Assessment of LCH Limited's SwapClear Service 2. Material Developments

LCH Ltd has implemented a number of changes over the assessment period to support its provision of the SwapClear service to the Australian market. Some of these changes have been in response to the regulatory priorities and areas of supervisory focus set out by the Bank in the previous Assessment; others have been driven by changes to SwapClear's global product offering, risk management arrangements and governance.

2.1 2017/18 Regulatory Priorities

2.1.1 Operating hours extension

The SwapClear service is officially open from 6am UK time to 7pm New York time, but can open from an hour earlier, at LCH Ltd's discretion. In practice, LCH Ltd opened the service at 5am UK time on almost all business days in the assessment period. The official operating hours correspond to 3pm-9am AEST in the Australian winter, and 5pm-11am AEDT in the Australian summer.[8] While the SwapClear service is closed, trades cannot be cleared. Therefore Australian participants must manage bilateral credit risk exposures during much of the Australian business day, which also introduces operational complexity and uncertainty.

Over the assessment period, LCH Ltd continued to analyse the technical and risk management changes required to extend the SwapClear service's operating hours. In line with the Bank's expectations, LCH Ltd has indicated to the Bank that it will only extend its operating hours further if it would not adversely affect the operational resilience of SwapClear. LCH Ltd updated its trade registration and margining platform during the assessment period, but did not extend its operating hours. LCH Ltd will consider further extending operating hours in the next assessment period.

LCH Ltd has partly addressed the Bank's regulatory priority regarding extending its operating hours. In the next assessment period, LCH Ltd should complete its analysis and present this and a plan to the Bank of how it will implement any changes.

2.1.2 Australian Protected Payments System

LCH Ltd operates an Australian PPS, which facilitates AUD payments to and from the SwapClear service's Australian participants. Currently, five Australian participants use the Australian PPS to settle their AUD obligations with LCH Ltd directly using their ESAs at the Bank, up from three last year. This is in line with the Bank's expectation that any direct participant of SwapClear with an active ESA (and which joined since LCH Ltd was licensed to offer the SwapClear service in Australia) settle AUD obligations using the Australian PPS (CCP Standard 9).

Of the two Australian participants that began using the Australian PPS in the last assessment period, one existing participant completed its technical testing in early 2018. Macquarie Bank Limited became a direct participant of SwapClear in April 2018 (section 2.3.1), and also joined the Australian PPS.

LCH Ltd has fully addressed the Bank's regulatory priority regarding the Australian PPS.

2.2 2017/18 Areas of Supervisory Focus

2.2.1 Developments in LCH Ltd's governance arrangements

In the assessment period, the size of the LCH Ltd Board was set to eleven directors. LCH Ltd currently has five independent non-executive directors, two of whom do not sit on any other boards within LCH Group. LCH Ltd has also implemented changes designed to improve the effectiveness of board challenge and oversight. The Bank will continue to monitor developments in LCH Ltd's governance arrangements.

There were a number of key personnel changes at LCH Ltd and LCH Group during the assessment period:

  • Marshall Bailey OBE was appointed the Chair of the LCH Group Board, replacing Professor Lex Hoogduin. Professor Hoogduin continues as the Chair of LCH Ltd, and remains a director of LCH Group.
  • Kate Birchall was appointed Head of Asia-Pacific, LCH Ltd in October 2018. This role is based in Sydney. She replaces Marcus Robinson, who moved to a different role internally.
  • Dennis McLaughlin was appointed the LCH Ltd Chief Risk Officer (CRO), in addition to his role as the LCH Group CRO.
  • Mamun Ahmed, formerly the LCH Ltd CRO, became the Head of Risk Resilience at LCH Group and LCH Ltd; this is a newly created role.
  • Boaz Schechter was appointed Head of Shared Operations (a new role), taking responsibility for Member Onboarding, Collateral Operations and Collateral and Liquidity Management (CaLM) Middle Office Regulatory Reporting and Fees.
  • David Schwimmer was appointed as a director of LCH Group. Mr Schwimmer was also appointed the Chief Executive Officer (CEO) of the London Stock Exchange Group plc (LSEG), following the resignation of Xavier Rolet in November 2017.

There were also a number of other changes in the directors of LCH Ltd and LCH Group.

