## _cr11235 - Executive Summary ## Source details **Canonical URL:** [_cr11235 - Executive Summary](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11235.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11235.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11235.pdf.json) --- ### Key findings — executive summary - LCH Clearnet Limited (LCH) is one of the main central counterparties (CCPs) in Europe, serving major international exchanges and platforms, as well as a range of OTC markets. - LCH is a user-owned, constrained-for-profit organization. - LCH’s risk management framework is robust and routinely measures and manages exposures to members using intraday positions in all markets calculated at least once a day (and up to three times a day) as routine and on an ad-hoc basis as required by market conditions. - The intraday measurement routine is not undertaken for the NYSE Euronext LIFFE (LIFFE) market; this is a routine capacity that should be developed. - LCH’s liquidity management is conservative, but it should put in place other safe and reliable funding options, including committed credit lines, to help face extreme but plausible circumstances (for example, disruptions to tri-party repo arrangements or dislocations in the repo market). - LCH secures its collateral pursuant to a conservative custody and investment policy, but needs to confirm that its U.S. custodian (and any new custodians) employ accounting practices and safekeeping procedures that fully protect customers’ securities (Recommendation 12 of the RSSS). - LCH mainly uses a private settlement bank model, which exposes the CCP to intraday credit risk; settlement in central bank money when possible and practicable should be pursued to reduce settlement exposures. - Supervision and oversight are risk-based and implemented on a prioritization basis; they have been strengthened since the crisis at both the Bank of England (BoE) and the Financial Services Authority (FSA). ### Scope and institutional coverage - Assessment context: IMF Financial Sector Assessment Program (FSAP) exercise for the United Kingdom over the period January–July 2011. - Assessment focus: LCH’s observance of the CPSS-IOSCO Recommendations for Central Counterparties (RCCPs). - LCH structure and ownership: - LCH.Clearnet Limited (LCH) is a wholly owned subsidiary of LCH.Clearnet Group Limited, a private company limited by shares, created as part of a merger in December 2003. - The Group’s operating subsidiaries include LCH (formerly The London Clearing House Limited) and Banque Centrale de Compensation SA (trading as LCH Clearnet SA). - Asset classes and currencies: - LCH clears securities, exchange traded derivatives, energy, freight, interbank interest rate swaps, and euro and sterling denominated bonds and repos. - Currencies operated: Australian dollar, Canadian Dollar, Swiss franc, Czech koruna, Danish kroner, euro, sterling, Hong Kong dollar, Hungarian forint, Islandic krona, Japanese yen, Norwegian krone, New Zealand dollar, Polish zloty, Swedish krona, South African rand and the U.S. dollar. ### Markets, participants, and volumes - CCP services provided for: London Stock Exchange (LSE); NYSE Euronext LIFFE (LIFFE); London Metal Exchange (LME); EDX London; SIX Swiss Exchange; Nodal Exchange; several European Multilateral Trading Facilities (MTFs). - OTC services: SwapClear (interest rate swaps) and RepoClear (cash bond and repo trades) across a range of European government bond markets. - Market structure notes: - In addition to LCH, two CCPs are based in the United Kingdom and two more were expected to begin operations in 2011 and 2012 (EuroCCP, ICE Clear Europe, CME Clearing Europe, NYSE/EURONEXT planned CCP for LIFFE). - Several non-U.K. CCPs hold a Recognized Overseas Clearing House license to clear U.K. securities and derivatives outside the United Kingdom. - Trading and settlement: - In 2010, in terms of value, around 60 percent of equities were traded on the LSE and cleared via LCH and SIX x-clear. - Transactions are settled in CREST; Euroclear Bank SA/NV; SegaInterSettle (SIS); and the Zurich-based ICSD. - Volumes and market shares: - Overall trade volume for 2009 was 1.6 billion (just over two billion contracts in 2008). - SwapClear currently clears more than 40 percent of the interest rate swap market, representing trades with a total notional principal of $248 trillion. - RepoClear clears 250,000 traded sides per month, representing a nominal value of €11 trillion. - Total initial margin at LCH has typically been in the range of 40–50 billion euro-equivalent, approximately 64 percent of which is currently covered in cash. ### Legal, regulatory, and supervisory framework - Tripartite UK structure (MoU 2006): HM Treasury (HMT), the Financial Services Authority (FSA), and the Bank of England (BoE). - Treasury: institutional structure, legislation, negotiation of European directives, management of serious problems, accounting for financial sector resilience to operational disruption. - FSA: supervision of financial markets, securities listings, clearing and settlement systems; conduct of operations in response to problem cases; regulatory policy to promote resilience. - BoE: contribute to stability, oversee systemically significant infrastructure (particularly payments systems), advise the Chancellor, develop infrastructure to reduce systemic risk. - Current LCH regulation and oversight: - FSA: main regulator of LCH as a Recognized Clearing House. - BoE: oversight remit focuses on LCH’s inter-bank payment system. - Planned policy shift: - February 2011 Treasury consultation indicates government intends to transfer regulation and supervision of CCPs to the BoE by end 2012; under the proposed framework, the BoE would directly supervise providers of systemically important infrastructure and take over FSA responsibilities for settlement systems under the Uncertificated Securities Regulations 2001 and regulate CCPs under FSMA. ### Risk management, margining, and default resources - Legal soundness: clear legal basis exists for LCH to act as a CCP, for netting arrangements, rights in collateral, and procedures upon default; LCH obtains legal opinions where necessary. - Membership standards: - Minimum capital requirements (typical per product type): - Futures and options £5 million - Cash equity £5–10 million - Cash bonds and repos €100–400 million - Swaps $5 billion - SwapClear membership additional requirement: minimum notional interest rate swap portfolio of US$1 trillion or equivalent (LCH is revisiting this; FSA will review proposed change). - Exposure measurement: - LCH measures exposures a minimum of three times per day and more frequently in extreme market conditions. - Exception: LIFFE market does not have routine intraday exposure calculation capacity; assessors recommend developing routine intraday position measurement for LIFFE. - Margining: - Models used: SPAN, PAIRS, ERA (variance-covariance and historical simulation approaches). - Board risk appetite: initial margin to cover 99.7 percent of observations over the assumed holding period. - Back-testing: initial margin is back-tested daily; results reported to Senior Executive monthly and Risk Committee quarterly. - Intraday margin practice: - Intraday recalculations are made at least three times per day. - Routine intraday margin calls are subject to minimum transfer amount of £100,000. - For LIFFE, intraday calls in high volatility are based on previous day’s positions; LCH should develop capacity to use current positions for routine intraday calls. - Default fund: - Default Fund total: approximately £600m. - Composition: secured cash deposits at a number of financial institutions. - Default Fund comprised of four fixed segments with minimum contributions: - Exchange Fund Amount, minimum contribution £100,000. - EquityClear Fund Amount, minimum contribution £1,000,000. - RepoClear Fund Amount, minimum contribution £1,000,000. - SwapClear Fund Amount, minimum contribution £2,000,000. - Design intent: cover default of the higher of (a) the member with the largest stress testing losses plus other members from the same financial group together with simultaneous default of the five least creditworthy members; or (b) the second and third largest members by stress testing losses (plus other members from the same financial group). - Stress testing: adequacy stress tested daily using approximately 60 scenarios across members; scenarios include historical and theoretical events. - Pecking order for resources following a default: - Defaulter’s margin. - Defaulter’s contribution to the Default Fund. - Up to £20 million of LCH’s capital. - Remainder of Default Fund (i.e. survivors’ contributions). - If a SwapClear default uses all of the Default Fund, LCH has the right to request £50 million from each remaining SwapClear member on a nonvoluntary basis. - Remainder of LCH’s capital. - Historical record: LCH has successfully managed five defaults, including Lehman; has not once had cause to utilize the Default Fund. ### Liquidity and funding - Liquidity management: - Daily estimation of liquidity demands for each settlement member and for default scenarios. - Liquidity scenarios set to the larger of: - The default of the member with the largest first day liquidity requirement, together with the simultaneous default of the five least creditworthy members; or - The default of the two members with the second and third largest first day liquidity requirement. - None of LCH’s credit lines are committed. - Recommended improvements: - Put in place safe and reliable funding options subject only to presentment (committed credit lines). - Consider mutualization of liquidity risk among CCP membership. - Purpose: to face extreme but plausible circumstances, such as disruptions to tri-party repo arrangements or dislocations in the repo market. ### Default management, operations, custody, and settlement - Default management: - LCH has broad authority to close out a defaulter’s contracts, transfer open contracts, and sell securities; maintains an internal Default Management Framework with operational procedures. - LCH would be in close contact with regulators in a default event. - LCH has successfully managed five defaults; assessors note Lehman default was managed effectively. - Treasury and investment policy: - Treasury Investment Policy is comprehensive and conservative; safety takes priority over revenue maximization. - Majority of cash secured via tri-party repo, DBV, and directly purchased Government assets; not all cash can be secured because of liquidity needs and settlement timing. - Custody arrangements: - Noncash collateral mainly held at two European CSDs and one U.S. custodian bank. - Due diligence in place but LCH should confirm U.S. custodian and any new custodians conform to Recommendation 12 of the RSSS (accounting and safekeeping practices that fully protect customers’ securities). - Settlement model and intraday credit risk: - LCH mainly uses a private settlement bank model via the Protected Payments System (PPS), exposing the CCP to intraday credit risk. - PPS features: - Two PPS systems: “London PPS” and “U.S. PPS”. - Transfer methods: CHAPS for sterling; TARGET2 for EUR; Fedwire and CHIPS for U.S. dollars; other currencies via nostro-style arrangements. - 2010 distribution of net payments through the PPS: 40 percent in U.S. dollars; 32 percent in Euro; 24 percent in pounds sterling; 4 percent in the other currencies. - Total daily sum of all (net) payments: pounds sterling equivalent 5,955 million over all currencies. - Concentration banks: - BoE acts as concentration bank for sterling and euro PPS and provides collateralized intraday liquidity in sterling up to a pre-agreed limit. - Citibank NA is concentration bank for U.S. dollars. - HSBC Bank plc is concentration bank for all other currencies. - Mitigants and limitations: - PPS banks must have minimum Fitch credit rating of A (or equivalent). - A formal deadline of two hours (maximum) for transfer of funds to the concentration bank is incorporated into the PPS Agreement. - Assessment: Broadly observed. - Recommendation: reduce settlement exposures; pursue settlement in central bank money when possible and practicable. ### System resilience, capacity, and operational risk - Resilience and contingency: - Contingency plans and back-up facilities in place to allow timely recovery and completion of settlement. - LCH operates two live IT centres in the greater London area, around nine miles apart, linked in synchronous mode; no second IT back-up site (three sites architecture). - Immediate recovery: two-hour recovery window for IT swap; no third IT centre and both office sites are in London. - LCH undertakes at least an annual internal testing exercise; offers participants voluntary testing of IT swap twice a year; no compulsory contingency testing for largest participants. - Operational frameworks and staffing: - Operational risk management framework exists at Group level; Internal Audit reviews operations; LCH does not outsource core