’s most important market infrastructures. It’s rulebook is published on the CME Group website here. This page provides an index with over 250 chapters, each linking to a specific pdf document with many pages. That is certainly a lot of content.

In this article, I examine this rulebook using Google Gemini 2.5 Pro (preview).

Let’s Start

In last weeks article, Examining a Clearing Service Rulebook, I looked into the DTCC FICC rulebook and as that was one pdf document (with 337 pages), I simply uploaded the pdf into the context window for Gemini and started prompted.

Today, given that there are over 250 pdf documents, we clearly can’t do that. Instead I will start with the following prompt:

The CME Rulebook is at https://www.cmegroup.com/rulebook/CME/ with pdf documents for each numbered section, using this source of data, please answer the following questions

The response is:

Looks good, now we are ready to begin.

Member Default

The default of a clearing member is a very serious event, with potential demands on other members financial resources, so it is important that rules on this are clear.

Scanning the section headings of the contents page, I don’t see any relating to “Default”, so I would have had to use trial and error and a lot of time consuming reading to find the appropriate section.

However, today I can just enter the following into Gemini:

In the event of a member default how are financial resources utilised to address this?

The response is copied and pasted below:

In the event of a clearing member default, CME Clearing employs a multi-layered approach to utilize financial resources, often referred to as a "default waterfall," to cover the outstanding obligations and manage the default.¹ The process is designed to protect other clearing members and their customers from the financial impact of the default.

According to information from CME Group, the typical order of financial resource utilization is as follows:

Defaulting Member's Resources: CME Clearing will first use the financial resources of the defaulting member. This includes:
- Their performance bond collateral (margin).
- Their contribution to the guaranty fund.
- Any other assets deposited by the defaulting member with CME Clearing.
CME Clearing's Own Contribution: If the defaulting member's resources are insufficient to cover the losses, CME Clearing will then contribute its own capital to the relevant financial safeguards waterfall.² CME Group pre-funds these contributions, with stated amounts such as $100 million for base products and $150 million for IRS products (as of July 2020).
Non-Defaulting Clearing Members' Guaranty Fund Contributions: Should losses persist after CME Clearing's contribution, the pre-funded guaranty fund contributions of the non-defaulting clearing members in the specific financial safeguards waterfall where the default occurred are utilized.³
Assessments on Non-Defaulting Clearing Members: If the above resources are still not enough to cover the losses, CME Clearing has the authority to levy assessments on its non-defaulting clearing members. These clearing members would be required to provide additional financial resources up to a capped amount.

Throughout this process, CME Clearing also prioritizes the transfer, or "porting," of the positions and performance bond collateral of the defaulting member's non-defaulting customers to one or more solvent clearing members.⁴ This is done to minimize disruption and protect these customers.

The CME Rulebook, particularly sections within Chapter 8 (Clearing House) such as those dealing with the protection of the clearing house and the application of funds, outlines the detailed procedures and authorities of CME Clearing in a default scenario.

For further details, you can refer to materials available on the CME Group website, including articles on "CME Clearing Financial Safeguards Waterfalls" and "101 Overview: Default Management," as well as the official CME Rulebook.⁵

Looks good and is correct (based on my prior knowledge) and clearly notes that Chapter 8 has the detailed procedures.

Sources Used

At the bottom of the response, the following Sources and related content is listed:

While I am happy with these links as from the CME website and the content is specific to my request, it does make me suspicious if all of the response came from these links and not the rulebook itself.

Indeed, expanding “Show thinking” I can see:

Oops, I forgot that learning from one of my earlier blogs, PDF documents are not directly parsed from a URL, instead Search results provide text snippets.

So while the response above does include a reference to Chapter 8 of the Rulebook and I can see from the Show Thinking that sections 802.A, 802.C and 802.D are mentioned, it has not been created from the full text.

Is that a problem?

