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, governance and international developments.

2.1 2018/19 Regulatory Priorities

2.1.1 Extension of operating hours

The SwapClear service is officially open from 6am UK time to 7pm New York time.[4] Since February 2017, the service has been able to open up to one hour earlier at LCH Ltd's discretion. In September 2019, in line with the Bank's 2018/19 regulatory priority, LCH Ltd brought forward the flexible open time by an additional hour to 4am UK time. In practice, LCH Ltd has opened the service at the commencement of the flexible open on most business days during the assessment period. However, the service remains closed for at least four hours of the Australian business day. Until the SwapClear service opens and trades can be novated, firms are required to manage bilateral credit risk exposures. Trades sent for clearing will be queued up to be cleared once the service is opened. LCH Ltd also provided the Bank with analysis of the key challenges to further extensions to the operating hours of the SwapClear service.

In the next assessment period, LCH Ltd should provide the Bank with an approved timeline of how it will continue to extend operating hours in the medium term while maintaining the safety and resilience of its operations.

2.1.2 Protected Payment System contingencies

LCH Ltd operates the PPS to settle cash payments to and from participants. LCH Ltd calls funds from, or pays funds to, clearing participants across the books of PPS banks (commercial settlement banks) acting on behalf of those participants. PPS banks then make or receive payments to or from the LCH Ltd ‘concentration bank’ via the relevant real-time gross settlement system for each currency. In the event of a PPS bank outage, LCH Ltd expects its participants to have access to contingency arrangements so that they can continue to make payments to and receive payments from LCH Ltd. LCH Ltd has previously identified several areas where improvements are necessary to ensure the timeliness, robustness and effectiveness of its PPS contingency arrangements.

During the assessment period, LCH Ltd has made progress on improving these arrangements. This work has involved developing a plan to enhance the efficiency of its PPS contingencies, including testing and implementing changes designed to improve the automation of aspects of its existing direct funding contingency arrangements. In addition, LCH Ltd has engaged with participants and settlement banks to explore the feasibility of complementary contingencies, such as using backup PPS banks and leveraging existing commercial relationships.

LCH Ltd should continue to make progress against its plan to improve the effectiveness of its PPS contingency arrangements and demonstrate that its enhanced arrangements have the capacity to meet LCH Ltd's service targets in the next assessment period.

2.2 2018/19 Areas of Supervisory Focus

2.2.1 Governance

Over recent years there has been a continued focus on the governance arrangements in place at LCH Ltd. During this period, LCH Ltd has made a number of changes to these arrangements to enhance their effectiveness, including changes to the structure of the LCH Ltd Board to improve its independence. Throughout this period, the Bank has monitored the outcomes of the recent changes, including those arising from an external review into the LCH Ltd Board's effectiveness, and is satisfied that LCH Ltd's approach to governance has become more robust.

There were a number of key personnel changes at LCH Ltd and LCH Group Holdings Limited (LCH Group) during the assessment period. These changes have affected the composition of the LCH Ltd Board, as well as senior management positions and reporting lines (Appendix B.2). During the assessment period:

  • Bruce Kellaway was appointed the Global Head of Rates, Securities and Collateral; this is an expanded role, replacing the existing roles of Global Head of RepoClear and Collateral (previously held by Mr Kellaway) and Global Head of Rates following Michael Davie's resignation from the latter role. Bruce Kellaway will also continue to serve in his capacity as Head of EquityClear at LCH Ltd.
  • Susi de Verdelon, formerly the Chief Operating Officer for Rates at LCH Ltd, became the Head of SwapClear and Listed Rates at LCH Ltd; this is a newly created role that reports to the Global Head of Rates, Securities and Collateral.
  • Isabelle Girolami has been appointed the next Chief Executive Officer (CEO) of LCH Ltd and will take up the position in November 2019 following the resignation of Martin Pluves in July. Dan Maguire, the CEO of LCH Group, is acting as the interim CEO.

While this area of supervisory focus will be closed, the Bank will nevertheless continue to monitor developments in LCH Ltd's governance, including the effects of recent changes to key personnel and the increase in LCH Group ownership by London Stock Exchange Group plc (LSEG), as part of its ongoing supervisory work.

