Background information on LCH and LCH SwapClear
LCH, established in 1888, acts as central counterparty to trades executed by its members:
- on the London International Financial Futures and Options Exchange (LIFFE), the London Metal Exchange (LME), the International Petroleum Exchange (IPE) and the Tradepoint Stock Exchange;
- in certain classes of over-the-counter (OTC) products, specifically interbank interest rate swaps, repos and cash bonds; and
- from early 2001, in equities traded on the London Stock Exchange's SETS system.
In 1999 LCH cleared approximately 205 million contracts traded on the London exchanges.
Once LCH has registered a matched trade it becomes principal to that contract. This is designed to ensure the financial performance of such contracts in accordance with LCH's General Regulations, and provides the following key benefits:
- Reduced risk - LCH's role reduces counterparty risk for its members;
- Increased market liquidity - LCH's position as a central counterparty allows members to net out contracts originally traded with different members;
- Decreased settlement costs and risk - LCH operates a centralised settlement process, netting payments and receipts across contracts and exchanges reducing settlement costs for members and systemic risk.
LCH is owned by its members and derivatives exchanges, 75% and 25% respectively.
LCH's primary protection in the event of default by a member is the initial margin collected from that firm. As protection against the insufficiency of initial margin, members collectively contribute to LCH's Default Fund. This currently stands at £191m, and there is provision to increase its value up to £300m as new members join SwapClear and Repoclear. The Default Fund is supplemented by an insurance policy, providing a further £100m of cover.
LCH SwapClear was launched in September 1999. It is designed to be used by the major global swap dealers. Five banks are currently using the service: Banca IMI S.p.A., HSBC Bank plc, KBC Bank NV, Lehman Brothers International (Europe) Ltd, and Tokyo-Mitsubishi International plc. Ten other banks, including the eight banks in the announcement, are in the process of implementation or final systems testing.
LCH SwapClear clears vanilla interest rate swaps in G-4 currencies, up to 10 years' maturity. SwapClear will increase its product scope to include the addition of currencies and indices, longer maturities, cross-currency swaps and options.
LCH becomes the counterparty to every registered and cleared swap, replacing the current bilateral netting arrangements with more efficient multilateral netting. Multilateral netting can reduce exposures by up to 80% more than bilateral netting.
Clearing through LCH SwapClear reduces regulatory and economic capital requirements for credit risk because of an exemption from calculating Counterparty Credit Risk (CRR). The CAD Annex II exemption is available for OTC derivatives cleared through a recognised clearing house in certain jurisdictions. This results in major improvements in return on capital for swaps' trading books and hundreds of millions in capital savings.
LCH SwapClear offers considerable benefits to its users. These include:
- a reduction in credit risk through effective multilateral netting and margining of exposures, freeing up bank credit lines for further business;
- a reduction in regulatory capital requirements through the CAD Annex II exemption, removing the need for banks to calculate counterparty risk requirements;
- initial margin offsets between swaps and interest rate and government bond futures and options positions traded on LIFFE;
- a reduction of operations risk through the centralisation and standardisation of processes providing post trade straight-through processing;
- a reduction in operational and administrative costs;
- an improvement in legal risk, both in netting and in collateral management;
- creating a highly scalable processing model for vanilla OTC derivative