Assessment of LCH Limited's SwapClear Service Appendix B: Risk Management, Governance and the LCH Limited Regulatory Environment

B.1 Risk Management

A CCP acts as the buyer to every seller, and the seller to every buyer in a market. This is commonly achieved by the CCP interposing itself as the legal counterparty to all purchases and sales via a process known as novation. These arrangements provide substantial benefits to participants in terms of counterparty credit risk management as well as greater opportunities for netting of obligations. However, these arrangements result in a significant concentration of risk in the CCP. This risk can crystallise if a clearing participant defaults on its obligations to the CCP, since the CCP must continue to meet its obligations to all of the non-defaulting participants. LCH Ltd manages this risk in a number of ways, including through participation requirements, margin collection, the maintenance of pooled resources and loss allocation arrangements.

B.1.1 Clearing participation requirements

To limit its exposure to its participants, LCH Ltd only allows institutions to become SwapClear clearing participants if they meet certain financial and operational requirements. Prospective clearing participants of SwapClear are required to have net capital of at least US$50 million, appropriate payment arrangements, staff with sufficient experience, and appropriate systems to manage their clearing activities. Prospective participants must also demonstrate their operational capability to participate effectively in default management processes, including their ability to value and bid on the portfolio of a defaulting participant.

B.1.2 Margin collection

LCH Ltd covers its credit exposures to its SwapClear participants by collecting several types of margin:

  • Variation margin. All SwapClear positions are marked-to-market at the end of the day and three times intraday. At the end of each day, variation margin is collected from participants with loss-making positions and paid to those with profit-making positions. This practice ensures that uncovered losses on SwapClear participants' positions do not accrue over time.
  • Initial margin. In the event of a clearing participant default, LCH Ltd would be exposed to risk arising from potential changes in the market value of the defaulting participant's open positions between the last settlement of variation margin and the close-out of these positions. LCH Ltd collects initial margin to mitigate this risk. Most trades will only be registered if, at the point of registration, there are sufficient resources at the clearing participant level, either in the form of initial margin or the real-time trade registration (RTTR) component of the default fund (Appendix B.1.3) to cover the potential future exposure of the trade (up to a given confidence level).[19]
  • Intraday margin. LCH Ltd monitors participants' portfolios intraday to take account of changes in both prices and positions; LCH Ltd makes intraday margin calls where margin liabilities exceed predetermined participant-specific credit thresholds.
  • Additional margin. LCH Ltd collects various forms of additional margin to cover any risks – including credit, liquidity, concentration and sovereign risks – not captured by the base initial margin model.

LCH Ltd calculates initial margin requirements for SwapClear using its Portfolio Approach to Interest Rate Scenarios (PAIRS) model. The model sets initial margin requirements to cover potential losses over a five-day close-out period with 99.7 per cent confidence, based on historical movements in yield curves and exchange rates over a 10-year lookback period. LCH Ltd assumes that an additional two-day period will be required to close out client positions; initial margin requirements on the positions of clients of participants are scaled up accordingly.[20] LCH Ltd assesses the performance of its margin model through daily and monthly backtesting. LCH Ltd also assesses the adequacy of the model assumptions through monthly sensitivity analysis (CCP Standard 6.6).

B.1.3 Pooled financial resources

In the event of a clearing participant default, any losses would first be covered by the margin and other collateral posted by the defaulter across all LCH Ltd services in which it participated.[21] Should these resources prove insufficient to meet LCH Ltd's obligations, LCH Ltd may draw on other resources in the Rates service default waterfall. The Rates service default fund covers the SwapClear and Listed Rates services, as LCH Ltd allows for portfolio margining between these services (CCP Standard 6.5).[22] The available resources are depicted in Figure 1, which shows the order in which financial resources would be used to cover default losses in excess of the defaulter's collateral, as at September 2018.

Prefunded resources

In the event that all of the defaulting clearing participant's margin and other collateral, including its contribution to the Rates service default fund, were exhausted, LCH Ltd would allocate remaining losses arising from the default to its capital contribution to the default fund waterfall (€44.1 million for the Rates service, as at the end of September 2018). Should this also prove insufficient, losses would be allocated to the Rates service default fund.

