1. Audit and Compliance
   
   
   The KLCE is a self-regulatory body with rules and regulations broadly similar to those of US Exchanges.
   
   The Exchange conducts regular and ad hoc audits of Members’ books and operations, to ensure compliance with the Exchange Rules. Members found violating any Exchange Rule will be brought before the Business Conduct Committee (BCC) for disciplinary action.
   
   
2. Financial Surveillance
   
   
   In recognition of the need to monitor the financial condition of its corporate Members, KLCE together with the Clearing House operate an effective financial surveillance programme. For example:
   
   
   • Reporting

   Broker Members must submit financial statements at least quarterly, provide audited financial statements once a year, and make more frequent reports (monthly, weekly or daily) as directed.

3. Market Surveillance

   KLCE recognizes the need to have a fair and equitable market place. To this end, the market surveillance programme has been designed for such purpose.

   • Reportable Positions

   The Audit and Compliance Division of KLCE has daily access to specific account position information regarding individual Members and non-Member clients, all of which are maintained on a highly confidential basis. This is achieved by requiring Members to report their own positions and their clients’ positions once a specified level is reached. Such critical information allows the identification of concentrated positions as they arise and the aggregating of positions, which may be owned by common principals through the different broker Members. Knowledge of concentrated or high-risk positions, coupled with information routinely gathered on the cash and/or related derivative markets, enables the Exchange to respond rapidly to market situations that may adversely affect the clearing system and the financial integrity of its marketplace.

   • Position Limit

   KLCE imposes a limit on the positions that any one person may hold or control in any one contract or all contracts combined. This is to prevent the concentration of positions in the hand of any one person for the reasons outlined above. In addition, this will also reduce the risk of manipulation or cornering of the marketplace.

   • Price Limit

   KLCE imposes a daily price limit on the forward months of each contract traded to provide some breathing space to broker Members to enable them to collect sufficient margin from their clients at times of extreme market stress or volatility. The imposition of a daily price limit also provides some comfort for market participants to protect their uncovered positions under extreme market conditions.

4. Floor Surveillance

The Floor Surveillance Unit is responsible for detecting any fraudulent trading practice, abuse and any other violation of the KLCE’s Rules and Regulations or the objects contained in the KLCE’s Floor Procedures Manual.

Duties include the following:

1. To ensure all traders on the floor maintain a high standard of conduct and professionalism
2. To conduct regular audits on Members pertaining to Floor Rules violation
3. To investigate complaints officially received from Members, Locals, the Clearing Corporation and identified sources as well
4. To conduct special audits at the request of the Chief Executive Officer and the Audit & Compliance Division or the Legal Manager.

A CCTV (closed-circuit television) Surveillance System is in place to enhance the Division’s performance. The system includes cameras located at strategic positions within the trading floor, microphones, television monitors, video recorders and a scanner with pan, tilt and zoom capabilities.

Each Clearing Member is required to lodge a security deposit of minimum RM 1,000,000 and clearing fund of minimum RM 1,000,000 with the Clearing House as a performance bond to cover its obligations. In addition, the Clearing House establishes minimum initial margin and maintenance margin levels for all products traded on the KLCE based on historical price volatility, current and anticipated market conditions, and other relevant information. Together, these requirements serve as a performance bond to cover the Clearing House’s potential exposure to price movements between daily margin calls.

Trades are cleared up through the hierarchy from the clients through their brokers and held in books of the Clearing House while the guarantee of financial performance of these trades extends downward.

All contracts executed on the trading floor are automatically guaranteed, initially by the respective Clearing Members, and thereafter by the Clearing House, once the contracts have been matched and accepted for registration.

It should be noted that the guarantee of financial performance only extends between each party linked in the clearing hierarchy. In other words, the Clearing House only guarantees the contracts to its Clearing Members, who in turn guarantee the contracts held on behalf of the Non-Clearing Members, Locals and clients clearing through them. Clients’ contracts held in the books of a Non-Clearing Member are guaranteed by the Member.