2.2.2 Operational and cyber risk management

Over the assessment period, LCH Ltd's approach to managing operational and cyber risk has continued to evolve. LCH Ltd has implemented key aspects of its resilience framework for managing distinct types of operational risk, and is continuing to embed the relevant policies and controls to mitigate any control weakness identified based on risk and control assessments (Appendix B.4). LCH Ltd also continues to refine its approach to cyber risk management, in part based on changes in cyber threats and new technology available to combat threats. During the assessment period, LCH Ltd benchmarked its cyber risk management against the National Institute of Standards and Technology (NIST) Framework for Improving Critical Infrastructure Cybersecurity and participated in CBEST testing, while continuing to implement actions through its resilience program.

LCH Ltd has made further enhancements to how it manages its outsourcing and critical service provider arrangements, including with LSEG's Business Services Ltd (BSL). LCH Ltd has made changes to its assessment survey of critical service providers in line with the CPMI-IOSCO Assessment methodology for the oversight expectations applicable to critical service providers. LCH Ltd has also reviewed how it manages its relationship with BSL, including through changes to service level agreements. Over the next assessment period, LCH Ltd will continue work to enhance its oversight of critical service providers.

The Bank will continue to monitor LCH Ltd's operational risk management framework, including in the area of cyber risk. The BoE has also continued to focus on operational resilience and cyber risk management in its supervision of FMIs (Appendix B.3.3). The Bank will continue to engage regularly with the BoE on its work in this area.

2.2.3 Financial risk management

The CCP Resilience Guidance, published in July 2017, clarifies and elaborates on the standards set out in the PFMI relating to CCPs' financial risk management.[5] 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 previous assessment period, the Bank identified two areas of LCH Ltd's financial risk management where it considers further analysis is required: the validation of LCH Ltd's margin system and LCH Ltd's access to foreign exchange market liquidity.

Margin system validations

The CCP Resilience Guidance clarifies that CCP Standard 6 – which outlines the design, features, and governance arrangements that a CCP should have with respect to its margin system – applies to the system, as a whole. The SwapClear margin system consists of its base initial margin model and several add-ons designed to mitigate specific risks not captured by the base model (for more information on LCH Ltd's margin system, see Appendix B.1).

LCH Ltd's model validation policies require it to validate each component of the SwapClear margin system (including all add-ons) annually. During the assessment period, LCH Ltd completed model validations for all of its existing margin add-ons.

LCH Ltd has also introduced two new margin add-ons for SwapClear participants in this assessment period, which are designed to cover:

  • the foreign exchange risk arising from a mismatch between the currency of a participant's collateral and the currency of its positions
  • the risk that LCH Ltd would be required to enter into replacement trades, as part of the default management process, for any directional risk that arises from futures products effective from the point of expiry or notice to deliver. This margin add-on is only called from participants that use LCH Ltd's portfolio margining service for combined SwapClear and Listed Rates portfolios.

These add-ons will be reviewed by LCH Ltd in its next cycle of model validations.

The Bank will monitor LCH Ltd's governance of its model validations as an area of supervisory focus over the next assessment period.

Access to foreign exchange market liquidity

During the assessment period, LCH Ltd tested its access to foreign exchange market liquidity under stressed market conditions as part of its regular liquidity tool testing. The results demonstrated that LCH Ltd has enhanced its access to liquidity by increasing the number of its foreign exchange swap counterparties. In 2018, LCH Ltd also conducted tests of its operational capability to execute foreign exchange transactions in all currencies in which it clears products (excluding non-deliverable interest rate swaps). This aspect of the area of supervisory focus on financial risk management has been closed.

2.2.4 Tiering

Following significant growth in client clearing at LCH Ltd, the Bank set an area of supervisory focus in the previous assessment to monitor developments in how LCH Ltd manages and mitigates potential risks. Over the assessment period, total initial margin requirements at SwapClear have continued to increase, though the client share of total margin has stabilised at around 55 per cent (Appendix A.1). The number of clients has grown steadily over the assessment period, while the number of participants offering client clearing has increased to 59.[6] Some of the increase in client accounts is due to the implementation of clearing mandates and margin requirements for uncleared derivatives.

Graph 1
Graph 1: Number of Client Accounts at SwapClear
Graph 2
Graph 2: Direct Participants at SwapClear

LCH Ltd has explicitly set out standards for the management and monitoring of risks arising from tiered participation arrangements. For example, SwapClear has the power to gather relevant information from direct participants about client exposures, and has the ability to port affected clients in the event of a clearing member default.