The Rates service default fund is a pool of mutualised resources, prefunded by clearing participants. The Rates service default fund comprises two components: a core component (£4.6 billion at the end of September 2018) and an additional component that supports the intraday provision of credit needed to facilitate real-time trade registration (£400 million as at September 2018) (see ‘Default fund real-time trade registration component’ below). Both components are available to cover losses from participant defaults. Both SwapClear and Listed Rates participants contribute to the core component, but only SwapClear participants contribute to the RTTR component.

Figure 1
Figure 1: Rates Service Default Waterfall after the Defaulter's Collateral

Default fund core component and default fund additional margin

The core component of the default fund is calibrated to cover any losses LCH Ltd would incur if the two clearing participants (including their affiliates and clients) with the largest exposures defaulted under extreme but plausible conditions, after using the defaulters' initial margin and monthly default fund additional margin (DFAM). This is intended to meet the ‘cover two’ requirement under CCP Standard 4.4 and its equivalent under EMIR.

The core component is resized on the first business day of each month. LCH Ltd calculates this by summing the largest two participant stress test losses over initial margin (STLOIM) over a 60-day lookback period, adding a buffer, and then subtracting the amount of monthly DFAM called.[23]

Each SwapClear participants' contribution to the core component is equal to their average share of total initial margin requirements over the previous month based on its house positions only.

Contributions are subject to a minimum of £17.5 million for SwapClear participants who are also Listed Rates participants, £10 million for SwapClear-only clearing participants and £500,000 for Listed-Rates-only clearing participants. Contributions are rebalanced each month when the core component is resized. Participants are informed of their new contributions on the third business day of the month, and payments are due the following day if their contribution has changed.

LCH Ltd uses monthly DFAM to achieve a balance between defaulter-pays and mutualised resources, ensuring that participants with large exposures relative to other Rates service members provide larger contributions to the resources required to cover those exposures. Monthly DFAM is called from a participant if its STLOIM exceeds a specified threshold of the sum of the combined stressed exposure value and buffer, determined by its internal credit score (ICS). Monthly DFAM is not mutualised; it can only be used to cover losses from the participant that posted it.

LCH Ltd also calls daily DFAM from those participants and affiliates with STLOIM that exceed a predefined proportion of the default fund.[24] The relevant default fund proportion is based on those participants' ICSs. The amount called is the difference between the participant's STLOIM and the relevant proportion of the default fund on that day, less any monthly DFAM. Like monthly DFAM, daily DFAM is not mutualised; it can only be used to cover losses from the participant that posted it.

Graph 13
Graph 13: Default Fund and Stress-test Losses

Over the assessment period, LCH Ltd maintained sufficient financial resources to meet the cover two requirement (Graph 13). That is, stress test losses in excess of initial margin and daily and monthly DFAM of the two participants with the largest exposures were smaller than the default fund core component (see CCP Standard 4.7 for further detail). For most of the assessment period, the Rates service default fund was at the cap of £5 billion (£4.6 billion core component and £400 million RTTR component) prescribed in the LCH Ltd Rulebook. Where the cap is binding, LCH Ltd maintains sufficient prefunded financial resources to meet its cover two requirement by collecting monthly DFAM.

Default fund real-time trade registration component

To meet European regulatory requirements, SwapClear must novate or reject new trades within 10 seconds. Most trades are novated provided that the incremental margin requirement arising from the trade is covered by collateral lodged by that participant, or is below a tolerance limit set by LCH Ltd. LCH Ltd assigns these tolerance limits to participants based on their ICSs. By extending credit to participants through tolerance limits, the frequency with which LCH Ltd can register trades is not restricted by the frequency with which LCH Ltd can collect margin.

LCH Ltd mitigates the credit risk that arises from offering trade registration tolerance limits through an additional RTTR component in the default fund. This additional component is currently sized at £400 million. The proportion that each SwapClear participant is obliged to contribute is based on its tolerance limit utilisation relative to that of other participants over the previous 20 business days, subject to a floor of £3 million and a cap of £30 million. Listed-Rates-only participants do not contribute to the RTTR component of the default fund. Participant contributions to the additional component are rebalanced on the same timeline as those to the core component. Usage of this additional component is limited on a cover two basis, which means that no clearing participant may use more than half of this component at any time.