activities. - LCH staff is stable and experienced; independent adviser on operational risk within executive management. - Testing and incidents: - LCH performs regular stress testing on key systems; aims to comply with ISO/IEC 27002. - IT Services Production stress tests using multiples of peak daily volume. - Assessment: Observed. - Comment/recommendation: LCH should envisage making contingency testing compulsory for the largest participants and consider implementing a second back-up site (three sites architecture) outside the greater London area. ### Interoperability and inter-CCP exposures - Current interoperability: - Interoperates with SIX x-clear (Swiss CCP) for LSE and SIX Swiss Exchange clearing, and with Oslo Clearing for the EDX market. - Each link is a peer-to-peer model; both CCPs lodge initial margin with the other; either CCP can be placed in default subject to link agreements. - Neither CCP contributes resources to the other’s default fund; inter-CCP exposures are collateralized. - Exposure levels and arrangements: - Typical LCH–x-clear exposure: around €35 to V70 million; peaks over €250 million during high equity trading volume. - December 2010 LCH–OC inter-CCP exposure: average £5.9 million, maximum £9.2 million. - LCH collateralizes exposures via performance bonds secured by collateral lodged with LCH by its members. - Regulatory cooperation: - Authorities require these credit exposures be measured, monitored and mitigated by collateral holdings and other protections. - LCH has applied to interoperate with EuroCCP and EMCF; applications under review by competent authorities. ### Governance, transparency, and disclosure - Ownership and governance: - LCH.Clearnet Group Limited ownership: 83 percent users and 17 percent exchanges that clear through it; cap of 5 percent on individual membership. - Board includes four independent Board members (including the Chairman); Risk Committee chaired by an independent non-executive LCH Board member and includes user/member representatives. - Risk Management Department is independent from other departments. - Transparency and public disclosures: - LCH publishes rules and procedures, information on risk management, application costs and procedures, minimum contributions towards (and interest rates on) the default fund, and transaction tariffs. - Margin calculation models are provided to participants. - LCH does not disclose detailed objectives to participants nor publish default stress test results or comprehensive activity statistics publicly. - Assessors recommend LCH publish information about its management structure, disclose detailed objectives to participants and extent to which they are met, and publish additional public information on concentration banks and activity statistics. ### Supervision, oversight, and public authorities - BoE and FSA oversight: - BoE conducts payment system oversight under the Banking Act 2009; uses 10 Core Principles plus four additional principles (Business Risk, Interdependencies, Indirect Participants, Outsourcing). - The BoE follows a programme of risk reviews and formalizes outcomes in Expectations Letters. - FSA supervises LCH as a Recognized Clearing House; has increased focus on detailed analysis of CCP internal risk models since the crisis. - Cooperation and resources: - Domestic cooperation between FSA and BoE governed by MoU. - International cooperation via MoUs with CFTC, SEC, Swiss, Dutch and Australian authorities, and trilateral meetings where relevant. - Hiring and retaining expertise for oversight is challenging; HMT consulting to transfer regulation and supervision of CCPs to the BoE by 2013. - Assessment: Observed. - Suggested improvement: FSA and BoE may want to set up regular dedicated meetings with LCH participants and partners (exchanges, PPS and concentration banks) to gather views on CCP efficiency and robustness. ### Assessment results and recommended actions (summary) - Assessment categories: - Observed: Recommendations 1, 2, 3, 4, 6, 8, 10, 11, 12, 13, 14, 15 - Broadly observed: Recommendations 5, 7, 9 - Key recommended actions: - Develop routine intraday position measurement capacity for the LIFFE market to match intraday practices in other markets. - Enhance liquidity arrangements by securing committed credit lines subject only to presentment and considering mutualization of liquidity risk among membership. - Confirm custodial protections: verify U.S. custodian and any new custodians conform to Recommendation 12 of the RSSS. - Reduce settlement exposures: pursue settlement in central bank money where possible and practicable. - Operational risk actions: consider compulsory contingency testing for largest participants and a third IT site outside greater London. - Governance and transparency: publish management structure information, detailed objectives, and more activity statistics; publish a more detailed self-assessment. - Additional notable numeric targets and parameters: - Initial margin coverage target: 99.7 percent of observations over assumed holding period. - IT availability/robustness target referenced: 99.98 percent target. - Total daily PPS net payments: pounds sterling equivalent 5,955 million. - Default Fund total: approximately £600m. - SwapClear notional principal: $248 trillion. - RepoClear monthly traded sides: 250,000 representing a nominal value of €11 trillion. - Typical total initial margin at LCH: in the range of 40–50 billion euro-equivalent, approximately 64 percent covered in cash. - Members’ minimum transfer threshold for routine intraday calls: £100,000. - Haircut review reference: last collateral haircut review implemented on March 7 (year not specified in excerpt). - Minimum member capital examples: Futures and options £5 million; Cash equity £5–10 million; Cash bonds and repos €100–400 million; Swaps $5 billion. - SwapClear membership notional portfolio requirement: US$1 trillion (under review). - Default Fund fixed segment minimums: Exchange Fund £100,000; EquityClear £1,000,000; RepoClear £1,000,000; SwapClear £2,000,000. - LCH capital peg in pecking order: up to £20 million of LCH’s capital before survivors’ contributions; right to request £50 million from each remaining SwapClear member if Default Fund exhausted. - Inter-CCP exposure examples: LCH–x-clear typically €35 to V70 million; peaks over €250 million; LCH–OC average £5.9 million, maximum £9.2 million (December 2010). - PPS distribution of net payments (2010): 40 percent U.S. dollars; 32 percent Euro; 24 percent pounds sterling; 4 percent other currencies. *Executive Summary of IMF FSAP assessment of LCH Clearnet Limited (assessment period January–July 2011).* ### Executive Summary ...................................................................................................... ### _cr11235 - Executive Summary ...................................................................................................... ### Key findings — executive summary - LCH Clearnet Limited (LCH) is one of the main central counterparties (CCPs) in Europe, serving major international exchanges and platforms, as well as a range of OTC markets. - LCH is a user-owned, constrained-for-profit organization. - LCH’s risk management framework is robust and routinely measures and manages exposures to members using intraday positions in all markets calculated at least once a day (and up to three times a day) as routine and on an ad-hoc basis as required by market conditions. - The intraday measurement routine is not undertaken for the NYSE Euronext LIFFE (LIFFE) market; this is a routine capacity that should be developed. - LCH’s liquidity management is conservative, but it should put in place other safe and reliable funding options, including committed credit lines, to help face extreme but plausible circumstances (for example, disruptions to tri-party repo arrangements or dislocations in the repo market). - LCH secures its collateral pursuant to a conservative custody and investment policy, but needs to confirm that its U.S. custodian (and any new custodians) employ accounting practices and safekeeping procedures that fully protect customers’ securities (Recommendation 12 of the RSSS). - LCH mainly uses a private settlement bank model, which exposes the CCP to intraday credit risk; settlement in central bank money when possible and practicable should be pursued to reduce settlement exposures. - Supervision and oversight are risk-based and implemented on a prioritization basis; they have been strengthened since the crisis at both the Bank of England (BoE) and the Financial Services Authority (FSA). ### Scope and institutional coverage - Assessment context: IMF Financial Sector Assessment Program (FSAP) exercise for the United Kingdom over the period January-July 2011. - Assessment focus: LCH’s observance of the CPSS-IOSCO Recommendations for Central Counterparties (RCCPs). - LCH structure and ownership: - LCH.Clearnet Limited (LCH) is a wholly owned subsidiary of LCH.Clearnet Group Limited, a private company limited by shares, created as part of a merger in December 2003. - The Group’s operating subsidiaries include LCH (formerly The London Clearing House Limited) and Banque Centrale de Compensation SA (trading as LCH Clearnet SA). - LCH clears a broad range of asset classes including securities, exchange traded derivatives, energy, freight, interbank interest rate swaps, and euro and sterling denominated bonds and repos. - Currencies operated: includes Australian dollar, Canadian Dollar, Swiss franc, Czech koruna, Danish kroner, euro, sterling, Hong Kong dollar, Hungarian forint, Islandic krona, Japanese yen, Norwegian krone, New Zealand dollar, Polish zloty, Swedish krona, South African rand and the U.S. dollar. ### Markets, participants, and volumes - LCH provides CCP services for: - London Stock Exchange (LSE) - NYSE Euronext LIFFE (LIFFE) - London Metal Exchange (LME) - EDX London - SIX Swiss Exchange - Nodal Exchange - Several European Multilateral Trading Facilities (MTFs) - OTC services: SwapClear (interest rate swaps) and RepoClear (cash bond and repo trades) across a range of European government bond markets. - Market structure notes: - In addition to LCH, two CCPs are based in the United Kingdom and two more were expected to begin operations in 2011 and 2012 (EuroCCP, ICE Clear Europe, CME Clearing Europe, NYSE/EURONEXT planned CCP for LIFFE). - Several non-U.K. CCPs hold a Recognized Overseas Clearing House license to clear U.K. securities and derivatives outside the United Kingdom. - Trading and settlement: - U.K. equities are traded across exchanges and MTFs; in 2010, in terms of value, around 60 percent of equities were traded on the LSE and cleared via LCH and SIX x-clear. - Transactions are settled in CREST; Euroclear Bank SA/NV; SegaInterSettle (SIS); and the Zurich-based ICSD. - Volumes (group-level and service-level figures): - Overall trade volume for 2009 was 1.6 billion (just over two billion contracts in 2008). - SwapClear currently clears more than 40 percent of the interest rate swap market, representing trades with a total notional principal of $248 trillion. - RepoClear clears 250,000 traded sides per month, representing a nominal value of €11 trillion. ### Legal, regulatory, and supervisory framework - The United Kingdom’s tripartite structure (established in 1997) comprises HM Treasury (HMT), the Financial Services Authority (FSA), and the Bank of England (BoE). - Roles (MoU 2006): - Treasury: institutional structure of financial regulation, legislation, negotiation of European directives, management of serious problems in the financial system, and accounting for financial sector resilience to operational disruption within government. - FSA: supervision of financial markets, securities listings, clearing and settlement systems; conduct of operations in response to problem cases; regulatory policy to promote resilience to operational disruption of authorized firms and Recognized Bodies. - BoE: contribute to stability of the financial system, oversee systemically significant financial system infrastructure (particularly payments systems), advise the Chancellor on major problems, and develop/strengthen infrastructure to reduce systemic risk. - Current LCH regulation and oversight: - FSA: main regulator of LCH as a Recognized Clearing House. - BoE: oversight remit focuses on LCH’s inter-bank payment system. - Planned policy shift: - February 2011 Treasury consultation indicates government intends to transfer regulation and supervision of CCPs to the BoE by end 2012; under the proposed framework, the BoE would directly supervise providers of systemically important infrastructure and take over FSA responsibilities for settlement systems under the Uncertificated Securities Regulations 2001 and regulate CCPs under FSMA. ### Risk management, margining, and default resources - Legal soundness: - Regulation of LCH by the FSA and BoE is grounded in statute; a clear legal basis exists for LCH to act as a CCP, for its netting arrangements, rights in collateral, and procedures upon default. - LCH