In October 2018, LSEG announced it has entered into agreements with minority shareholders to acquire up to a further 15.1 per cent of LCH Group's share capital. This would take its majority ownership to over 80 per cent. As at the end of the assessment period, LCH Group was 68 per cent owned by LSEG.

2.2.2 Operational resilience and cyber risk management

Over the assessment period, LCH Ltd has continued to make enhancements to how it manages operational and cyber risk. As noted in the previous assessment, LCH Ltd has reviewed its cyber risk management against the National Institute of Standards and Technology (NIST) Framework for Improving Critical Infrastructure Cybersecurity (Cybersecurity Framework) and the Cyber Guidance. LCH Ltd has implemented a number of actions set out in its cyber roadmap.

LCH Ltd has reviewed and is enhancing how it manages the risks of its outsourcing arrangements with LSEG's Business Services Ltd (BSL). LCH Ltd also aligned its assessment survey for all critical service providers with the CPMI-IOSCO Assessment methodology for the oversight expectations applicable to critical service providers. LCH Ltd has begun to implement this survey into its management of operational risk related to critical service providers. Over the next assessment period, LCH Ltd will make further changes to its risk management and governance of critical service providers, including BSL, and continue to embed the assessment survey into its approach.

The Bank will continue to monitor LCH Ltd's operational risk management framework, including in the areas of cyber risk, outsourcing and critical service providers, and operational resilience. The BoE has also continued to focus on operational resilience in its supervision of FMIs (section 1.5). The Bank engages regularly with the BoE on its work in this area.

2.2.3 Developments in international standards

The CCP Resilience Guidance, published in July 2017, clarifies and elaborates on the standards set out in the CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI) relating to CCPs' financial risk management.[9] It focuses on five areas: governance; credit and liquidity stress testing; coverage of financial resources; margin; and a CCP's contribution to the default waterfall. The CCP Resilience Guidance does not create additional standards beyond those already set out in the PFMI. Instead, it aims to improve the financial resilience of CCPs by providing clarity on an acceptable way of observing the PFMI. The Bank applies this guidance in interpreting the CCP Standards, and expects CCPs active in Australia to align their practice with this guidance.

In the assessment period, LCH Ltd completed a self-assessment against the CCP Resilience Guidance. In almost all cases, LCH Ltd's risk management practices align with the CCP Resilience Guidance. There are two areas where the Bank considers further analysis is required:

  • Liquidity risk, with respect to how LCH Ltd accesses foreign exchange markets for minor currencies, including in times of market stress (CCP Standards 7.4 and 7.5). LCH Ltd maintains sufficient liquid resources in GBP, EUR and USD to meets its default liquidity requirements without access to foreign exchange markets, and also has access to central bank liquidity in certain currencies (including AUD). Although LCH Ltd does not rely on foreign exchange markets for the majority of its default liquidity requirements by value, LCH Ltd may need access to foreign exchange markets to meet its liquidity outflows in other currencies. The Bank considers further analysis is required on LCH Ltd's access to these markets, including in stressed conditions.
  • Margin, with respect to LCH Ltd's validation of its margin add-ons, and how it assesses the SwapClear margin system as a whole. The CCP Resilience Guidance clarifies that CCP Standard 6 applies to all aspects of a CCP's margin system, including any add-ons. LCH Ltd's margin system comprises its base initial margin model, and a number of add-ons to mitigate specific risks not captured by the base model (for more information on LCH Ltd's margin system, see Appendix B1). LCH Ltd independently validates the SwapClear base initial margin model and the largest add-on, liquidity margin, annually. The Bank will monitor LCH Ltd's validation of its margin system in the next assessment period, specifically to see that LCH Ltd can demonstrate that it reviews all add-ons periodically and the margin system as a whole against alternatives.

The Bank has set an area of supervisory focus on financial risk management with respect to these two points, and will monitor them over the next assessment period. The CCP Resilience Guidance clarifies that CCPs' credit and liquidity stress tests should be consistent. In line with this, in September 2018 LCH Ltd changed its proxy for variation margin outflows in its liquidity stress tests to bring them in line with its credit stress tests. In its liquidity stress testing, LCH Ltd now uses credit stress test losses of the defaulting participants as its proxy for variation margin outflows. LCH Ltd previously used the defaulting participants' initial margin as the proxy in its liquidity stress tests.

