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April 27, 2012

Analysis of the new SwapClear – the membership gates are wide open

The membership framework at SwapClear has been in place in the early 2000s, linking the entry criteria to the default management procedure tightly. The announcement yesterday of a heavily revised framework opens the door to many more direct members, provided they can live with the new approach to default.

Below I’ve done a rough comparison of the old SwapClear and new SwapClear+ framework, based on this PDF from this website published by LCH.

My conclusion is this:

  • The entry criteria to SwapClear for non-FCM direct members has been torn up, there is an unspecified capital requirement, but the credit rating and portfolio size constraints are gone.
  • This must surely appeal to firms who previously couldn’t join SwapClear and had the prospect of becoming a Client, and therefore being unable to clear in-turn their own clients business
    • A previously ineligible firm could join, and then offer client clearing to their local corporate or buy-side customers, and do more to preserve their precious client relationships, even if electronic trading disrupts the execution business
  • The Default Fund Contribution is now a minimum of £10mn up from £2mn, not a big ask for most firms – you get interest on it also
  • The Default Fund for SwapClear is now segregated from the rest of LCH, and is a minimum of £1bn
  • Overall this levels the playing field between SwapClear and CME, more or less
  • Game on!

The table below is also available in this PDF. Data on CME’s safeguards are in this PDF.

Area Old New
Default Fund State Integrated with the whole LCH business Segregated, specific to SwapClear. Sized to cover a default by the two ‘largest’ members. [I assume largest will be a risk based judgement]
Default Fund Value I believe it may have been £125m Between £1bn and £5bn [CME = $1bn]
DF Contribution Stress test on House trades Stress tests on House trades, and default of their two largest clients (if any)
DF Contribution Minimum £2mn £10mn
DF Exhaustion Can utilise the contribution from non-SwapClear LCH members – full waterfall utilising both SwapClear and non-SwapClear resources SwapClear resources only. Once the DF is exhausted, SwapClear will be closed.Excludes LCH Capital
Membership eligibility(Non-FCM members) ‘A’ rating$1trn notional portfolio size$5bn net capital

Assessment of financial and operational capabilities

Must complete biannual DMP fire-drill

RemovedRemovedReduced to $[RESERVED] [CME = $5bn FYI]

Retained

Retained

Membership eligibility(FCM members) $1trn notional portfolio size$1bn net capitalAssessment of financial and operational capabilities

Must complete biannual DMP fire-drill

Must have an affiliated non-FCM member

N/AReduced to $[RESERVED]Retained

Retained – but can be outsourced to an approved provider

Dropped

DF top-ups None If the DF is depleted by 25% then up to three additional contributions can be called for in any six month period
VM, PAI, Coupon Haircuts None In an extreme case, SwapClear can haircut these payments to prolong the viability of the service, in a default situation “Loss Distribution Process”, applied to a defaulters portfolio
Portfolio auction Trades packaged in currency portfolios, one file per currency A single currency portfolio can be split into sub-portfolios
Post-auction allocation Any trades not auctioned would be allocated to the surviving members Removed – new approach below
Loss Attribution(Post-auction process) None Contributions by non-default members are treated as “capital at risk”Each portfolio of trades will have an Auction Incentive Pool (AIP) attached, in proportion to the risk in the portfolio, drawn from the defaulters ‘contributions’ plus any called but unpaid top-upsOnce the Auction process is complete, SwapClear will determine which Auctions caused losses (if any) and decide if non-defaulters contributions must be used

The AIP will be drawn down for each currency portfolio in this order:

–        The defaulters contributions to those portfolios

–        The defaulters contributions to other portfolios in the same currency

–        Non-defaulters contributions in the same currency, where they have positions

–        Any other contributions

These amounts are drawn on relative to the bidding activity of the non-defaulting members

So in other words, if the any trades of the defaulted member survive beyond the auction process, any losses are then shared by remaining members based on how they bid in the auction (but not clear how that determination is made)

FCM Capital N/A New rules to ensure FCMs are sufficiently capitalised
Reporting N/A New reporting requirements to comply with the CFTC rules
Visibility of member risk management policies Not formalised LCH.Clearnet is introducing a new requirement for all SwapClear Clearing Members to maintain written risk management policies and procedures that outline the risk areas that a SwapClear Clearing Member poses to LCH.Clearnet, and on request of LCH.Clearnet to provide such information and documents to LCH.Clearnet regarding their risk management policies, procedures and practices, including, but not limited to, information and documents relating to the liquidity of their financial resources and their settlement procedures. In addition, LCH.Clearnet may also require its SwapClear Clearing Members to make such information available to the Commission upon the Commission’s request.

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