obtains or requires legal opinions where necessary. - Membership standards: - LCH sets and monitors requirements for members commensurate with membership type and markets cleared, including minimum levels of financial resources, credit worthiness, and operational capacity. - Exposure measurement: - LCH regularly measures exposures to members using intraday positions in all markets except LIFFE; assessors recommend developing routine intraday position measurement for the LIFFE market. - Margining: - LCH uses various initial margin models depending on market: SPAN, PAIRS, and ERA. - Margining assumptions are generally conservative; LCH regularly back-tests intended coverage. - LCH can and does make both routine and ad hoc intraday margin calls, subject to a minimum transfer threshold. - For LIFFE, in periods of high volatility LCH will make an intraday call based on the previous day’s positions; LCH should develop capacity to use current positions for routine intraday calls. - Collateral eligibility for initial margin is conservatively managed. - Default fund: - The default fund is comprised only of cash and is designed to have sufficient resources to cover more than the single largest default. - Testing: daily testing using historical and theoretical scenarios, with end-day positions. - Liquidity and funding: - LCH’s liquidity management is comprehensive and conservative. - Recommendation: put in place other safe and reliable funding options, which should include committed credit lines subject only to presentment, and could include mutualization of liquidity risk among the CCP’s membership. - Purpose: to face extreme but plausible circumstances such as disruptions to tri-party repo arrangements or dislocations in the repo market. ### Default management, operations, and custody - Default management: - LCH has broad authority to close out a defaulter’s contracts, transfer open contracts, and sell securities. - LCH maintains an internal Default Management Framework providing high-level and detailed operational procedures for managing defaults. - LCH would be in close contact with regulators in a default event. - LCH has successfully managed five defaults; discussions suggest the Lehman default was managed effectively. - Treasury and investment policy: - LCH’s Treasury Investment Policy is comprehensive and conservative; safety takes priority over revenue maximization. - The vast majority of cash is secured; policy sets minimum credit rating criteria for counterparties, concentration limits at the counterparty group level, diversification of assets, and criteria to mitigate interest rate risk. - Custody arrangements: - Noncash collateral is mainly held at two European Central Securities Depositories (CSDs) and one custodian bank in the United States. - LCH needs to confirm that the U.S. custodian and any new custodians conform to Recommendation 12 of the RSSS (i.e., employ accounting practices and safekeeping procedures that fully protect customers’ securities). - Settlement model: - LCH mainly uses a private settlement bank model, exposing the CCP to intraday credit risk. - Recommendation: reduce settlement exposures, with settlement in central bank money when possible and practicable. ### Assessment methodology and implementation notes - Assessment methodology: - The assessors used the methodology developed in parallel with the CCP recommendations in 2004. - Each recommendation was assessed qualitatively using a five-fold categorization: observed, broadly observed, partly observed, non-observed, and not applicable. - Assignment of an assessment category is based on current situation without regard to proposed or ongoing actions; material changes underway are described in comments. - Categorization guidance: - Observed: all assessment criteria generally met without significant deficiencies. - Broadly observed: only minor shortcomings that do not raise major concerns and corrective actions are scheduled and realistically achievable within a prescribed period. - Partly observed: shortcomings raise doubts about achieving observance within a reasonable time frame. - Non-observed: major shortcomings found. - Not applicable: recommendation does not apply given structural/legal/institutional conditions. - Information and process: - Prior assessments and materials reviewed include a 2009 self-assessment and FSA/BoE reviews; the FSA provided the 2009 assessment and a summary of main changes since then. - Extensive meetings were held with officials from the FSA, BoE, LCH, three LCH members and settlement banks, and two exchanges. - No obstacles were faced; the authorities and others were fully cooperative. ### Suggested priorities and recommended actions (summary) - Develop routine intraday position measurement capacity for the LIFFE market to match intraday practices in other markets. - Enhance liquidity arrangements by: - Securing committed credit lines subject only to presentment. - Considering mutualization of liquidity risk among CCP membership. - Ensuring funding options to cover extreme but plausible market disruptions (e.g., tri-party repo disruptions). - Confirm custodial protections: - Verify that the U.S. custodian and any new custodians conform to Recommendation 12 of the RSSS regarding accounting practices and safekeeping procedures that fully protect customers’ securities. - Reduce settlement exposures: - Pursue settlement in central bank money where possible and practicable to reduce intraday credit risk arising from a private settlement bank model. - Continue conservative margining and default fund practices, maintain daily scenario testing of the default fund, and ensure operational readiness of the Default Management Framework. *Executive Summary of IMF FSAP assessment of LCH Clearnet Limited (assessment period January–July 2011).* ### 24. The system is reliable and secure, and has adequate, scalable capacity. ### 24. The system is reliable and secure, and has adequate, scalable capacity. ### System resilience and contingency arrangements - Contingency plans and back-up facilities are in place to allow for timely recovery of operations and completion of the settlement process. - There is no compulsory contingency testing for the largest participants. - There is no second IT back-up site (three sites architecture). ### Settlement model and intraday credit risk - LCH mainly uses a private settlement bank model, which exposes the CCP to intraday credit risk. - Recommendation implied: LCH should find a way to reduce its settlement exposures, with settlement in central bank money when possible and practicable. ### Physical delivery obligations - The CCP clearly states its obligations with respect to physical deliveries. - The risks from these obligations are identified and managed. ### Interoperability and inter-CCP exposures - LCH interoperates with the Swiss CCP SIX x-clear in the clearing of trades executed on the London Stock Exchange and on the SIX Swiss Exchange; and with Oslo Clearing for the EDX market. - Each link is a peer-to-peer model in which both CCPs lodge initial margin with the other CCP, and either CCP can be placed in default should it fail to meet its contractual arrangement to the other CCP. - Each CCP calculates the margin it requires from the other using the standard margin methodology it applies to its members. - Neither CCP contributes resources to the other’s default fund, to minimize contagion risk from defaulting members between the CCPs. - Inter CCP exposures are collateralized. - LCH has applied to interoperate with EuroCCP and EMCF; this is under review by the competent authorities. ### Cost control and competition - LCH has procedures to control its costs of operation and undertakes regular analysis and benchmarking on charges. - Over the past three years, competition has led to significant fee reductions. ### Ownership, governance, and transparency - A three-year program to align the ownership of the Group more closely to its users through a significant share buyback came to an end in 2009. - LCH.Clearnet Group Limited is now owned 83 percent by its users and 17 percent by exchanges that clear through it. - As a U.K. incorporated company, LCH’s Board and management are accountable to the shareholders. - The Board includes four independent Board members (including the Chairman). - LCH publishes its rules and procedures for the various markets cleared, together with information on risk management, application costs and procedures, minimum contributions towards (and interest rates on) the default fund, and the transaction tariffs. - Margin calculation models are provided to the participants; but not the CCP’s activity statistics, nor its detailed objectives4 and the extent to which they are met. *Source: _cr11235 - 24. The system is reliable and secure, and has adequate, scalable capacity.* ### 30. The role and responsibilities of relevant public authorities with respect to ### _cr11235 - 30. The role and responsibilities of relevant public authorities with respect to ### Governance, supervision and public authorities - The CCP’s supervision and oversight are risk-based and implemented on a prioritization basis. - Supervision and oversight have been strengthened since the crisis at both the BoE and the FSA. - Hiring and keeping the right expertise is challenging. - The government intends to transfer regulation and supervision of central counterparty clearing houses to the BoE by 2013. ### Assessment results (Table 1) - Assessment category — Observed: Recommendations 1, 2, 3, 4, 6, 8, 10, 11, 12, 13, 14, 15 - Assessment category — Broadly observed: 5, 7, 9 - Assessment category — Partly observed: (none listed) - Assessment category — Non-observed: (none listed) - Assessment category — Not applicable: (none listed) ### Recommendation 1 — Legal risk: legal framework and enforceability - Governing law and regulatory status: - LCH is a private limited company incorporated in the United Kingdom and subject to U.K. company law. - LCH is regulated by the FSA as a Recognized Clearing House under the Financial Services and Markets Act 2000 (FSMA). - LCH is subject to Recognition Requirements for Investment Exchanges and Clearing Houses issued under FSMA Regulations 2001 (SI 2001/1995). - LCH is regulated under FSA’s specialist sourcebook “Recognized Investment Exchanges and Recognized Clearing Houses” (REC) and additional FSA Guidelines. - LCH is designated under the Financial Markets and Insolvency Regulations 1999 (SI 1999/2979) (the Settlement Finality Regulations). - The interbank payment system operated as part of LCH is recognized by HM Treasury for oversight by the Bank of England under Part 5 of the Banking Act 2009. - LCH is a Derivatives Clearing Organization in the United States and is subject to CFTC rules and the U.S. Commodity Exchange Act. - Contractual basis and novation: - A clear contractual basis exists for LCH to act as CCP, either through open offer or novation. - LCH novates trades as received by its systems, except futures and options which are novated at the end of each business day. - LCH may technically refuse to accept a trade awaiting novation, but policy is to accept matched trades for non-defaulting members. - LIFFE Clear acts as CCP for LIFFE exchange trades; clearing guarantee arrangements and related risk functions are outsourced to LCH. LCH assumes liability for LIFFE trades only if a counterparty defaults. - Legal protections and finality: - LCH is protected by a recently updated Part VII of the Companies Act 1989 (Part VII), protecting recognized clearing houses from general application of financial markets insolvency laws of England and Wales. - Part VII protects rights such as netting, offsetting profits and losses, and prevents liquidator “cherry-picking”. - Designation under the Settlement Finality Regulations further reduces legal challenge risk. - Conclusion: High degree of assurance that actions taken by LCH in managing a default would not be subject to successful legal challenge. - Cross-border participation and legal evaluations: - Cross-border participation is extensive among 132 members; most are incorporated under the laws of England and Wales, with significant numbers in France, Germany, the Netherlands, and the United States. - Foreign members must provide a legal opinion on application of laws in their jurisdiction of incorporation. - Protections of the Settlement Finality Regulations are limited to EU Members. - LCH obtains legal advice in the United States and other countries and procures external legal advice on foreign jurisdictions’ enforceability issues. - LCH minimizes legal risk by holding collateral in countries with preferable enforceability and by holding accounts in its own name where possible. - Assessment: Observed ### Recommendation 2 — Participation requirements - Financial resource requirements: - Requirements depend on membership type and exchanges/markets cleared. - Typical minimum net capital requirements per product type: - Futures and options £5 million - Cash equity £5–10 million - Cash bonds and repos €100–400 million - Swaps $5 billion - Minimum capital for multiple markets/products is the sum of minimums for each market/product. - If financial regulatory requirements are lower than LCH requirements, additional resources must be provided. - SwapClear membership additional requirement: minimum notional interest rate swap portfolio of US$1 trillion or equivalent (LCH is revisiting this, FSA will review proposed change). - Creditworthiness and ratings: - LCH conducts credit evaluations using financial reports, regulatory returns, external credit ratings, internal evaluation of management and control, and information-sharing with the FSA. - Examples of minimum ratings and consequences: - RepoClear member (or guarantor) must maintain rating of BBB or above. Downgrades to BBB- or BB+ attract greater initial margin; downgrade below BB+ results in required exit from the service. - SwapClear member (or guarantor) must maintain rating of A. Downgrades to A-, BBB+, BBB attract greater initial margin; downgrade below BBB results in required exit from the service. - As of 2008, the credit rating distribution of members in LCH was provided (data table referenced). - Operational capacity requirements: - Members must have arrangements to effect payment and collateral/delivery obligations, staff with appropriate experience and training, and Boards/senior management of suitable fitness and propriety. - Onboarding back office requirements: - Remote from trading floor/desks - Adequate systems (computer and communications) and records - Adequate administrative staff conversant with procedures - Necessary equipment including technology and connectivity - SwapClear applicants must successfully participate in a SwapClear “fire drill” (submit a bid for a notional portfolio within a specified timeframe). - Settlement arrangements: - All members must have money settlement arrangements with a PPS bank for cash margin payments, physical delivery payments, cash settlements and Default Fund contributions. - PPS arrangements operate in the United Kingdom and the United States. - Each member required to maintain PPS bank account(s) in London in pounds sterling and for each currency in which it incurs settlements at one of the participating PPS banks. - U.K.-based arrangements operate from 07:00 until 16:00 London time; U.S. arrangements until 22:00. - Members are required to have PPS banking arrangements in the United States under the U.S. PPS scheme, utilized after the U.K. cut-off time for PPS. - Members must have necessary CSD or SSS facilities to meet delivery obligations. - Ongoing monitoring and corrective measures: - LCH monitors membership requirements via member risk assessments and a risk-based approach; less creditworthy and nonregulated members are monitored more closely. - LCH receives annual accounts from all clearing members and quarterly balance sheet data from nonregulated members; members must immediately notify LCH of significant capital decreases or other relevant financial information. - If a member is inactive for continuous period of three months, asked to confirm intent or resign. - Measures available where concerns arise (all have been exercised at times): - Higher initial margin requirements (super margin) - Additional financial resource requirements (buffers) - Position transfers to other Members - Trading for liquidation only - Prior authorization of trades above a certain size - Reduction in positions - Gross margining of client account positions - Termination of the Clearing Member agreement - Declaration of Member default - Suspension, termination and orderly exit: - Suspending or terminating clearing members would occur only in extreme cases, after consultation with the FSA. - Membership termination: LCH or member may terminate membership with three months’ notice; member obliged to close out all positions within this period. - If resigning member has not closed out or transferred contracts by termination date, LCH may liquidate contracts per the Rulebook and require continued membership until no contracts remain. - Access and transparency: - FSA requires fair and open access; FSA assesses participation criteria during product onboarding. - Participation criteria appear objective and risk-based; detailed participation requirements are publicly available. - LCH is exploring ways to alter access criteria to facilitate greater global participation while managing risk. - Assessment: Observed ### Recommendation 3 — Measurement and management of credit exposures - Frequency and intraday capacity: - LCH measures exposures a minimum of three times per day and more frequently in extreme market conditions. - For the LIFFE market, LCH does not have routine intraday exposure calculation capacity; intraday price moves are monitored and additional margin may be called intraday based on end-day positions from the previous day. - LCH’s monitoring focuses on internal credit evaluations and pays particular attention to positions large relative to a member’s financial resources or open interest that threaten assumed holding period of initial margin calculation. - Position monitoring looks at house and client accounts both separately and together. - Limiting exposures and risk controls: - LCH uses membership requirements, initial and variation margin, and contributions to a default fund. - Additional measures to limit losses from defaults: - Additional financial resource requirements (buffers) - Additional initial margin requirements - Imposition of position limits - Trading for liquidation only - Prior authorization of trades above a certain size - Issuing instructions to reduce positions - LCH monitors large cumulative profits or losses and contacts compliance officers and senior executives or boards when large/unusual trading activity is detected. - Assessment: Observed - Comment: LCH should develop a routine capacity for calculating exposures intraday for the LIFFE market. ### Recommendation 4 — Margin requirements - Intended coverage and models: - Initial margin is intended to cover possible losses in the event of a default under normal market conditions, between last margin payment and time positions are closed out, transferred, or hedged. - Close-out period assumptions and data horizons vary by product and model. - LCH uses two main model types: - Variance-Covariance models – London SPAN© (used for listed derivatives on NYSE Liffe, EDX and LME, and for EnClear and RepoClear) - Historical Simulation models – for EquityClear (ERA), for SwapClear (PAIRS) and for Nodal (VaR model) - Variance-Covariance (London SPAN©): - Main parameters: ‘scanning range’ and volatility shift factor for options. - Scanning ranges defined as highest of price movements over one or two days (close-out period assumed, for most markets, to be two days) based on historical data usually over past 60 business days. - Margin offsets may reflect price correlations and covariance between contracts or lower-risk trading strategies. - Margin parameters reviewed at least quarterly; ad hoc reviews when initial margin levels are challenged by significant market moves. - Historical Simulation models: - Use one year of data for equities, two years for energy products, and five years for OTC interest rate swaps. - Close-out period assumed: between two and seven days for equities, three days for OTC energy, and five or six days for interest rate swap contracts depending on the currency. - Confidence level and back-testing: - LCH.Clearnet Group Board Risk Appetite: initial margin to cover 99.7 percent of observations over the assumed holding period of a product. - LCH back-tests initial margin calculation results daily, reporting to Senior Executive monthly and Risk Committee quarterly. - Back-test compares initial margin held against profit and losses incurred by each contract over its assumed holding period. - Aggregate margin amounts and composition: - Total initial margin at LCH has typically been in the range of 40–50 billion euro-equivalent, approximately 64 percent of which is currently covered in cash. - Intraday margin authority and practice: - Under LCH Rules, LCH can and does make intra-day margin calls when prices are especially volatile. - Routine intraday margin calls are subject to minimum transfer amount of £100,000. - LCH has routine intraday capability to recalculate initial and variation margin using intraday positions and prices (except LIFFE market). - For the LIFFE market, if prices change by a certain trigger percentage (of the initial margin level for that contract) during the trading day, LCH will make an intraday call based on previous night positions. - Intraday recalculations are made at least three times per day; additional margin is called routinely at 13:00 or on an ad hoc basis as necessary up until close of business. - Acceptable collateral and haircuts: - Members may elect to use cash or securities for margin; securities may be lodged directly (bilateral collateral) or via tri-party collateral. - Acceptable collateral currencies and assets listed in the policy include: - Cash: Sterling, Euros, U.S. Dollars, Swiss Francs, Japanese Yen, Swedish Krona, Danish Krone, Norwegian Kroner - Government debt: Austria, Australia, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Luxembourg, Netherlands, Norway, Spain, Sweden, United Kingdom, United States - Other: Performance Bonds, U.S. Govt Agencies, Govt guaranteed bonds - For U.S. government agencies, concentration limit per member is the lower of 20 percent of total margin requirement or $500 million. - For performance bonds, acceptable issuers subject to limit of £50mn (or equivalent) per issuer. - LCH has discretion to decline any collateral type even if within acceptable policy. - Collateral acceptance policy subject to audit; appropriateness reviewed annually by the Risk Committee. - Haircut rates are calculated using the largest two-day change in yield over the last five years. - Securities are bucketed; longest duration in each bucket represents the bucket. - Reviews of collateral haircuts take place on a regular and ad-hoc basis; last collateral haircut review implemented on March 7 (year not specified in excerpt). - Assessment: Observed *Source: IMF Assessment excerpt of United Kingdom: Detailed Assessment of Observance of the Recommendations for Central Counterparties (LCH), _cr11235 - 30. The role and responsibilities of relevant public authorities with respect to* ### 2011. Members generally get one week notice of a haircut change, although ### _cr11235 - 2011. Members generally get one week notice of a haircut change, although ### Assessment summary and recommendation context - Assessment: Observed / Broadly Observed (where noted in text). - Recommendation 5 (Financial resources): "A CCP should maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions." - Recommendation 6 (Default procedures): "A CCP’s default procedures should be clearly stated, and they should ensure that the CCP can take timely action to contain losses and liquidity pressures and to continue meeting its obligations. Key aspects of the default procedures should be publicly available." ### Default Fund structure and member contributions - Default Fund total: approximately £600m. - Default Fund holdings: secured cash deposits at a number of financial institutions (through fixed deposits, swaps, security purchases or repo transactions). - Members are required to make a cash contribution to the Default Fund according to the markets that they clear, based on their usage of those markets and subject to minimum levels. - Default Fund comprised of four fixed segments with minimum contributions: - Exchange Fund Amount, minimum contribution £100,000. - EquityClear Fund Amount, minimum contribution £1,000,000. - RepoClear Fund Amount, minimum contribution £1,000,000. - SwapClear Fund Amount, minimum contribution £2,000,000. - Redistribution: The fixed segments are redistributed among the clearing members once per quarter, based on the relative share of each member’s clearing activity. - Clearing activity metric: defined with reference to average levels of initial margin (except for Exchange Fund calculation, which also takes into account the average volume of trades). ### Default Fund adequacy and stress testing - Design intent: Default Fund designed so that LCH has enough financial resources to withstand the default of the higher of: - The member with the largest stress testing losses plus other members from the same financial group, together with the simultaneous default of the five least creditworthy members, representing a measure of contagion risk; or - The second and third largest members by stress testing losses (plus other members from the same financial group). - Stress testing frequency and scope: - The adequacy of the Default Fund is stress tested daily. - LCH runs approximately 60 scenarios daily across the portfolios of all members. - Scenarios are a combination of: - Historical scenarios (examples: the 1987 stock market crash, Sterling Exchange Rate Mechanism exit, the 1998 bond market