LCH.Clearnet SA CDS Clearing Service - EIFR Pierre-Dominique Renard
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LCH.Clearnet SA CDS Clearing Service EIFR Pierre-Dominique Renard
From bilateral trading to multilateral clearing European CDS as an illustration – initial stages Since 2008, the US, European and Japanese regulators have been focusing their attention, analysis and requirements on facilitating the interposition of CCPs into the OTC derivatives business stream. Up until July 2009, the CDS segment was a pure OTC business segment. A great deal of efforts have been invested in standardising and industrialising the definition and management of the CDS segment by various infrastructure providers involved in the segment and more specifically through: • ISDA definitions and master agreements; • ISDA protocols; • ISDA coordinating the opinions and actions for the dealers especially before the various regulators and political or legislative authorities; • DTCC who manages the Trade Information Warehouse (TIW) which is used extensively by bilateral counterparties as a matching platform and has become a kind of de facto register; • Markit which has been recognised as the source of product referential and price data (for iTraxx indexes). Three CCPs now offer clearing services in Europe: ICE Clear Europe, LCH.Clearnet SA and Eurex Clearing. 2
From bilateral trading to multilateral clearing
European CDS as an illustration – current stages
The pressure from regulators continues to strengthen:
1. Under regulators’ pressure to encourage the interposition of CCPs in the OTC derivatives
business stream,
• Following September 2009 G-20 recommendations,
• The Dodd-Frank Act, US legislation on OTC derivatives, July 2010
• European Market Infrastructure Regulation - formal proposals in September 2010
to reduce systemic risk by increasing the safety and efficiency of the OTC derivatives market through
the adoption of measures that would:
• require the use of CCP clearing for OTC derivatives that meet predefined eligibility criteria;
• require market participants to report all necessary information on their OTC derivatives
portfolios to a Trade Repository or, if that would not be possible, directly to Regulators …
2. Thanks to the huge efforts made by ISDA which recently published (March 2011) a
commitment letter stating objectives and commitments, amongst which the extension and
standardization of clearing services.
3Business Model
High Level Service Offer
• LCH.Clearnet’s business model aims
to follow existing practices established
in the OTC market as closely as
possible .
• Multiple upstream affirmation and/or
confirmation platforms can be used.
• The ISDA definitions and protocols
relating to CDS are used as a
foundation for CDS contracts under
clearing, Markit is used as the
referential data provider and the Trade
Information Warehouse (TIW)
managed by DTCC is used as the
trade data store.
• CLS is retained for products related
cash flows.
4Business Model
Eligible members and products
• LCH.Clearnet SA already has experience in clearing OTC products (fixed
income, securities lending, ...) and has extended its clearing offer to OTC
Derivatives, starting with CDS for eligible products and eligible members.
• To be eligible to become a Clearing Member on CDS with LCH.Clearnet
SA, institutions must meet the following criteria:
Maintain capital of at least €3 Billion (could be reviewed)
Maintain a long term credit rating from the international rating agencies of at least A.
Participate in the Default Management process
• The following CDS contracts are eligible for clearing:
iTraxx Europe (Main, HiVol, CrossOver indices, 3, 5, 7, 10 year maturities; quarterly coupons (Mar,
Jun, Sept, Dec) payable on or immediately following the 20th; from Series 5 onwards.
Single Names, exclusively when created due to Restructuring
5Trade Integration and Novation Timeline 6
Trade Integration and Novation Trade Capture and Margin Calculation • LCH.Clearnet sources all trades for novation directly from the TIW. Dealers must have flagged “LCH” as the required CCP in the TIW on both sides (Gold Records confirmed for clearance). • Following the validation of new Gold Records received from DTCC, the daily margin calculation is performed based on the portfolio of trades already cleared by LCH.Clearnet and the new Gold Records presented for clearing. • This margin call must be paid by all Members to enable novation. 7
Trade Integration and Novation Treasury process 8
Trade Integration and Novation Novation and Backloading • Novation occurs at 9.15am CET, following the receipt of margin from all CDS Clearing Members. • Backloading refers to the process of retrospectively presenting original transactions for Clearing. Transactions presented for clearing three days after the trade date are considered as backloaded trades. • The main difference for backloaded trades is that the upfront premium has already been settled. As such, when a backloaded trade is cleared the upfront is not included in the guarantee perimeter. 9
Position Management
Account Structure and Products related cash flows
• LCH.Clearnet provides account structure management at three levels:
Trade accounts (cleared transactions);
Margin Accounts (risk);
Financial Accounts (collateral and other payments).