The Bank also reviewed LCH Ltd in light of the updates to the Recovery Guidance, and is comfortable LCH Ltd's arrangements align with the updates.[10] The Global College previously reviewed LCH Ltd's Recovery and Wind-down Plans against the original Recovery Guidance in 2015/16.

2.3 Other Material Developments

2.3.1 New Australian SwapClear member

In April 2018, Macquarie Bank Limited joined as a direct member of SwapClear. Macquarie Bank Limited uses the Australian PPS to settle its AUD obligations with LCH Ltd. There are now six Australian-domiciled direct members.

2.3.2 AUD cash as initial margin

In the 2016/17 Assessment period, LCH Ltd fully addressed the Bank's regulatory priority to proceed with its plans to accept AUD cash as initial margin. LCH Ltd announced that it would accept AUD cash as initial margin from December 2017. To date, no participants or clients have posted AUD cash as initial margin.

2.3.3 Minimum default fund contributions

LCH Ltd increased the minimum contribution to the Rates default fund for participants who clear both SwapClear and Listed Rates products in May 2018. These participants must contribute at least £10m for the SwapClear service and £7.5m for the Listed Rates service (Appendix B2). Previously participants of both services had to contribute at least £10m for the SwapClear service and £0.5m for the Listed Rates service to the default fund. The minimum contribution for participants that clear only SwapClear products remains at £10m, and at £0.5m for participants that clear only Listed Rates products.

2.3.4 New products

Over the assessment period, LCH Ltd added the following products to the SwapClear service:

  • AUD BBSW-AONIA basis swaps were added in December 2017. AONIA is the interbank overnight cash rate, which is the operational target of the Bank's monetary policy. These basis swaps comprise a small share of AUD-denominated swaps cleared by LCH Ltd (Appendix A).
  • Non-deliverable interest rate swaps denominated in CNY, INR and KRW were added in April 2018. Counterparties settle the net cash flows on these swaps in USD. At the end of September 2018, these non-deliverable interest rate swaps were 0.5 per cent of notional value outstanding in SwapClear.
  • USD overnight index swaps (OIS) and basis swaps referencing SOFR were introduced following the publication of SOFR from April 2018 in line with global benchmark reform (section 2.3.6). SOFR is the US secured overnight financing rate. A small share of USD OIS outstanding referenced SOFR at the end of the Assessment period.

Several new products from the Listed Rates service are now eligible for portfolio margining with SwapClear products. In addition to short-term interest rate futures, from late 2018, LCH Ltd allows portfolio margining with long-term interest rate futures that reference UK long gilts as well as German 2-year Schatz, 5-year Bobl and 10-year Bunds. 3-month CurveGlobal SONIA Futures have also been included. Portfolio margining is allowed between these products and SwapClear derivatives denominated in 14 of 21 currencies (CCP Standard 6.5).

2.3.5 Default management fire drills

LCH Ltd took part in the annual LCH Group default management fire drill in parallel with its participation in a multi-CCP fire drill coordinated and observed by a number of regulators, including the BoE. The multi-CCP drill allows regulators, CCPs and participants to assess the possible impact of the default of a large member across several CCPs.

The LCH Group fire drill tested LCH Ltd's response to the default of two participants under one group (including a Futures Commission Merchant (FCM) participant), active across all clearing services in LCH Group, under stressed market conditions.[11] As a result of the drill, LCH Ltd identified some areas where its processes could be improved, and is currently working to implement the necessary changes.

2.3.6 Benchmark reform – transition away from LIBOR

LCH Ltd is counterparty to a large number of trades that reference interbank offer rates such as LIBOR. The international regulatory community is reforming these benchmarks, and establishing suitable alternative risk-free rates. For example in Australia, the BBSW methodology has been enhanced, and the Australian Government has introduced a new regulatory framework for financial benchmarks which gives ASIC the power to set rules for (and license administrators of) significant benchmarks.[12]

Market participants are beginning to use alternative rates, such as SOFR (for USD swaps) and SONIA (for GBP swaps). LCH Ltd now accepts USD SOFR basis swaps and OIS for clearing (see 2.3.4). In the assessment period, LCH Ltd adjusted the risk-free reference rate on GBP OIS and basis swaps to the new calculation of SONIA by the BoE. LCH Ltd has also made changes to its Rulebook so that it may determine alternative interest rates for products to be used in the event that the original reference rate is unavailable or ceases to be published. The Bank will continue to monitor global work on benchmark reform, including at LCH Ltd.