crisis, the Long Term Capital Management collapse, Hurricane Katrina and Lehman Brothers default); and - Theoretical scenarios (either where observed correlations in historical scenarios are stressed further or LCH has created scenarios more extreme than historical scenarios). - Stress tests use end-day positions to examine losses each clearing member would have suffered under each scenario, whether margin would have been sufficient, and how much of the Default Fund would have been required. - Internal triggers and escalation: - Internal triggers ensure further analysis is carried out daily for any member identified as having a sharp increase in stress testing losses or which are material in the context of their business. - If members have stress testing losses of greater than 90 percent of the total Default Fund, procedures are in place to take necessary action to ensure the member(s) continue to meet margining obligations. - Stress test results are assessed daily by senior management. - Results inform the "Default Fund adequacy exercise", undertaken monthly by the Executive and each quarter by the Risk Committee and reported to the Board. - If stress testing results move beyond certain trigger points between quarterly assessments, the Secretary of the Risk Committee must report to the Chairman of the Risk Committee and the Chief Executive Officer, and may convene a special Risk Committee meeting; a full report with recommendations is provided at the next Risk Committee meeting. ### Resource types, pecking order, and historical record - Default Fund totals approximately £600 million. - SwapClear specific additional resource: for SwapClear related losses only, LCH can apply a further £50 million from each nondefaulting SwapClear member. - Pecking order for resources following a default: - Defaulter’s margin. - Defaulter’s contribution to the Default Fund. - Up to £20 million of LCH’s capital. - Remainder of Default Fund (i.e. survivors’ contributions). - If the default of a SwapClear member were to use all of the Default Fund, LCH then has the right to request £50 million from each remaining SwapClear member on a nonvoluntary basis. This can then be used to cover any further losses resulting from the defaulted member’s Swaps portfolio. - Remainder of LCH’s capital. - Historical note: LCH has withstood five member defaults, including most recently the default of Lehman, and has not once had cause to utilize the Default Fund. ### Liquidity management and recommended improvements - Liquidity management plan: LCH has a liquidity management plan to meet operational liquidity needs and liquidity needs arising from the default of one or more members. - Daily liquidity demand estimation: Each day, and for each settlement member, LCH estimates the liquidity demands that would arise from the default of that member. - Liquidity scenarios for preparedness are set to the larger of: - The default of the member with the largest first day liquidity requirement, together with the simultaneous default of the five least creditworthy members; or - The default of the two members with the second and third largest first day liquidity requirement. - Additional considerations: LCH includes the impact of the simultaneous default of any other member within the same group as the defaulted member(s). When calculating liquidity availability, LCH does not take into account any liquidity flows resulting from treasury investment activity with any of the defaulting members. - Liquidity comparisons: LCH regularly compares its liquidity demands with available liquidity maturing and liquidity that it can make available (for example via credit facilities with CSDs). - Limitation and recommendation: - None of LCH’s credit lines are committed. - Recommendation (Assessment Comments): LCH should put in place safe and reliable funding options that are subject only to presentment (committed credit lines) and could also include options like mutualization of liquidity risk among the CCP’s membership. This would help it face extreme but plausible circumstances, such as disruptions to its tri-party repo arrangements or dislocations in the repo market. ### Default definition, procedures, and powers - Default definition: Broadly defined with element of discretion for LCH: "In the event of a Clearing Member appearing to the Clearing House to be unable, or to be likely to become unable, to meet his obligations in respect of one or more Contracts..." - Rule 5 examples of actions that constitute a default include: - breaching any terms of the Regulations or Procedures or of any agreement with LCH. (5a); - failing to pay any sum due and payable to LCH (5f); - having a bankruptcy petition presented or bankruptcy order made or a voluntary arrangement approved (5i); - having a petition presented for the winding up of a member (5l). - Rule 3: LCH may take such steps listed in Rule 6 as in the circumstances appear to it best calculated to: - discharge all the Clearing Member’s rights and liabilities; and - complete the process set out in Rule 8 (process to determine the net amount(s) owed/owing by the defaulter). - Rule 3 also requires regard to the interests of the financial system and members of any market the Clearing Member may belong to, where reasonably practicable without prejudice. - Rule 6 actions available following a default include: - closing out the defaulter’s contracts (6b); - selling securities deposited by the defaulter (6e); - transferring defaulter’s open contracts to other clearing members (6g); - taking actions deemed necessary by LCH for its protection (6p); - taking other steps to complete the process in Rule 8 (6r). - Rule 8 netting and cover provisions: - setting off amounts payable by or to the defaulter to produce net amount(s) owed/owing; - if there is net amount owed by the defaulter to LCH, setting off against any cover standing to the credit of the defaulter's account; - using positive balances in proprietary accounts to meet shortfalls in customer accounts. *IMF Staff Assessment (content unit)._cr11235 - 2011. Members generally get one week notice of a haircut change, although* ### Part VII of the Companies Act protects LCH from the general application of ### _cr11235 - Part VII of the Companies Act protects LCH from the general application of ### Legal protections and customer asset framework - Part VII of the Companies Act protects LCH from the general application of the financial markets insolvency laws of England and Wales by: - protecting LCH’s right to manage a default by netting positions or offsetting profits and losses; and - preventing a liquidator from “cherry-picking” profitable contracts. - Designation under the Settlement Finality Regulations reduces the likelihood that English courts would entertain a challenge to actions taken by LCH to manage a member default. - MiFID (European directive 2004/39/EC) provides for the protection of customer’s assets. Following MiFID implementation in the U.K.: - The FSA’s Principles for Business apply to all firms, including Principle 10: “A firm must arrange adequate protection for clients’ assets when it is responsible for them”. - The Client Assets sourcebook (CASS) contains the FSA’s rules on how authorized firms hold and control customer assets; objective: ensure customers’ assets cannot be used by a firm for its own account and that, in insolvency, customers get back their rightful entitlement assets. - The FSA’s client asset rules do not apply directly to LCH because LCH falls outside the scope of the relevant MiFID provisions relating to customer asset segregation; however, the rules impose obligations on investment firms (including brokers and custodians) when they effect transactions using LCH. ### Default management framework, discretion, and testing - LCH maintains an internal Default Management Framework for single or multiple product default management; objective: provide a reference guide and high-level operational procedures manual for managing potential or actual member defaults and arrangements for each business stream. - LCH’s aims in default management: - minimize the impact on the membership and fulfil obligations where possible towards remaining members; - minimize losses for LCH and protect the Default Fund (by closing out the defaulter’s portfolio at minimal cost); and - maintain market integrity. - Discretion and governance: - All default management plans are subject to the discretion and assessment, at the time, of the Chief Executive of LCH, who has overall responsibility for placing a member in default. - The Executive and Risk Committees review the Default Management Framework annually. - Exercises and lessons learned: - Workshops, desk top reviews and fire drills are conducted internally on a regular basis. - These were utilized during the default of a major financial institution in September 2008. - A “lessons learnt from the recent default experience” exercise was conducted; all material items identified are in the process of being addressed. ### Public availability of default procedures - The Default Rules are available on the website. - A document titled “Default Management Overview Exchange & Commodity Derivatives Markets” outlines key aspects of LCH’s default management arrangements and member interaction/communication processes; it does not detail internal LCH activities performed during default management. - A publicly available document on LCH’s Default History also exists. ### Custody and investment risks (Recommendation 7) — key practices and findings - Cash collateral and investments: - Cash collateral is held at a number of banks. - Cash is invested with approved counterparties through fixed deposits, swaps, security purchases or repo transactions. - Principle preference: transactions secured with, or investments in, marketable securities are preferable to fixed deposits. - Noncash collateral custody: - Noncash collateral is mainly held in the U.K. and Europe at CSDs; a bank custodian is used for U.S. Treasuries. - LCH has an up-to-date legal opinion for one European CSD; legal opinion for another European CSD is being revised. - The only securities held outside the European time zone are held in New York. - Due diligence and RSSS12: - LCH has conducted due diligence on legal agreements surrounding holding of collateral to confirm enforceability in jurisdictions where collateral is held. - The due diligence does not specifically include an assessment of custodians’ compliance with RSSS12, although LCH intends to do so with any new custodian. - For the U.S. custodian, LCH should undertake due diligence that specifically confirms compliance with RSSS12 and follow through on its stated intention for any new custodians. - Investment standards and controls: - LCH has a comprehensive and conservative treasury investment policy. - Majority of cash deposits are secured through tri-party repo, DBV (general collateral repo mechanism in CREST), and directly purchased Government assets such as treasury bills. - Not all cash can be secured because of liquidity needs, intra-day calls too late in the day, settlement failures, or payment flow imperfections. - Base haircuts for repo transactions depend on the credit rating of the counterparty; incremental haircuts depend on type of security. - Haircuts are determined by the Risk Management Department on a regular basis (at least quarterly) and based on 99.7 percent of the moves of generic bond yields; based on the larger of one or two-day yield movements over the previous five years. - Additional haircuted transactions: cross currency transactions, securities not priced for two or more days, zero-coupon bonds. - Back testing of haircuts is conducted on a quarterly basis and haircuts are benchmarked against relevant central bank haircuts. - Limits, eligibility and concentration: - LCH specifies limits for security purchases; limits vary by counterparty and maturity (ranging from three months to three years) subject to systems/processes to manage exposures. - All securities purchased from counterparties must be ECB eligible. - Government securities should be purchased in the domestic currency wherever possible, with the exception of U.K., France, Germany and the Netherlands Government guaranteed debt (which must be AAA rated). - All Government or Government Guaranteed Securities over one year in term are limited to a maximum of 10 percent of any particular issue. - LCH monitors counterparty credit ratings, financial resources and CDS spreads on a continuous basis; limits are changed immediately if ratings or financial resources deteriorate or improve. - LCH has minimum counterparty credit ratings and a concentration limit of 10 percent to any one counterparty group (with the exception of AAA-rated governments). - LCH divides collateral acceptable for repo securities into three different “sets” according to credit quality and sets concentration limits accordingly. - Investment horizon and reinvestment: - LCH manages its own capital assets; funds are re-invested only in short term instruments. ### Operational