Participants can register sub-block trading venue trades without this credit check. Sub-block trading venue trades are trades below a certain size which are transacted on an electronic trading facility. Participants can register these trades even if they do not have sufficient collateral held by LCH Ltd or RTTR component tolerance available. However, participants will need to meet any incremental initial margin requirement at the next intraday margin call (CCP Standard 6.4).

Unfunded loss allocation rules

In extreme cases it is possible that prefunded financial resources could be insufficient to fully absorb default-related losses, leaving the CCP with an uncovered credit loss shortfall. In such an event, LCH Ltd would allocate remaining losses to surviving clearing participants through ‘loss allocation rules’, which are described in detail in CCP Standard 4.8.

  • Unfunded contributions. For each default, LCH Ltd is able to call unfunded contributions from non-defaulting participants up to the value of their last default fund contribution, subject to a maximum of three defaults in any six-month period.
  • Loss distribution process. LCH Ltd may apply haircuts to the variation margin payments owed to non-defaulting SwapClear participants whose positions make gains. Participants in the Listed Rates service would be allocated losses in proportion to their default fund contributions. These haircuts are capped at the higher of £200 million or twice a participant's default fund contribution, and the Loss Distribution Process is limited to 10 days. In the event a participant reaches the cap, or variation margin gains haircuts (VMGH) was likely to extend beyond 10 days, participants will vote on whether the Loss Distribution Process should continue (CCP Standard 4.8).
  • Voluntary service continuity contributions. Should losses remain, LCH Ltd would ask non-defaulting participants to make voluntary contributions. Participants can make these payments at any time during the default management process, but are not obliged to make any voluntary payments.
  • Service closure. If insufficient voluntary payments were made to cover the remaining credit losses, the Rates service Default Management Group (DMG) would make an Insufficient Resources Determination and LCH Ltd would close the SwapClear and Listed Rates services (CCP Standard 3.5). In the event the SwapClear and Listed Rates services were wound down, all outstanding SwapClear and Listed Rates contracts would be terminated and the Rates service DMG would calculate a sum owing between LCH Ltd and each non-defaulting clearing participant (CCP Standard 4.8).

B.2 Governance

B.2.1 Structure of LCH Group

LCH Ltd is a wholly owned subsidiary of LCH Group (Figure 2). As at the end of September 2018, LCH Group is 68 per cent owned by the London Stock Exchange (C) Limited, a wholly owned subsidiary of LSEG, and 32 per cent owned by others, including clearing participants and other exchanges.

LCH Group is a holding company incorporated in the UK. In addition to LCH Ltd, LCH Group has another wholly owned subsidiary that actively operates central clearing services, LCH SA. It also has a US CCP subsidiary, LCH.Clearnet LLC (LCH LLC), which holds a CFTC Derivatives Clearing Organization (DCO) licence. The three CCPs are legally separate entities. LCH Group's SwapAgent service, which offers processing, margining and settlement services for non-cleared derivatives, is provided by a separate subsidiary.

Figure 2
Figure 2: LCH Group Structure

B.2.2 LCH Group and LCH Ltd governance arrangements

LCH Group and LCH Ltd (as well as the other LCH Group CCPs) have independent governance structures, including their own boards, board-level committees and executive-level committees (Figure 3).

Figure 3
Figure 3: LCH Group Board and Committee Structure

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Although LCH Ltd, LCH Group and the other LCH Group CCPs each operate under independent governance arrangements, there is close coordination between each entity. To promote consistency and to avoid duplication, a number of the CCP and LCH Group board-level and executive-level committees have overlapping memberships, with some routinely sitting together (see below). Many of the key policies that govern LCH Ltd's operations – such as the Financial Resources Adequacy Policy, the Collateral Risk Policy and the Operational Risk Policy – are Group policies. Group policies are developed by LCH Group and the LCH Group CCPs in coordination, and apply across each of the CCPs. LCH Group Risk policies must be approved by the LCH Ltd Board to be applicable to LCH Ltd; all LCH Group Risk policies are approved by the LCH Ltd Board after review by the board-level Risk Committee.[25]

LCH Ltd also coordinates closely with LCH Group and the other LCH Group CCPs in day-to-day processes; some processes, such as the assignment of ICSs and model validations, are performed at the LCH Group level, rather than the individual CCP level (CCP Standards 2.6 and 4.2).