Well, most likely it is not, as we expect the other content on the CME Group website to be correct. However to be 100% confident, we would need to read the specific language found in Chapter 8 of the Rulebook itself.

Next I tried the following:

Please use just the rulebook resource I have given and not other CME URLs

To which the response is:

Hmm, what gives?

Expanding Show Thinking, I can see what is happening.

So while the Browse tool cannot navigate a URL to discover pdfs, if a prior Search did return direct links to the pdf rulebook chapter (which it did in this case), the Browse tool can access the pdf.

Note the Browse tool may not successfully parse all text in a pdf (data tables, OCR scanned etc) but it does a reasonable good job.

Provided you check Show Thinking, you can confirm what documents and sources have been used.

(For more details on the Browse tool, you can simply ask Gemini what it does and it’s limitations).

VM Gains Haircuts

A particularly contentious concept and one that I remember debated at an FIA Boca panel, is Variation Margin Gain Haircuts, which was not mentioned in the first response above.

Let’s ask about this.

Is there any mention of VM Gains Haircuts in the Rulebook, if so where and explain what it is?

But this is not the text just the Chapter 8 document, what is VM Gain haircutting?

And the full response, copied below:

You are right to ask for a clearer explanation. Based on the information previously extracted from Rule 802.B of the CME Rulebook (specifically from the PDF document at https://www.cmegroup.com/rulebook/CME/I/8/8.pdf), here's an explanation of what VM (Variation Margin) Gains Haircutting (referred to as "Base Gains Haircut" in the context of that rule) entails:

In essence, VM Gains Haircutting is a mechanism used by the Clearing House in the critical situation of a clearing member default.

Here's a breakdown:

Context: It occurs following a default by a Base Clearing Member, specifically during a final settlement cycle conducted on the day of a "Bankruptcy Event" (as defined in the rules).
What it is: If non-defaulted clearing members (or non-defaulted customers of the defaulted member) have accrued gains (positive variation margin) on their positions in "Base Contracts," they would normally be entitled to receive the full amount of these gains. However, under a "Base Gains Haircut," a portion of these accrued gains is withheld by the Clearing House. They don't receive 100% of their gains for that settlement period.
Purpose: This "haircut" (reduction) of the gains helps provide immediate liquidity and resources to the Clearing House to manage the financial consequences of the default. The withheld amounts can be used to cover losses or obligations arising from the defaulter.
Claim for Recovery: Importantly, the clearing members and customers whose gains were subject to this haircut do not necessarily lose this withheld amount permanently. They acquire a claim against any funds recovered from the defaulted member (or their estate) for the amount of the haircut they experienced.
Pro-Rata Recovery: If the total amount recovered from the defaulted member is less than the total aggregate amount of all the gains haircuts applied, then the non-defaulted members and customers will share the recovered funds on a pro-rata basis, according to the proportion of their individual haircut.

So, "VM Gains Haircutting" is a tool within the default management process where the Clearing House reduces the variation margin gains paid out to non-defaulting members in specific circumstances to help absorb the impact of a default, with those members then having a claim to recover the haircut amounts from the defaulter's assets.

This explanation is derived from the previously provided summary of Rule 802.B. For the precise legal wording and complete details, one would need to consult the full text of that rule within the CME Rulebook itself.

That’s a good explanation, with a clear message at the end to consult the rulebook for 802.B and the precise legal wording.

Let’s stop there.

Learnings

Clearing Service rulebooks are often split into a large number of documents (pdfs).

While the URL for the contents page is a good start point for prompts.

Its is important to check what Sources are actually used for the response.

Show Thinking in Gemini is important for this.

Gemini will use Search and Browse tools.

Search may find other sources to use and these are clearly listed.

Browse will act on pdf documents returned from Search results.

However it does not navigate a directory page to ingest all documents referenced.

That would often be too large for a context window.

Even one as large as Gemini’s 1 million tokens.

In some cases, you may need to upload the pdf document yourself.

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