LCH Ltd has made several changes to its risk management to account for client risk more explicitly. In June 2019, the margin period of risk for the floor component of the margin model was increased from 5 days to 7 days for clients (see Appendix B.1.2 for more detail on SwapClear's margin model). This change was made to align with the margin period of risk for the base Portfolio Approach to Interest Rate Scenarios (PAIRS) model. In March 2019, LCH Ltd began incorporating client risk directly in the allocation of default fund contributions (see section 2.3.2 for more detail). SwapClear participant contributions to the default fund are based on their house and client shares of total stress test losses over initial margin (STLOIM); house STLOIM is applied a weighting of one, while the weighting applied to client STLOIM depends on the number of backup arrangements (and therefore portability) of the participant's clients. As a result of LCH Ltd's progress, the Bank has closed this area of supervisory focus.[7]

2.3 Other Material Developments

2.3.1 Product offering

Over the assessment period, LCH Ltd made the following changes to its product offering within the SwapClear service:

  • Non-deliverable interest rate swaps denominated in BRL, CLP, COP, THB and TWD were added in March 2019. LCH Ltd also increased the maximum tenor of KRW-denominated non-deliverable interest rate swaps from 11 years to 15.5 years. Counterparties settle the net cash flows on non-deliverable interest rate swaps in USD. At the end of September 2019, the notional value of non-deliverable interest rate swaps outstanding comprised 1.4 per cent of total notional value outstanding in SwapClear.
  • In February, maximum tenors for CZK, HUF, ZAR and HKD swaps were extended from 10.5 to 11 years, the maximum tenor for SGD swaps was extended from 10.5 to 21 years and for PLN and NOK swaps, the maximum tenors were extended from 15.5 to 16 years.
  • In May, maximum tenors for swaps referencing the Fed Funds index and the CDOR were extended from 31 years to 51 and 41 years, respectively.
  • CAD CDOR-CORRA and JPY LIBOR-TONA basis swaps were added in July 2019. CORRA and TONA both reflect the cost of overnight funding and are used as reference rates for overnight index swap (OIS). LCH Ltd also increased the maximum tenor for swaps referencing CORRA from 2.25 to 31 years.
  • From October 2018, LCH Ltd's portfolio margining service was expanded to allow positions in long-term interest rate futures to be offset with positions in eligible swaps and short-term interest rate futures.

2.3.2 Changes to the default fund

The LCH Ltd Rates service default fund is a prefunded pool of mutualised resources for the SwapClear and Listed Rates services held to cover losses arising in the event of a participant default that cannot be covered first by the defaulter's own collateral and subsequently by LCH Ltd's own capital contribution to the Rates service (Appendix B.1.3). The Rates service default fund has two components: a core component and an additional component that supports the intraday provision of credit needed to facilitate real-time trade registration (RTTR). Both SwapClear and Listed Rates participants contribute to the core component of the default fund, but only SwapClear participants contribute to the RTTR component.

In March 2019, LCH Ltd revised the allocation rules for SwapClear participants' contributions to the default fund. Prior to the change, each SwapClear participant's contribution was proportional to its average share of total initial margin requirements over the previous month, based on house positions only (Appendix B.1.3). The new allocation rules change the metric used for calculating contributions from initial margin requirements to STLOIM, aligning it with the metric used for sizing the core component of the default fund. The rules also now include client positions in the calculation of each participant's share of total STLOIM, adjusted for the portability of each client portfolio.

LCH Ltd also increased both the cap on the size of the core component and the size of the RTTR component of the default fund in September 2019. The cap on the core component was increased from £4.6 billion to £5.4 billion and the RTTR component was increased from £400 million to £600 million, bringing the maximum size of the Rates service default fund to £6 billion.

2.3.3 Brexit

LCH Ltd is licensed in Australia under section 824B(2) of the Corporations Act 2001, which provides licensing for an overseas-based CS facility subject to requirements and supervision in its home country that are considered sufficiently equivalent to those in Australia. LCH Ltd is incorporated in the UK, and is primarily regulated by the BoE under UK and EU legislation.