Box A: Client Clearing in the SwapClear Service[13]

The share of risk managed in SwapClear from client exposures has grown substantially in recent years (Graph 1). Clients are now responsible for more than half of the initial margin requirements in the SwapClear service. The number of client accounts has also grown (Graph 2). The risks posed by client clearing to CCPs differ in a number of respects from that of direct participants; CCP Standards 13 and 18 (Appendix C) describe how LCH Ltd mitigates these risks. This Box discusses recent international work relating to client clearing, the growth in client clearing at SwapClear, and the composition of global and Australian clients.

Graph 1
Graph 1: Initial Margin Requirements
Graph 2
Graph 2: Number of Client Accounts

Firms can access a CCP either as a direct participant or as a client of a direct participant.[14] Firms may elect to clear as a client for several reasons. For example, they may be unable or unwilling to meet a CCP's participation requirements, it may be too onerous operationally, or it may be cheaper than clearing directly. In most client clearing arrangements (including in SwapClear), the CCP is only exposed to the direct participant, which must continue to meet its clients' obligations in the event a client defaults.[15] Providers of client clearing are typically large international banks. Clients are mostly smaller banks, pension and superannuation funds, asset managers and non-financial corporations.

The number of clients clearing over-the-counter (OTC) derivatives has increased globally. The Derivatives Assessment Team (DAT), comprised of international standard-setting bodies, has examined the incentives to centrally clear OTC derivatives.[16] With respect to client clearing, the DAT found that the reforms to OTC derivatives following the global financial crisis have created an incentive for direct participants as well as larger and more active clients to clear. These reforms include mandatory clearing of certain products, and margin requirements and higher capital requirements for derivatives that are not centrally cleared. The reforms have also interacted with non-regulatory pressures – such as liquidity shifting to cleared markets, netting efficiencies and benefits for counterparty credit risk management – to further encourage clearing.

However, the incentives for smaller firms to clear their derivatives portfolios may be somewhat lower. This is because the benefits for these firms (such as netting and more liquid markets) may be smaller relative to the fees and fixed costs of accessing a CCP as a client. The DAT also found evidence of concentration in offering client clearing; more than four-fifths of client margin at large OTC-derivatives CCPs was cleared through the largest five direct participants.

Characteristics of SwapClear clients

As noted above, the risk and activity brought to LCH Ltd by clients has increased substantially. This growth has been driven both by an increase in the number of clients in the SwapClear service, and the average risk brought by each client. There were about 6,300 distinct, active clients in the SwapClear service at the end of September 2018; SwapClear has around 21,000 open accounts in total.

In addition to the rapid growth in firms accessing clearing as clients, another reason for the relatively high share of client margin is that clients tend to hold more directional exposures than clearing participants, which are typically dealers that prefer to hold balanced books. Therefore the risk associated with client positions is likely larger than measures of activity (such as notional value) imply.

Graph 3
Graph 3: Direct Participants
Graph 4
Graph 4: Client Accounts

Of the 111 direct participants in the SwapClear service, 50 are client clearers (as at end-September 2018). 37 offer client clearing through the SwapClear Clearing Member model, and 13 offer the FCM model. US-domiciled clients must clear through FCMs, though non-US clients may also clear through FCMs. The number of direct participants offering client clearing has been fairly stable in recent years (Graph 3). At LCH Ltd, the largest 10 client clearers in the SwapClear service clear about 92 per cent of client activity (by notional value).

Client account types

LCH Ltd offers four broad types of accounts for clients in SwapClear: Legally Segregated Operationally Commingled (LSOC) accounts; Individual Segregated Accounts (ISAs); gross Omnibus Segregated Accounts (OSAs); and net OSAs (see CCP Standard 13.2 for more detail). Different account types provide varying levels of protection from fellow client risk, and differ in collateral and netting efficiencies. Fellow client risk is the risk that a client is exposed to losses due to the simultaneous default of their direct participant and a fellow client. Around 60 per cent of client activity in SwapClear (by notional value, as at June 2018) is in LSOC accounts, which must be used by all clients of FCMs that clear swaps (Graph 4). In an LSOC account, clients are protected from fellow client risk in almost all circumstances, as positions are recorded (and margined) separately, and the value of collateral is legally segregated. However, all the collateral for all clients of FCMs is physically held together.