risk (Recommendation 8) — frameworks, continuity, staffing, and incidents - Operational risk management: - An operational risk management framework exists at the Group level, supported by tailored enterprise-wide software to systematically identify, assess, monitor and control/mitigate material operational risks. - Risk identification relies on departmental self-assessment of risks and controls, loss data collection/analysis, and development of Key Risk Indicators. - Identified operational risks are reviewed against LCH’s risk appetite as set by the Board. - Internal Audit reviews business operations; results are reported to Group management and audit committees; action plans are put in place following reviews. - LCH does not outsource core activities; only ancillary activities (such as software development) are outsourced. - Business continuity and disaster recovery: - Business recovery strategy is founded on a Business Impact Assessment, reviewed annually and when significant changes occur. - Business continuity framework covers departmental emergency procedures, staff contact details and agreed emergency procedures; business continuity and disaster recovery plans are reviewed on an ongoing basis and assessed on a quarterly basis. - LCH operates its own two live IT centers in the greater London area, around nine miles apart, with two distinct risk profiles, linked in a synchronous mode; activity is continuously shared between both. - One IT center can take over the whole activity in case the other is down; network needs re-pointing and operational staff need to check services, hence a two-hour recovery window. - There is no third IT center to resort to if both primary IT centers fail. - Two office sites for operational teams are both located in London; they are not active/active, and a 45 minutes walk is needed to switch operational activity from one site to the other. - Remote access is possible from operational staff homes and is regularly tested; it has been used several times in 2009 and 2010 due to inclement weather, G20 summit, and public transportation strikes. - Immediate recovery would occur within two hours of a major incident affecting the primary offices — business critical functions would be relocated to the dedicated live site and work would resume; the Crisis Command Centre would be activated for Crisis Management Team occupation. - No loss of data or data reconciliation is expected since both IT centers operate on a synchronous basis (Synchronous Data Replication); however, the swap is not fully transparent for participants, who would need to check a number of services. - Testing and participant involvement: - LCH undertakes at least an annual internal testing exercise, which includes IT Disaster Recovery, Office Recovery and crisis simulation with Executive and Senior Management, table top exercises and Call Tree exercises. - LCH undertook four internal exercises in 2010, although not all included IT recovery. - LCH offers its participants to test the swap between both IT centers twice a year, on a voluntary basis. There are no compulsory tests for participants, even the largest ones. - The operational failure of a major participant to interact with LCH would be very disruptive, underscoring the need to ensure participant operational reliability and tested contingency arrangements. - Management controls, staffing and oversight: - LCH staff is stable (low turn-over rate) and experienced. - Procedures are regularly tested to ensure appropriate implementation in case of operational failure. - Independent review of operational performance occurs at CEO level and through the Operational Committee of LCH; the committee regularly reviews reports for all production and operational incidents, along with the Audit Committee. - An independent adviser on operational risk sits within executive management; operational risks and controls are embedded in Internal Audit work. - The Audit Committee is fully involved in business continuity plan processes. - Incident classification and history: - LCH grades incidents affecting key systems on a priority scale from 1 to 4; Priority 1: “An incident which prevents LCH from fulfilling its financial, legal or regulatory obligations - widespread unavailability of services to all Members or Partners.” Priority 2: “An incident which impairs LCH ability to fulfil its financial, legal or regulatory obligations - limited availability of services to multiple Members or Partners.” - Three priority 1 or 2 incidents have occurred since 2008, without any loss of data; two of them occurred outside business hours. *Source: _cr11235 - Part VII of the Companies Act protects LCH from the general application of* ### 99.98 percent target. ### 99.98 percent target. ### Security, capacity, and testing - Security is built into all systems and services to ensure their accuracy, reliability and confidentiality. - LCH aims to comply with ISO/IEC 27002 information security standard. - For financial messaging, LCH uses industry accepted systems ensuring a high level of message integrity (e.g. Swift and Arrow). - Some partners, in particular exchanges, communicate through secure communication mechanisms (VPN), which provide authentication on the messages that detect when the integrity of a message has been compromised. - LCH seeks to ensure that all systems (both software and hardware) have headroom capacity well in excess of expected volumes. - IT Services Production performs regular stress testing on key systems using the multiples of peak daily volume. - Assessment: Observed. - Comment/recommendation: LCH should envisage making contingency testing compulsory for the largest participants to ensure they are operationally reliable and have in place tested contingency arrangements to deal with an operational failure, affecting either their access to LCH or LCH itself. - Comment/recommendation: Such a core and global infrastructure should envisage implementing a second back-up site (three sites architecture), located outside the greater London area. ### Money settlements — overview and model - Recommendation 9: A CCP should employ money settlement arrangements that eliminate or strictly limit its settlement bank risks, that is, its credit and liquidity risks from the use of banks to effect money settlements with its participants. Funds transfers to a CCP should be final when effected. - KQ1 — Does the CCP use the central bank model or the private settlement bank model? - LCH mainly resorts to a private settlement bank model via the Protected Payments System (PPS). - PPS consists of a network of commercial banks (PPS banks) providing accounts to both LCH and its members in one or more currencies. - In each currency there is also a concentration bank which LCH holds an account with, used to collect surplus funds from PPS banks and send funds to PPS banks where LCH has a net debit position. - The PPS consists of two separate systems: - “London PPS” based in London, used for making the vast majority of cash transfers. - “U.S. PPS” operates in New York/Chicago, used at the end of the day, after the U.K. payment systems have closed. - LCH members are required to open an account in London in pounds sterling and each currency in which it incurs settlements, and to open a U.S. dollars account in the United States. - Transfer methods to/from the concentration bank vary by currency: - Pounds sterling transfers via CHAPS (though not all sterling PPS banks are direct members in CHAPS). - EUR transfers through TARGET2. - U.S. dollars transfers over Fedwire and CHIPS. - All other currencies via a nostro-style arrangement through relevant PPS banks. - 2010 distribution of the sum of all (net) payments between LCH and its members through the PPS: - 40 percent in U.S. dollars - 32 percent in Euro - 24 percent in pounds sterling - 4 percent in the other currencies - The total daily amount of the sum of all (net) payments was pounds sterling equivalent 5,955 million over all those currencies. - The payments included cash margin payments, payments for commodity deliveries, cash settlement, and default fund contributions. ### Concentration banks, BoE role, and intraday liquidity - The Bank of England (BoE) acts as the concentration bank to LCH for both the sterling and euro PPS, offering LCH “concentration bank accounts”. - Surplus funds from LCH’s accounts at PPS banks are collected in concentration bank accounts at the BoE and paid away to cover LCH’s obligations. - Concentration bank accounts are also used to send and receive funds to/from LCH’s unsecured money market counterparties, and to top-up/draw down accounts at International Central Security Depositories (Euroclear and Clearstream). - The BoE provides collateralized intraday liquidity to LCH in sterling up to a pre-agreed limit. - For U.S. dollars, Citibank NA is the concentration bank. - For all other currencies the concentration bank is HSBC Bank plc. - Funds transfers by PPS banks to and from these concentration banks are effected through FedWire, CHIPS or via nostro accounts. - LCH uses several settlement banks in CREST for daily settlement activities. - The BoE is its settlement BoE for gilts’ transactions and provides LCH with collateralized intraday credit for these purposes. ### Settlement finality and legal framework - KQ2 — Do the CCP’s legal agreements with its settlement bank or banks provide that funds transfers to its accounts are final when effected? Do the laws of the relevant jurisdictions support these provisions? Do the payment systems for the currencies used support intraday finality? Does the CCP routinely confirm that funds transfers have been effected as and when required by those agreements? - LCH has been designated by the FSA under the European Settlement Finality Regulations. When a PPS Bank sends a SWIFT message confirming payment on behalf of a member, the sending of the message represents a commitment by the PPS bank on behalf of that member to pay what has been demanded by LCH. - Settlement finality for funds transfers by the PPS banks to and from the concentration banks follows the rules of the systems through which they are effected: CHAPS, TARGET2, FedWire, CHIPS or via nostro accounts. ### Bank criteria, exposures, monitoring, and mitigation - KQ3 — If the private settlement bank model is used, does the CCP establish and monitor strict criteria for the banks used that address their creditworthiness, access to liquidity, and operational reliability? - LCH has unsecured intra-day credit balances at the PPS banks and the concentration banks. - LCH is directly exposed to member default risk until PPS banks have transferred the funds internally to LCH’s account at the PPS bank. - From that point, LCH is exposed to the risk of default of the PPS bank until the PPS bank has transferred the funds to LCH’s account with the concentration bank. - Once the money has been transferred to the concentration bank account, LCH is exposed to the risk of a default of the concentration bank. - For euro and sterling transactions this risk is mitigated because the concentration bank is a central bank; LCH remains exposed to default of its commercial concentration banks for other currencies. - Because of differences in timing for sending/receiving funds, LCH frequently builds up intra-day balances at its concentration banks. - Mitigants: - PPS banks must have a minimum Fitch credit rating of A (or the S&P or Moody’s equivalent). A downgrade below the minimum long-term rating criterion, or failure to meet operational capability criteria, requires the PPS bank to leave the service. - A formal deadline of two hours (maximum) for transfer of funds to the concentration bank has been incorporated into a PPS Agreement between LCH and the U.K. PPS banks, limiting the time period of exposure to bank failure; this is strictly monitored. - LCH surveyed whether members could appoint a back-up PPS bank and whether members have other back-up arrangements like pre-arranged borrowing facilities with alternative banks other than the PPS banks. Results: all members have implemented at least one back-up arrangement to mitigate exposure to their primary PPS bank. - The requirements to be a commercial concentration bank are not published and there is no formally agreed alternative in place. - KQ4 — If the private settlement bank model is used, does the CCP actively monitor the concentration of exposures among the settlement banks, and routinely assess its potential losses and liquidity pressures from a settlement bank’s failure? - LCH routinely monitors operational performance of PPS banks and their efficiency in meeting required deadlines. - A monthly report on performance is prepared for LCH senior management. - Regular “PPS bank forums” are held where performance issues are discussed. - Particular performance issues are discussed directly with senior management of the bank(s) concerned. - Assessment: Broadly observed. - Comment/recommendation: LCH should find a way to reduce its settlement exposures to PPS and commercial concentration