LCH Group and LCH Ltd Boards

The LCH Group Board is responsible for the overall management and strategic direction of the LCH Group. As at 30 September 2018, the LCH Group Board has 15 members, including 6 independent directors (including the Chair). The LCH Group Board meets at least five times a year and on an ad hoc basis, as required. Four members of the LCH Group Board – three of the independent directors and the CEO of LCH Group – also sit on the LCH Ltd Board.

The LCH Ltd Board has ultimate responsibility for LCH Ltd. This includes responsibility for: establishing clear objectives and strategies; establishing and overseeing the risk management function; ensuring compliance with legal, regulatory and contractual responsibilities; overseeing the compliance and internal control functions; and monitoring LCH Ltd senior management (CCP Standard 2.3). Where there is overlap in the matters reserved for the LCH Group and LCH Ltd Boards, the relevant matter will require the approval of both boards. As at 30 September 2018, the LCH Ltd Board has 11 directors, including 5 independent directors (including the Chair), the CEOs of LCH Group and LCH Ltd, the LCH Group CRO, 2 member representatives and 1 director nominated by LSEG.

Group-level, board-level and executive-level committees

LCH Ltd and LCH SA have similar board-level and executive-level committee structures. The committees have overlapping, but not identical memberships. The board-level Risk Committees routinely sit together facilitating cooperation and coordination, and reducing repetition. The CCP board-level Audit and Remuneration Committees may also sit together with the equivalent Group-level committees. Issues specific to a particular CCP can be considered at combined meetings.

Key LCH Group and LCH Ltd board-level and executive-level committees include:

  • LCH Ltd Risk Committee. The LCH Ltd Risk Committee is a board-level committee responsible for reviewing all risk policies prior to recommending approval by the Board, considering and commenting on all aspects of LCH Ltd's risk appetite, tolerance and strategy, and assisting the LCH Ltd Board to fulfil its responsibility for the oversight of risk management of LCH Ltd (CCP Standard 2.6). The terms of reference for the Risk Committee of each of LCH Ltd and LCH SA require that the Committee consider proposals for harmonisation of policies or procedures between the LCH Group CCPs.
  • LCH Ltd Technology, Security and Resilience Committee. The board-level LCH Ltd Technology, Security and Resilience Committee assesses LCH Ltd's management of technology, security, operational and cyber risks, and assists the LCH Ltd Board in reviewing the frameworks, policies and strategies that set the internal control environment in relation to LCH Ltd's technology, operational resilience and security.
  • LCH Group Executive Committee. The LCH Group Executive Committee is the most senior LCH Group management committee. It is an advisory body, which provides advice and recommendations to the Group CEO and the CEOs of the Group's CCPs. The Executive Committee is made up of: the Group CEO, who acts as the Chair; the CEOs of each of the Group CCPs; the business line heads; and the Group functional heads.
  • Local Management Committees. Each of LCH Ltd, LCH SA and SwapAgent has a Local Management Committee (LMC). Unlike some of the board-level committees and other executive-level committees, the LMCs do not sit jointly. This allows the LCH Ltd LMC to consider issues from the perspective of LCH Ltd in isolation. The LCH Ltd LMC provides support and advice to the LCH Ltd CEO on risk management, strategy, financial management and reporting, operational management, audit and governance. The LCH Ltd LMC reports directly to the LCH Ltd Board and provides direction and oversight to the LCH Ltd Executive Risk Committee (ERCo). Permanent members of the LCH Ltd LMC include senior management from both LCH Ltd and LCH Group. LMC members are allowed to nominate delegates to attend in their place.
  • Executive Risk Committees. LCH Ltd, LCH SA and SwapAgent each have an ERCo. The ERCos have overlapping membership, meet concurrently and are chaired by the Group CRO. Each ERCo is responsible for the management, monitoring and oversight of all material risks faced by the relevant entity. The LCH Ltd ERCo reports directly to the LCH Ltd Risk Committee and, via the Ltd CRO, provides regular updates on its activities to the LCH Ltd LMC.
  • Other key committees and working groups. Various committees support decision-making within LCH Ltd. These include (among others): the Group-level Risk Resilience Committee and, at a CCP level, the Change Management Committee and Rule Change Committee. In addition, the LCH Group Financial Risk Working Group typically considers matters related to financial risk at LCH Ltd before they are submitted to the LCH Ltd ERCo for review or approval.