The UK is preparing to leave the EU on 31 January 2020. The Australian Securities and Investments Commission (ASIC) and the Bank will consider how Brexit may affect the continued sufficient equivalence of LCH Ltd's home regulatory regime. Any actions by ASIC and the Bank will depend on the nature of Brexit:

  • In the event the implementation period (which has been provisionally agreed between the UK and the EU) comes into effect, EU law – including the European Market Infrastructure Regulation (EMIR) – will continue to have effect in the UK until the end of 2020.[8],[9] There will be no need for the Bank and ASIC to consider any changes to the regulatory regime and the sufficient equivalence of the regime until the end of the transition period, because LCH Ltd's home regime will not change during the transition period.
  • In the event the implementation period does not eventuate, there are contingency arrangements in place that will allow applicable EU law, such as EMIR, to be converted into UK law.[10] As LCH Ltd's home regime will have changed, the Bank and ASIC will consider the changes to the regime and the sufficient equivalence of LCH Ltd's home regime. The UK's HM Treasury have stated that the statutory instruments to convert EU law (including EU Regulations) into UK domestic law ‘are not intended to make policy changes, other than to reflect the UK's new position outside the EU, and to smooth the transition’. The UK has released draft statutory instruments to this effect.[11] The BoE has also released a consultation paper outlining its proposed changes to FMI-related Binding Technical Standards and the BoE's domestic rules for FMIs so that these work effectively in the UK after it leaves the EU.[12] In the event the implementation period does not eventuate, ASIC and the Bank will advise the Minister of the sufficient equivalence of the new home regime for LCH Ltd. Subject to there being no significant changes to the approach the UK authorities have published, the Bank expects the regime to continue to be sufficiently equivalent.

The EU has also confirmed that it will recognise the UK regulatory regime for CCPs as being equivalent for a limited period in the event that the UK becomes a foreign country under a no-deal scenario.

2.3.4 Benchmark reform – transition away from LIBOR

There has been significant international work over the past few years to progress the reform of the reference rate regime based on interbank offered rates (IBORs). This has resulted in the establishment of alternative risk-free rates (RFRs) being introduced and, in some cases, reforms to existing reference rate methodologies such as BBSW in Australia.[13] With widespread recognition that some existing reference rates, such as LIBOR will be discontinued, a key focus over the past year has been on developing more robust fall-back methodologies for IBORs and agreement on the pre-cessation triggers.[14] Through its consultations, ISDA has found there to be strong support for the use of a compounded RFR with an adjustment for the historical spread between the IBOR and RFR should a fall-back be required. ISDA is continuing to work with the market to determine how best to address concerns regarding the implementation of pre-cessation fall-backs for derivatives.

Trading activity in products referencing RFRs has been increasing. LCH Ltd, through its SwapClear service, now accepts a range of products for clearing referencing new RFRs, including AONIA, SONIA and SOFR. LCH Ltd began clearing €STR swaps in October 2019. LCH Ltd has also previously 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. LCH Ltd expects to transition its discounting and calculation of price alignment interest for interest rate swaps settled in EUR and USD to €STR and SOFR in June and October 2020, respectively. The Bank will continue to monitor global work on benchmark reform, including initiatives at LCH Ltd.


The official operating hours correspond to 3pm-9am AEST in the Australian winter, and 5pm-11am AEDT in the Australian summer. Differences in when the Australian states, New York and the UK transition in and out of daylight savings may affect these times. [4]

The CCP Resilience Guidance is available at <>. [5]

These data are drawn from LCH Ltd's quantitative disclosures, which are available up to the end of the June quarter 2019. These data are published under the CPMI-IOSCO Public quantitative disclosure standards for central counterparties, and are available at <>. [6]

Portability refers to the ease with which LCH Ltd is able to transfer a client's positions and associated collateral from one direct participant to another. [7]

EMIR is the European regulatory regime for CCPs (Appendix B3). It is also known as Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories. [8]

See paragraph 1.2 in HM Treasury's approach to financial services legislation under the European Union (Withdrawal) Act. Available at <>. [9]

See paragraphs 1.8 and 1.9 in HM Treasury's approach to financial services legislation under the European Union (Withdrawal) Act. Available at the link in footnote 9. [10]

Instruments relevant to EMIR include: draft The Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations. Available at <>; and draft Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018. Available at <>. [11]

UK Withdrawal from the EU: Changes to FMI rules and onshored Binding Technical Standards, BoE consultation paper, October 2018. Available at <>. The BoE published a further consultation paper in July 2019 to cover changes following the Article 50 extension. Available at <>. [12]

For further information, see G Debelle, 2019, Progress on Benchmark Reforms at ISDA's 34th Annual General Meeting, Hong Kong. Available at <>. [13]

For further information, see ISDA's website on Benchmark Fallback Consultations. Available at <>. [14]