banks. Settlement should be in central bank money when possible and practicable. ### Physical deliveries and delivery risk management - Recommendation 10: A CCP should clearly state its obligations with respect to physical deliveries. The risks from these obligations should be identified and managed. - KQ1 — Does the CCP have rules that clearly state its obligations with respect to deliveries of physical instruments? - LCH’s regulations state its obligations in respect of physical deliveries in all relevant markets. - Procedures for members are laid out in Clearing House Procedures Section 5: Commodity Deliveries. - Contracts are physically delivered upon expiry or option exercise. LCH obligations are to make delivery of the relevant instrument or (as appropriate) indemnify participants for losses incurred in the delivery process. - KQ2 — Does the CCP have obligations to make or receive deliveries of physical instruments? If yes, does the CCP use DvP mechanisms that eliminate principal risk? If no DvP mechanism is available, does the CCP take other steps to mitigate principal risk? - When LCH is obligated to make or receive deliveries of physical instruments or commodities (2–5 percent of open interest is physically delivered) it will, as far as possible, eliminate principal risk through the use of the Delivery versus Payment (DvP) mechanism provided by the relevant SSS. - Where no DvP mechanism is available (for example for soft commodity contracts like coffee and cocoa), LCH uses a Receive versus Payment (RvP) instruction, by definition stating that only cash will be accepted in exchange for delivery of the physical instruments. LCH holds the commodity until cash is received. - For power and gas contracts, payment follows physical delivery, and LCH holds delivery margin against this settlement risk. - KQ3 — Has the CCP identified the liquidity, storage and delivery (other than principal) risks to which it is exposed because of the delivery obligations that it assumes? Does the CCP take steps to mitigate these risks? - The initial margin held against the relevant positions is far in excess of the negligible cost of storage, insurance etc. - The liquidity of products as both futures and during delivery is considered in the setting of the initial margin. - Assessment: Observed. ### Risks in links between CCPs (interoperability) - Recommendation 11: CCPs that establish links either cross-border or domestically to clear trades should evaluate potential sources of risks arising from the link, and ensure risks are managed prudently on an ongoing basis. There should be a framework for cooperation and coordination between the relevant regulators and overseers. - KQ1 — What kinds of link are in operation? Has the CCP carried out a risk analysis of the potential sources of risks arising from the link? Are the resultant risk management arrangements designed to minimize or contain these risks such that the CCP remains able to observe the other recommendations contained in this report? - LCH currently interoperates: - with the Swiss CCP SIX x-clear in the clearing of trades executed on the London Stock Exchange and on the SIX Swiss Exchange. Trading members of these exchanges can elect to clear their business in the equity products covered by the interoperability arrangement on either LCH or x-clear — both the London Stock Exchange and Swiss Exchange list products for trading that are not within the scope of the interoperable arrangement; and - with Oslo Clearing for the EDX market. EDX London is the Equity Derivatives Market initially formed by the London Stock Exchange. *IMF staff report excerpt: _cr11235 - 99.98 percent target.* ### 2003. On December 7, 2009, EDX London changed their technology ### _cr11235 - 2003. On December 7, 2009, EDX London changed their technology ### Interoperability and linked platforms - On December 7, 2009, EDX London changed their technology platform and formed a strategic relationship with Oslo Børs to offer their respective members access to each others’ markets, order book and liquidity. - EDX and Oslo Bourse operate linked order books, in which an order placed on both trading platform can match and trade with an order placed on the other trading platform. - All business traded on EDX is cleared by LCH and all business traded on Oslo Bourse is cleared by Oslo Clearing (OC). - EDX trades an average daily volume of 100,000 contracts. - LCH has applied to interoperate with EuroCCP and EMCF; this is under review by the competent authorities. - LCH and x-clear have proposed to extend their interoperable arrangement to include cash equity business traded on other platforms (including Chi-X, BATS and Turquoise); U.K. and Swiss authorities have assessed this application and informed the CCPs that changes to their interoperable arrangement will be required. ### Legal and contractual frameworks for links - SIX x-clear has been granted a special membership of LCH (effectively similar to the General Clearing Member class (GCM)), to clear SIX Swiss Exchange (U.K. equity only) and LSE equity trades. - Through a mutual structure between LCH and SIX x-clear, both parties are able to co-clear for one another. - A similar arrangement exists for OC. - The Swiss Financial Market Supervisory Authority (FINMA) and the Norwegian Financial Supervisory Authority (FSA) are signatories to Annex A of the IOSCO MMOU, allowing confidential information exchange within the remit of the MMOU. - The Norwegian Kredittilsynet is a signatory to the CESR MMOU. - The FSA has an MoU with FINMA and the Swiss National Bank (SNB) as SIX x-clear is a Recognized Overseas Clearing House (ROCH) and was recognized as such in August 2004. - The FSA and the Swiss authorities engage closely on supervisory oversight of the LCH and x-clear link, including an annual face-to-face meeting between the FSA, BoE, SNB and FINMA and additional meetings as required. - The NFSA and the FSA are discussing the text of a clearing specific MOU to be put in place between the two authorities. ### Operational, credit and liquidity risk features of interoperable links - The LCH – x-clear link is a peer-to-peer model in which both CCPs lodge initial margin with the other CCP, and either CCP can be placed in default (subject to the terms of the CCPs’ link clearing agreement and the respective CCP’s default rules) should it fail to meet its contractual arrangement to the other CCP. - Each CCP calculates the margin it requires from the other using the standard margin methodology it applies to its members. - Neither CCP contributes resources to the other’s default fund (to minimize contagion risk between the CCPs). - LCH collateralizes its exposures to x-clear using a performance bond issued by a bank that is independent of both CCPs; LCH uses collateral lodged by its members to secure this bank guarantee. - x-clear collateralizes its exposure to LCH using bonds sourced from collateral lodged with x-clear by its members. - Exposure levels between LCH and x-clear have been typically at around €35 to V70 million, but have been observed to peak at values of over €250 million during periods of high equity trading volume. - The LCH – OC link mirrors the peer-to-peer model: both CCPs lodge initial margin with the other, and either CCP can be placed in default (subject to link clearing agreement and default rules). - LCH and OC collateralise their respective inter-CCP positions lodging a performance bond (issued by a bank that is independent of both CCPs) with the other CCP. - The bank guarantee LCH has lodged with OC is separate (and issued by a separate bank) from the bank guarantee lodged with LCH by OC. - The value of performance bonds varies as the level of inter-CCP exposure varies and is secured by collateral lodged with LCH by its members. - During December 2010, the average inter-CCP exposure was £5.9 million, with a maximum exposure of £9.2 million. - The authorities (U.K., Swiss, Dutch) require that these credit exposures are measured, monitored and mitigated by the holding of collateral by the interoperating CCPs, in addition to existing member collateral and default protections. ### Regulatory cooperation, oversight and supervisory activity - LCH has been informed by the FSA that it is required to implement changes to its link with OC to bring the link into compliance with the FSA’s requirements for interoperable links. - The interaction between the FSA and the Swiss authorities increased substantially as a result of the application by LCH, EuroCCP, x-clear and EMCF to interoperate; a number of tri-lateral (U.K., Swiss, and Dutch) meetings have been held in the past 18 months and a bi-weekly conference call between the authorities is held. - In February 2010, the authorities made available a joint statement on regulatory standards for the interoperable arrangement; for cash equity clearing. - LCH is regulated by the FSA: - as a Recognized Clearing House (RCH) under the Financial Services and Markets Act 2000 (FSMA); - subject to the Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001 (SI 2001/995); - according to the FSA’s specialist sourcebook, ”Recognized Investment Exchanges and Recognized Clearing Houses‟ (REC); - designated under the Financial Markets and Insolvency Regulations 1999 (SI 1999/2979). - LCH is also a Derivatives Clearing Organization in the United States and subject to Commodity Futures Trading Commission (CFTC) rules and the U.S. Commodity Exchange Act. - LCH has been classified as a High Impact Firm by the FSA and is subject to a close and continuous supervisory program, with comprehensive assessments in 2006 and 2010 and regular thematic “deep-dive” analyses. ### Governance, transparency and disclosure - LCH is a wholly owned subsidiary of LCH.Clearnet Group Limited (Group); group-wide governance rests with the Group Board. - The governance arrangements are publicly available in the Group annual report (currently the 2010 annual report). - The LCH Board meets at least quarterly and monitors executive management through review of information provided by executive management and reports from Internal and external Audit and LCH’s Risk and Audit Committees. - The Risk Committee is a sub-committee of the LCH Board, chaired by an independent non-executive LCH Board member and includes user/member representatives; it sets and approves market, counterparty, liquidity and operational risk related policies. - The Risk Management Department is independent from all other departments within LCH. - Ownership structure: LCH Group is now owned 83 percent by its users and 17 percent by exchanges that clear through it; there is a cap of 5 percent on individual membership. - The Board includes four independent Board members (including the Chairman); non-executive directors are drawn from Group Board membership. - The Board receives an annual report reviewing risk management arrangements, defines the risk appetite of the company and receives various other risk related reports on a regular basis. - Since 2009, the FSA has routinely interviewed Board-level appointees as part of its work to ensure the Recognition Requirement Regulations are being met. - LCH publishes its high-level objectives on its website: - To reduce risk and safeguard the financial infrastructure in the markets they serve; - To deliver market leading and cost-effective clearing services; and - To be the leading multi-asset clearing house, independently serving diverse markets around the world. - LCH does not specifically disclose detailed objectives to participants and the extent to which they are met (LCH Clearnet SA published its 2010 achievements and roadmap for 2011, but this is not the case for LCH Clearnet limited). - The assessors recommend LCH should publish information about its management structure, and disclose detailed objectives to participants and the extent to which they are met. ### Efficiency, costs, service levels and operational reliability - LCH has procedures to control its costs of operation, including an annual budget process reviewed by senior management and approved by the Board, monthly management accounts comparing actual results against budget, a full year forecast, and monthly meetings with department heads to review actual and forecast costs. - LCH undertakes regular analysis and benchmarking on charges; competition has led LCH to significantly reduce its fees over the past three years. - Service level agreements are in place between LCH and the trading platforms which set out operational reliability; capacity levels versus projected demand are reviewed regularly. - LCH does not have formal SLAs with its members; members are required to complete a Membership Application and are subject thereafter to the Clearing House Procedures. - Operational reliability is monitored by operations and IT; reports are produced for review by the Operations Committee and capacity impacts are assessed when service enhancements are proposed. ### Transparency and public disclosures - LCH publishes rules and procedures for markets cleared, information on risk