Clients of SwapClear Clearing Members have a broader choice of accounts. The most common accounts for clients of SwapClear Clearing Members are individually segregated. ISAs offer protection against fellow customer risk, as each client's positions and collateral are held separately from other clients, and margin requirements are calculated separately for each client. LCH Ltd also offers an account that provides custodial segregation; the Custodial Segregated Account (CSA) differs from the ISA in that clients can lodge non-cash assets directly with LCH Ltd using a central securities depository (CSD) rather than via the direct participant. By contrast, in omnibus account structures clients may be exposed to fellow client risk depending on how their positions and collateral are held. LCH Ltd offers gross and net OSAs. A net OSA may be cheaper for clients as multiple clients' positions can be margined together, which may reduce their margin requirements.

The type of account also affects the likelihood a client could be ported. Porting refers to the shifting of a client's positions and collateral, in the event of the default of their direct participant, to a surviving clearing member. If porting is not possible, then the client's positions would be liquidated. For clients of SwapClear Clearing Members, porting requires the assent of the client, as well as the surviving participant to which their account is ported. Positions and collateral held in accounts with other clients (net OSAs and certain groups of clients in gross OSAs) can only be ported if all positions of all clients were ported to the same surviving clearing participant. Therefore porting may be more straightforward for positions and accounts of a single client (in ISAs, CSAs and certain gross OSAs).

Different provisions apply to clients of FCMs. In the event of default, porting is coordinated by all FCMs and LCH Ltd with the oversight of the Commodity Futures Trading Commission (CFTC). Porting these accounts may be more straightforward than other omnibus accounts because, as noted above, client positions are maintained in legally segregated accounts, and are margined separately. CCP Standard 13 describes LCH Ltd's client account structures and porting arrangements in detail.

Client clearing in Australia

The Australian banks that are now members of SwapClear previously cleared all their trades as clients of other direct participants. Although they are now direct members of the SwapClear service, the Australian participants still clear OTC interest rate derivatives in certain currencies as clients in part due to cost and convenience.

Client clearing by Australian firms has broadly mirrored international trends. There are currently 17 active Australian-domiciled clients in SwapClear, including banks, asset managers and superannuation funds. The notional value outstanding of Australian clients was A$676 billion in September 2018; by contrast the Australian direct participants have about A$13 trillion outstanding (Graph 10 in Appendix A). Around two-thirds of Australian client activity is cleared through LSOC accounts. Australian clients currently contribute around A$650 million in initial margin to the SwapClear service. For comparison, the Australian direct participants post about A$3.7 billion. The Bank has set tiering as an area of supervisory focus for 2018/19. The Bank will continue to monitor activity and risks of clients in SwapClear over the next assessment.


Differences in when the Australian states, New York and the UK begin and end daylight savings affect these times. [8]

The CCP Resilience Guidance is available at: [9]

The revised Recovery Guidance is available at:; a tracked changes version showing the revisions is also available. [10]

See CCP Standards 13 and 17 for more detail on FCMs and their clients. [11]

For more information, see G Debelle, 2018, Interest Rate Benchmark Reform, Keynote at ISDA Forum, 15 May. Available at: Interest Rate Benchmark Reform. For an example of international work, see BoE, Transition to sterling risk-free rates from LIBOR. Available at: [12]

Most data referred to in this Box are drawn from LCH Ltd's quantitative disclosures, which are available up to the end of the June quarter 2018. These data are published under the CPMI-IOSCO Public quantitative disclosure standards for central counterparties, and are available at: [13]

LCH Ltd also offers indirect client clearing at SwapClear, where a firm clears as the client of a client. However, there are currently no indirect clients in the SwapClear service. [14]

For more detail on client clearing arrangements, see A Clarke and Ryan P (2014), ‘Non-dealer Clearing of Over-the-counter Derivatives’, RBA Bulletin, March. [15]

Basel Committee on Banking Supervision (BCBS), CPMI, Financial Stability Board (FSB) and IOSCO, 2018, Incentives to Centrally Clear Over-the-counter Derivatives, 19 November. Available at [16]