Although the Clearing House does not guarantee the financial performance of contracts to the clients, the fact that it extends this guarantee to Clearing Members, who guarantee their Non-Clearing Members and clients, means that any broker and his clients are protected against a default by any Member of the Exchange. As such, a client’s exposure is limited to his own broker’s failure to meet payment.

In the event that his own broker defaults, then the broker may be unable to meet all his obligations to his clients. In such an event, the Clearing House and Exchange would carry out default procedures designed to protect the innocent parties, including transfer of their positions where possible to other KLCE Members. However, if in spite of these measures being taken, a client does suffer a loss as a result of his broker’s default, then his final recourse will be to the Exchange’s Compensation Fund.

How is the Clearing House able to guarantee the financial performance of the contracts to its Members? Basically, by requiring each Member to provide adequate collateral to cover their potential liabilities. This is done by a system of collecting deposits and margins daily. In effect, this is the basis of the system of financial security of the marketplace.

1. Initial Margin

Whenever a Member trades on the Exchange, he is required to put a deposit called "Initial Margin" to the Clearing House. The purpose of this deposit is to protect the Clearing House against possible adverse price movements in the contract concerned. As such, the level of Initial Margin is set based on the price volatility of the underlying commodity and represents an estimate of one to two day’s movement in the contract value. Typically, the level of Initial Margin is set at around 5 percent to 10 percent of the contract value.

For instance, if a Member buys or sells one Crude Palm Oil (CPO) futures contract, he may be required to put up a margin of RM 2,000 to the Clearing House. If the Member is doing the transaction on behalf of a client, he is also required by the Exchange to take a deposit from his client of at least as large as this Initial Margin, so that the risk is covered by margin throughout the clearing hierarchy.

The Initial Margin is repaid when the contract is closed out, either, by doing an equal and opposite trade at a later date or by reason of the contract maturing.

2. Variation Margin

It is the feature of futures markets generally that unrealized or "floating" gains and losses in the value of outstanding contracts are paid daily between the Clearing Member and the Clearing House. Thus, if a Clearing Member has bought one CPO futures contract (of 25-tonne) at a price of RM 1,000 per tonne and the price at the close of business yesterday was RM 900 per tonne, he has lost RM 100 x 25 tonnes or RM 2,500. He will therefore have to pay the Clearing House RM 2,500 in "Variation Margin" today to cover this unrealized loss. This sum of money will be in addition to the Initial Margin of RM 2,000 he had already paid earlier. The Variation Margin of RM 2,500 only covers the loss up to the close of business yesterday; any further loss arising today should, in principle, be covered by the Initial Margin. Variation Margin payments, therefore serve to keep the Initial Margin intact to meet possible adverse price movements today. Variation Margin works in both directions; losses must be paid in, gains are paid out. In the above example, let us suppose that the price had moved up to RM 1,100 per tonne, giving the Clearing Member an unrealized gain of (RM 100 x 25 tonnes) RM 2,500. The Clearing House would pay him RM 2,500 in Variation Margin today.

This daily settlement process ensures that price movements are directly reflected in cash movements - positions are automatically "marked-to-market" every day. In turn, the Member will debit or credit his client daily for Variation Margin on his transactions, so that when a Clearing Member deals on behalf of a client, the margin payments simply pass between the Clearing House and the ultimate client via the Clearing Member firm.

3. Maintenance Margin

For most clients these daily transfers of funds are an administrative inconvenience and so normally the client will arrange with the Member through whom he trades to set up a Futures Margin Account. This will usually be set up on the method known as the Maintenance Margin System. This is really no more complex than a simple current account with an agreed minimum balance called the Maintenance Balance. The client opens the account with an Initial Balance of perhaps twice the Maintenance Balance. Thereafter the account is debited or credited for daily Variation Margin, Initial Margin, realized gains and losses, commissions, etc., on an automatic basis. No payments are required from the client unless the account balance falls below the Maintenance Balance, in which case the client is required to top up the account to the Initial Balance once more. The client is only involved in making or receiving actual payments relatively infrequently, the day-to-day movements on the account being otherwise automatically made by the Member through whom he is trading.