management, application costs and procedures, minimum contributions towards (and interest rates on) the default fund, and the transaction tariffs. - LCH does not make public information relating to default stress tests; stress test scenario results are assessed by the Risk Management Department daily and the Risk Committee quarterly. - Margin calculation models are provided to participants (for example, Risk parameter files to calculate London SPAN initial margins). - PPS arrangements and requirements to be a PPS bank and the list of existing PPS banks are available on the LCH website; little information is available on concentration banks. - Little quantitative information is available on the LCH website on its clearing, netting and settlement activities. - Published in English on the LCH Clearnet Group website. - LCH published its 2009 self-assessment on the LCH Clearnet Group website, as validated by the authorities; key questions are answered in a very general way. - Assessors encourage LCH to publish additional public information (for example on concentration banks and LCH’s activity statistics) and a more detailed self-assessment. ### Payment system oversight and BoE principles - The inter-bank payment system operated as part of LCH has been recognized by HM Treasury for oversight by the BoE under Part 5 of the Banking Act 2009. - The BoE uses the 10 Core Principles for Systemically Important Payment Systems, plus four additional principles: - Business Risk: The system should manage its business risks so that its users can rely on continuity of its services. - Interdependencies: The system should regularly review the risks it bears from, and poses to, other infrastructures as a result of interdependencies, and should implement controls adequate to manage those risks. - Indirect Participants: The system should understand and manage risks that are brought to the system as a result of participants’ relationships with indirect participants. - Outsourcing: The system should manage its outsourced relationships prudently, ensuring that contractual and risk management arrangements are clear, appropriate and robust. - The BoE is drafting guidance to help with practical implementation of the four additional principles; this guidance is expected to be published by the end of Q1. *Source: _cr11235 - 2003. On December 7, 2009, EDX London changed their technology (IMF PDF).* ### 2011. The BoE makes an assessment of the risks to financial stability posed ### 2011. The BoE makes an assessment of the risks to financial stability posed by a particular system and aims to calibrate the intensity of its oversight accordingly. ### Oversight framework and routine practices - The BoE follows a programme of risk reviews for each system, which includes an annual review against the BoE’s principles. - The outcome of the BoE’s risk reviews is formalized in Expectations Letters to the system operator, which set out the BoE’s expectations for issues to be dealt with and actions to be taken by the operator, and specify a timescale by which the BoE expects them to be completed. - The BoE expects, as a matter of routine, to meet senior representatives of the operators of recognized interbank payment systems at least four times each year to gather information and review progress in mitigating risks, to carry out risk assessments and to communicate its expectations as to improvements. - The BoE has access to regular information on payment flows across the PPS generally, and has specific access to data on the performance of PPS banks in Sterling and Euro as it is LCH’s concentration bank for those currencies. - LCH has to provide the BoE with regular and detailed legal and operational information. - LCH is subject to the Recognition Requirements and the REC part of the FSA Handbook and adheres to the notification requirements, and requests made by the relevant regulators as to the provision of additional information. ### Statutory tools provided by the Banking Act - Under Section 204 the BoE may require the provision of information in relation to its oversight functions. - Section 190 gives the BoE a power to instruct an operator to take particular actions in respect of the system’s rules. - Section 191 gives the BoE a general power to issue directions to the operators of recognized interbank payment systems. - Section 193–194 gives the BoE powers to appoint an inspector to enter premises on, or from which, any part of a recognized interbank payment system is operated. This would include the premises of any outsourced technical services providers. - Section 195 gives the BoE powers to require an operator to commission an independent report from an expert in a particular field. - In the event of a compliance failure and in certain other circumstances, the BoE may choose to impose one or more of the sanctions set out in Section 197–200. These include: - publishing details of compliance failure and sanctions (197); - imposing a penalty (198); - stopping the system from operating (199); - disqualifying management (200). ### Supervision and oversight of LCH: practices and capacity - LCH’s supervision and oversight are risk-based and implemented on a prioritization basis. - Supervision and oversight have been strengthened since the crisis, both at the BoE (to which the 2009 Banking Act granted statutory powers to conduct payment systems oversight) and at the FSA (for example by analyzing CCP’s internal risk management models in detail, which was not the case previously). - The FSA now places a greater emphasis on: - the quality of close and continuous supervision and the use of regulatory judgement; - the need to anticipate and explore issues in a proactive manner; - on-going supervisory programs around the key issues. - Both the FSA and the BoE organize market intelligence meetings to get feedback on clearing issues, and the BoE meets members or PPS banks if it thinks there is a need to discuss an issue in more detail. - There is no regular dedicated meetings with LCH participants and partners (such as exchanges, PPS and concentration banks) to get their views on the efficiency and robustness of the CCP, and assess their own interaction with the system. - Both the FSA and the BoE have put in place dedicated teams to implement the supervision/oversight of market infrastructures and their embedded payment systems, with a mix of a few experienced senior staff and junior newcomers. - Hiring and keeping the right expertise, in particular as far as risk management is concerned, is challenging. Experts’ teams are facing other demands, in particular stemming from the EU and international regulatory agenda. - HMT is consulting regarding financial regulatory reform. The government intends to transfer regulation and supervision of settlement systems and CCPs to the BoE by 2013. These functions will sit alongside its existing responsibilities for payment systems oversight. ### Transparency of objectives, roles, and public disclosure - The rules and guidance governing the regulation of LCH by the FSA are publicly available on the FSA’s website and the FSA is required by law to consult on matters of policy which could affect the regulatory framework within which LCH operates. - The BoE’s approach to statutory oversight is set out in The Bank of England’s oversight of interbank payment systems under the Banking Act 2009, which is available on its website. - The respective roles and responsibilities of the BoE and the FSA are contained in a MoU, which is publicly available on each institution’s website (as well as the HM Treasury website). ### Domestic and international cooperation frameworks - Domestic cooperation between the FSA and the BoE in the regulation and oversight of LCH is governed by the MoU. The MoU, together with the clear separation between embedded payment systems and other functions of the CCP, provide a clear work distribution between both authorities. - European jurisdictions place reliance on the regulation of LCH by the FSA. - International cooperation is achieved through MoUs with the relevant regulators in the relevant overseas jurisdictions: - an MoU has recently been signed between the FSA on the one hand and the CFTC and the SEC respectively on the other; - there are also MoUs with the Swiss, Dutch and Australian regulatory authorities. - The MoUs primarily contain provisions on information sharing between the relevant regulators. - Meetings to discuss issues of common regulatory and oversight concern are held at least every three months between the FSA and the securities regulators and central banks of other jurisdictions. - The French prudential supervisory authority (ACP- Autorite de Controle prudentiel) conducts the consolidated supervision of the LCH.Clearnet Group Limited, since its only subsidiary with a banking license is located in France. ### Assessment outcome and suggested improvements - Assessment: Observed. - Comments: In addition to their existing market intelligence meetings, the FSA and the BoE may want to set up regular dedicated meetings with LCH participants and partners (such as exchanges, PPS and concentration banks) to get their views on the efficiency and robustness of the CCP, and assess their own interaction with the system. Recommended Actions (Table 3: United Kingdom: Actions to Achieve Observance) - Recommendation 5 – Financial Resources: - To fully observe, LCH should put in place other safe and reliable funding options, which should include committed credit lines subject only to presentment, and could also include other options like mutualization of liquidity risk among the CCP’s membership. This would help it face extreme but plausible circumstances, such as disruptions to its tri-party repo arrangements or dislocations in the repo market. - Recommendation 7 – Custody and Investment Risks: - To fully observe, LCH needs to confirm that the U.S. custodian it currently employs, and any future custodians it may use, conform to Recommendation 12 of the RSSS (i.e. that they employ accounting practices and safekeeping procedures that fully protect customers’ securities). - Recommendation 9 – Money settlements: - LCH should find a way to reduce its settlement exposures to PPS and commercial concentration banks. Settlement should be in central bank money when possible and practicable. Additional Actions (Table 4: United Kingdom: Additional Actions) - Recommendation 3 – Measurement and Management of Credit Exposures: - LCH should develop a routine capacity to recalculate exposures intraday for the LIFFE market. - Recommendation 4 – Margin Requirements: - For the LIFFE market, if prices are particularly volatile, then LCH will make an intraday call based on the previous day’s positions. LCH should develop the routine capacity to do so using intraday positions. - Recommendation 8 – Operational risk: - LCH should envisage making contingency testing compulsory for the largest participants to ensure they are operationally reliable and have in place tested contingency arrangements to deal with an operational failure, affecting either their access to LCH or LCH itself. - Such a core and global infrastructure should envisage implementing a second back-up site (three sites architecture), located outside the greater London area. - Recommendation 13 – Governance: - LCH should publish information about its management structure, and disclose detailed objectives to participants and the extent to which they are met. - Recommendation 14 – Transparency: - Additional public information would be welcome, for example on concentration banks and LCH’s activity (statistics). - The assessors encourage LCH to publish a more detailed self-assessment. - Recommendation 15 – Regulation and oversight: - In addition to their existing market intelligence meetings, the FSA and the BoE may want to set up regular dedicated meetings with individual LCH participants and partners (such as exchanges, PPS and concentration banks) to get their views on the efficiency and robustness of the CCP, and assess their own interaction with the system. ### Authorities’ response to the assessment - 31. The UK authorities welcome this assessment of the LCH.Clearnet Ltd (LCH) against the CPSS IOSCO recommendations for central counterparties (RCCPs). - 32. The UK’s supervision and oversight of LCH has changed since the financial crisis. It is therefore reassuring that the IMF notes the strengthened supervision and oversight of LCH. - 33. The assessment identifies recommended action which would improve observance with the RCCP and the UK authorities will consider and review all of the assessors’ recommendations. - 34. Finally, the authorities wish to express their strong support of the Financial Sector Assessment Program initiative and look forward to a continuing dialogue with the IMF and other global counterparts to seek to improve the stability and effective supervision of the global financial system. *IMF staff report excerpt (United Kingdom assessment of LCH oversight and recommendations).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11235.pdf_