Senior management

LCH Group and LCH Ltd have similar senior management structures and reporting lines (Figure 4). Some positions across LCH Ltd and LCH Group are held by the same person (‘double hat roles’).

Figure 4
Figure 4: Senior Management Positions and Reporting Lines

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B.2.3 Departments in LCH Ltd

LCH Ltd is organised into departments based on its core functions and the products it offers. The ‘functional’ departments include: Audit, CaLM, Compliance, Finance, Human Resources, Information Technology, Legal, Operations and Risk. The various departments are further divided by function. For example the Risk department includes teams responsible for credit risk, default management, reporting, collateral and liquidity risk. It also includes several product-specific Risk teams which operate as a second line of defence to the first-line Risk functions operated by each business. The separation of duties between first- and second-line risk management is discussed in CCP Standard 16.1. The CaLM function is responsible for ensuring investment activities are conducted in accordance with the relevant Group Risk policies and regulations and is separate to the Collateral and Liquidity Risk Management (CaLRM) function, which is responsible for monitoring and assessing various risks against Group Risk policies. ‘Product’ departments are structured around LCH Ltd's various clearing services and include the SwapClear business unit.

B.2.4 Governance of SwapClear

The Global Head of Rates, a Group-level position, is responsible for developing and managing the SwapClear and Listed Rates services, and has the authority to develop and implement business strategy, operational plans, policies and budgets for SwapClear and Listed Rates. The Global Head of Rates also has responsibility for launching and extending the SwapAgent service. The Global Head of Rates reports directly to the CEO of LCH Ltd and to the CEO of LCH Group. LCH Ltd also maintains regional representation for SwapClear in Australia. The Asia-Pacific Head for LCH Ltd, who reports directly to the LCH Ltd CEO, is responsible for overseeing the strategy and business operations of the SwapClear and other services in Australia and the Asia-Pacific region.

SwapClear operates as a distinct business unit within LCH Ltd, although it is not a separate legal entity. SwapClear has its own executive management team overseeing its operations and has a dedicated team that performs risk management functions consistent with policies set at the LCH Ltd and LCH Group levels. The Rates service risk management team's responsibilities include determining stress test scenarios and sizing the Rates default fund, pricing positions and calling variation margin, calling additional margin, determining and performing backtesting for initial margin, and determining SwapClear default management protocols. The Head of the Rates service Risk team reports directly to the Head of the Rates Service. The Group-level Risk department performs the second line of defence including the maintenance of risk policies aligned to the LCH Ltd Board's risk appetite, analysis of margin and default fund adequacy and methodologies, risk aggregation and reporting, default management coordination, determination and monitoring of internal credit scores and monitoring of credit risk related limits, new product approvals and the risk governance process.

B.3 Regulatory Environment

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 to be sufficiently equivalent to those in Australia. LCH Ltd is incorporated in England, and is primarily regulated by the BoE under UK and EU legislation.

The Bank has a memorandum of understanding in place with the BoE regarding supervision of CS facilities.[26] The memorandum provides a framework for bilateral cooperation, including information sharing and investigative assistance. The Bank also engages with the BoE on LCH Ltd supervision matters through the LCH Ltd Global College, which was established in 2012 (see below).

B.3.1 The regulatory regime

LCH Ltd's operations are subject to a number of regulatory regimes:

  • EU regulation. In July 2012, the EU introduced EMIR, a harmonised framework for the regulation of FMIs, including CCPs, incorporated in the region. In May 2018, EMIR was incorporated into the European Economic Area Agreement.[27] EMIR is therefore in force in the European Economic Area, which covers the EU and Iceland, Liechtenstein and Norway. EMIR and its associated technical standards largely implement the PFMI in the EU. Under EMIR, primary regulatory authority over a CCP is given to the national competent authority in the country in which that CCP is established; since LCH Ltd is established in the UK, this is the BoE.
  • UK regulation. Within the UK, LCH Ltd is regulated by the BoE as a ‘recognised central counterparty’ under the UK Financial Services and Markets Act 2000. This sets recognition requirements for UK CCPs including EMIR compliance, maintaining a recovery plan and loss allocation rules, and instituting measures to monitor and reduce potential market abuse. The PPS operated by LCH Ltd is regulated and overseen by the BoE as a ‘recognised payment system’ under the UK Banking Act 2009.
  • Regulation in other jurisdictions. LCH Ltd's operations span several jurisdictions. Outside the European Economic Area and Australia, LCH Ltd has been formally licensed or granted an exemption in the US, Switzerland, Japan, the Canadian provinces of Ontario and Québec, Mexico, Hong Kong and Singapore, allowing it to offer a range of clearing services in those jurisdictions.

The UK is preparing to leave the EU on 29 March 2019. The UK and the EU have provisionally agreed the terms of an implementation period, during which EU law (including EMIR) would continue to have effect in the UK until the end of 2020.[28] This implementation period is part of the wider Withdrawal Agreement between the UK and EU and needs to be approved by both the UK and EU before it can come into effect.[29]

In the event the implementation period does not come into effect there are contingency arrangements in place that will allow applicable EU law, such as EMIR, to be converted into UK law, with minimal changes made to ensure that these laws would work effectively in the UK.[30] The UK has released draft regulations in line with this approach.[31] The BoE has also released a consultation paper setting out 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.[32]

The Bank is monitoring developments related to LCH Ltd's future regulatory regime, and will continue to engage with the BoE and other relevant authorities as appropriate. The Bank will consider the continued sufficient equivalence of LCH Ltd's home regulatory regime to the Australian regulatory framework in the event of changes to the home regulatory regime (section 1.6).

B.3.2 The EMIR College and the Global College

EMIR provides a framework for cooperative oversight of CCPs among EU authorities, requiring that a supervisory college be established for each EU-based CCP.

The EMIR supervisory college for LCH Ltd (EMIR College) is chaired by the BoE and plays a role in the ongoing supervision of LCH Ltd, including when LCH Ltd applies to the BoE to expand its services or make significant changes to its risk models. The EMIR College also facilitates the exchange of information among its members.

The BoE has also established a Global College for LCH Ltd, membership of which extends beyond the EMIR College. The Bank is represented on the Global College.

B.3.3 The Bank of England's oversight approach and supervisory priorities

The BoE has a mandate to protect and enhance the stability of the UK financial system. In its role as supervisor, the BoE aims to ensure FMIs are ‘managed in a manner that is consistent with the public interest including reducing systemic risk’.[33] The BoE takes a risk-based approach to oversight, prioritising its supervisory efforts in areas where it considers risks to financial stability are greatest.

The BoE conducts at least an annual assessment of the risks each UK FMI presents to financial stability. Based on its assessment, the BoE sets expectations of risk-mitigating actions the FMI should take, in the form of supervisory priorities. The BoE provides LCH Ltd with a single set of supervisory priorities, covering its operations as a CCP and as a payments system. The BoE also conducts thematic reviews across all CCPs for which it has oversight responsibility.

The BoE publishes an annual report on its oversight of UK CCPs and other FMIs. The latest report, published in February 2018, summarised the BoE's supervisory priorities and thematic reviews during the period from February 2017 to February 2018, as they applied across all FMIs, and the FMIs' progress against them.[34] The relevant priorities and reviews, focusing on their applicability to the UK CCPs, were:

  • Operational resilience. The BoE began a cross-FMI review of business continuity and IT recovery capabilities, focussing on governance, strategy and risk management. The BoE is continuing to seek assurance that each FMI's business continuity arrangements are operating as intended and in line with the FMI's risk appetite. In addition, the BoE carried out a cross-FMI review of FMI's use of critical service providers, including outsourcing arrangements. The review found that FMIs' outsourcing arrangements were generally appropriate but identified areas in which FMIs could improve the way they risk manage and govern these relationships.
  • Recovery and resolution. The BoE continued a review of certain CCPs' recovery plans. The review concluded that arrangements were compliant with regulatory requirements, although some recommendations were made on how these plans could be enhanced. As noted in the Bank's 2016/17 assessment, the BoE (in coordination with Federal Financial Supervisory Authority (BaFin), Bundesbank and CFTC), requested that CME, Eurex Clearing and LCH Ltd conduct their 2017 fire drills in parallel. The BoE observed the fire drills, met with the CCPs and eight of the largest clearing participants after the drill, and reviewed procedures and documentation. The authorities concluded that the CCPs had the required measures in place to complete fire drills successfully, although they made a number of recommendations to enhance both CCPs' and participants' default management processes.
  • Financial resilience. The BoE started a number of assessments into financial resilience, which included looking at risk models used to calculate margin, default fund contributions and collateral haircuts. The BoE also began its cross-FMI review to assess how UK CCPs meet the CCP Resilience Guidance.
  • EU withdrawal. The BoE continued to ensure through its supervision that FMIs were able to identify, manage and mitigate risks arising from the UK's withdrawal from the EU. These include risks from potential changes in the arrangements for providing cross-border services and the potential for significant market moves.

The BoE's supervisory priorities for the period from February 2018 are discussed in section 1.5.

B.3.4 Resolution

As a UK-based CCP, any resolution of LCH Ltd would be governed by UK law. Under the UK's legal framework, resolution of CCPs is governed by the UK Banking Act 2009 (which was extended to include CCPs by the UK Financial Services Act 2012). In August 2014, secondary legislation was introduced to incorporate CCPs into the resolution regime.[35] The BoE is the resolution authority for UK CCPs. Clarification as to how a resolution scenario would work in practice is expected to develop in light of the UK's HM Treasury's negotiations with the European Commission about the pending EU regime for CCP recovery and resolution.

The BoE leads the LCH Ltd Crisis Management Group (CMG), of which the Bank is a member. The role of the CMG is to discuss and facilitate development of a resolution plan for LCH Ltd.


Participants can register sub-block trading venue trades without this credit check. [19]

The additional two-day holding period for client positions allows time for clients to decide whether to seek to port their portfolio to another clearing participant, as well as time to carry out any such transfer. [20]

A clearing participant that defaulted would be deemed to have defaulted in all LCH Ltd services. If any of that clearing participant's margin and default fund contributions for a given service were not required to meet losses in that service, they would be applied to losses in any other service of which that clearing participant was a member. [21]

Losses in one LCH Ltd service cannot be applied to the mutualised resources of the default waterfall of another LCH Ltd service (apart from within the Rates service). In an extreme situation, a given LCH Ltd service could be closed, while the other services remained open (apart from the services within the Rates service). [22]

The STLOIM of a participant and its affiliates is based on the stress test losses and initial margin of the participant, its affiliates, and all the clients of the participant and its affiliates. [23]

Participants can ask clients to cover their own stress test losses (rather than the member paying DFAM) through stress loss margin. Members and clients jointly agree to provide additional collateral to LCH in order to reduce the exposure generated by that client. [24]

The LCH Group Risk policies are: the Financial Resource Adequacy Policy; Liquidity Risk Policy; Operational Risk Policy; Investment Risk Policy; Collateral Risk Policy; Counterparty Credit Risk Policy; Contract and Market Acceptability Policy; Default Management Policy; Settlement, Payment and Custody Risk Policy; Model Governance, Validation and Review Policy; and the Procyclicality Policy. [25]

The memorandum is available at Memorandum of Understanding. [26]

For more information, see [27]

See paragraph 1.2 in HM Treasury's approach to financial services legislation under the European Union (Withdrawal) Act. Available at [28]

See Procedures for the Approval and Implementation of EU Exit Agreements: Written statement – HCWS342, available at: [29]

See paragraphs 1.8 and 1.9 in HM Treasury's approach to financial services legislation under the European Union (Withdrawal) Act. Available at footnote 28. [30]

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 [31]

UK Withdrawal from the EU: Changes to FMI rules and onshored Binding Technical Standards, BoE consultation paper, October 2018. Available at [32]

BoE (2013), The Bank of England's approach to the supervision of financial market infrastructures. Available at [33]

BoE (2018), The Bank of England's supervision of financial market infrastructures – Annual Report. Available at [34]

For more information on the circumstances under which resolution tools would be used, see [35]