Assessment of LCH Limited's SwapClear Service 2. Summary of Supervisory Activities

This section summarises the Bank's regulatory priorities and areas of supervisory focus for LCH Ltd and the progress that has been made on these issues over the assessment period.

2.1 Regulatory Priorities

The Bank sets regulatory priorities for LCH Ltd based on its assessment of LCH Ltd against the relevant CCP Standards. These priorities reflect the Bank's expectations regarding actions that LCH Ltd should take to enhance its observance of the CCP Standards and promote stability in the Australian financial system.

2.1.1 Extension of operating hours

Extension of operating hours. LCH Ltd should continue its work to extend the operating hours of the SwapClear service over the medium term, while maintaining the resilience of its operations; it should keep the Bank informed of its progress. LCH Ltd's future business developments should not negatively affect operating hours.

CCP Standards 6 (Margin) and 16 (Operational Risk)

The SwapClear service is currently closed for four hours of the Australian business day. Australian participants' trades are not cleared while the service is closed, so they are required to manage bilateral credit risk exposures until the service reopens. The SwapClear service is officially open from 6am UK time to 7pm New York time (5pm-11am Sydney summer time), but can open up to two hours earlier at LCH Ltd's discretion as part of its flexible opening arrangements. In practice, LCH Ltd opened the service at 4am UK time (3pm Sydney summer time) on most business days during the assessment period.

In the previous assessment period, LCH Ltd provided the Bank with a plan to fully address the operating hours regulatory priority by moving to a 24x5 operating model, and opening on Sunday evening UK time to accommodate trading in the Asia-Pacific region on Monday mornings. LCH Ltd has provided the Bank with ongoing updates on the implementation of its 24x5 plan. In August, LCH Ltd completed the technical enhancements required to facilitate the 24x5 operation of the SwapClear service. As part of a phased roll-out of functionality, LCH Ltd extended its official and flexible opening arrangements on Monday mornings by 4 hours on 27 September, which has seen SwapClear commence clearing trades from midnight Monday UK time (11am Sydney summer time). It is expected that the full transition to 24x5 operations for the SwapClear service, including opening at 8pm Sunday UK time (7am Sydney summer time), will occur in the first half of 2022.

In the next assessment period, LCH Ltd is expected to continue to provide the Bank with regular updates on its progress as it implements the final stages of its transition to 24x5 operation of the SwapClear service while maintaining the safety and operational resilience of the service.

2.1.2 Protected Payment System contingencies

Protected Payment System (PPS) contingencies. LCH Ltd should continue to implement its plans to enhance the effectiveness of its PPS contingencies, enabling the expected service level to be achieved in the event of a PPS bank outage or failure.

CCP Standard 9 (Money settlements)

The PPS is LCH Ltd's payments system through which all cash payments are settled between LCH Ltd and its 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/receive payments to/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 participants to have access to contingency arrangements so they can continue to make/receive payments to/from LCH Ltd. The primary contingency method is direct funding, whereby participants make payments directly to LCH Ltd's concentration bank.

Over recent assessment periods, LCH Ltd has been working towards improving its direct funding contingency arrangements, and has set objectives around the performance of these arrangements. These criteria include the ability to process all end-of-day margin calls for the largest PPS bank within a business day, have the capacity to make ad-hoc intra-day calls if required, and ensure that any liquidity requirements arising from the contingency solution can be covered on a timely basis.

During the current assessment period, LCH Ltd commenced a rolling annual cycle of PPS contingency testing of all participants. The scale of these tests has progressively increased and is now representative of the conditions anticipated to be experienced during a large PPS bank outage. LCH Ltd has demonstrated its ability to issue calls within one hour of invoking the contingency arrangements and complete the process within its stated objectives. Most participants have been able to meet these calls in an acceptable timeframe. LCH Ltd is on track to complete a full testing cycle of all participants, including retesting participants who fail the tests, by the end of the year.

Additional improvements to these arrangements are planned over the coming months, including to enhance reporting to participants during a contingency event, and where appropriate these will be embedded within LCH's systems. As this work is ongoing, this regulatory priority has been carried forward to the 2021/22 assessment period.

2.2 Areas of Supervisory Focus

Areas of supervisory focus describe matters that the Bank currently considers to be an important part of its supervision of LCH Ltd's SwapClear service. This may be due to changes underway at LCH Ltd, updates to regulatory standards, or in response to developments in the broader risk environment.

2.2.1 Cyber risk management

Cyber risk management. LCH Ltd's ongoing work to enhance and embed its cyber risk management control framework.

CCP Standard 16 (Operational risk)

Over the past few years, LCH Ltd has been engaged in a program of works to enhance and improve its cyber risk management. Reflecting the degree of change taking place, the purpose of this area of supervisory focus has been for LCH Ltd to keep the Bank abreast of its cyber-related work.

During the assessment period, LCH Ltd has continued to implement aspects of its strategic program of works related to cyber risk management, with a focus on enriching its cyber control environment and developing more regular, standardised reporting for management. The BoE has been closely monitoring LCH Ltd's program of work and the Bank will continue to engage with the BoE on this topic, including through the LCH Ltd Global College.

In light of the continuously evolving cyber threat landscape and further enhancements planned for LCH Ltd's cyber risk management, the Bank will continue to monitor the outcomes of this work as these changes are embedded in the next assessment period.

2.2.2 Model validations

Model validations. The governance of LCH Ltd's independent model validation processes, including the appropriate documentation of LCH Ltd's benchmarking process against industry practice.

CCP Standards 2 (Governance) and 6 (Margin)

Suitably documented processes and procedures assist LCH Ltd to minimise key person risk and enable them to be subject to appropriate oversight. LCH Ltd had previously demonstrated that it performs suitable validations of its models, and has now updated its Independent Risk Model Validation procedure, outlining its methodology for benchmarking ‘high importance’ models. This area of supervisory focus has been closed.

2.2.3 Legal basis

Australian legal opinion. A new legal opinion from external advisers to LCH Ltd addressing Australian law issues arising through its operations in Australia, including the extent to which LCH Ltd's rules and related contracts are enforceable under Australian law.

CCP Standard 1 (Legal basis)

In the latter part of the assessment period, the Bank engaged with LCH Ltd to clarify the scope and requirements for a new Australian legal opinion to support the Bank's targeted review of certain aspects of LCH Ltd's legal basis which are governed by Australian law. Work on this area of supervisory focus will continue in the next assessment period.