• All product related cash flows (upfront payment, quarterly coupon and
cash settlement following a credit event) are managed through CLS on the
basis of instructions created by DTCC.
10Position Management Netting / Compression The netting process is very similar to compression. It is a process where different trades are combined and replaced with a single resultant position. Cleared transactions can only be netted by LCH.Clearnet. This is to ensure that consistency is maintained between the TIW and the CDS Clearing system. 11
Succession and Credit Event Management DC, Succession events and Bankruptcy and failure to pay • The relevant ISDA Determination Committee (DC) is the source of all information regarding the occurrence of succession and credit events. LCH.Clearnet will strictly follow the decisions of the DC. • Succession events that occur on indexes or single names will be applied by LCH.Clearnet accordingly, based on the sourced information from ISDA, Markit and the DTCC. • Once the relevant Determination Committee has decided that a bankruptcy or failure to pay credit (B/FTP) event has occurred, LCH.Clearnet will follow the timeline defined by ISDA and DTCC for the management of the credit event. 12
Succession and Credit Event Management Restructuring credit event and Physical settlement • Once the relevant Determination Committee has decided that a restructuring event has occurred, LCH.Clearnet will follow the timeline defined by ISDA and DTCC for the management of the credit event. • Restructuring is an optional credit event (in contrast to B/FTP events). Exercise of the credit event is a trading decision to be taken by the trade counterparties. Therefore, LCH.Clearnet will create pairs of buyer and seller trades that define exactly which trade should be triggered in response to a trigger received on a cleared transaction. DTCC fully automated the restructuring process by the end of 2010 and LCH.Clearnet SA has adapted its system and procedures to fit these evolutions. • It is possible that ISDA decides not to hold an auction (cash settlement) with respect to a credit event. In which case, all cleared transactions will be settled by physical settlement (the Fallback Settlement Method). Clearing members will be required to act as agents for LCH.Clearnet and perform the obligations of the CCP with respect to other members. 13
Risk Management
Default Protections and Margin Calculation
• LCH.Clearnet has the following Default Protections in place for CDS
Clearing :
Membership Criteria;
Variation Margin, ensuring positions are properly valued on a daily basis;
Total Initial Margin;
Defaulter’s own Clearing Fund Contribution;
Remaining Clearing Fund;
LCH.Clearnet SA’s own capital.
• In the event of a member default, non-defaulters’ positions are
unaffected.
• The Risk engine retained by LCH.Clearnet SA is SPAN® which has
been adapted to the nature of CDS contracts for the buyer of protection
vs. the seller of protection.
14Risk Management
Daily Margins and Default Fund
• There are three kinds of daily margin payments:
Variation Margin exchanged between two participants, taking into account the potential profit or loss due to the
variation of the market value of a contract;
Predetermined margins (Accrued Coupon Liquidation Risk Margin, Upfront Premium Margin, Settlement Risk
Margin, Credit Event Margin (if any);
Total Initial Margin: Initial Margin and Short Charge.
• LCH.Clearnet maintains substantial default resources over and above the
minimum deposit and initial margin requirements that must be met by each
clearing member, including a dedicated clearing fund for CDS clearing to
cover its obligations in the event that the minimum deposit and margin
requirements are unsufficient to cover the obligations of LCH.Clearnet in the
event of a clearing member default.
• The resources of the CDS Clearing Fund are only available to cover
LCH.Clearnet’s obligations which arise from the default of a clearing member
clearing CDS.
15Risk Management Default Management • The default procedure is based on a combination of: The existing derivatives procedure (transfer of client positions and liquidation of House positions) SwapClear’s procedure and framework (liquidation of house positions through “blind auctions” with different buckets and recourse to a Default Management Group) • Working in line with the Default Management Group involving clearing members in the default management process • Covers macro and micro hedge plus liquidation processes under LCH.Clearnet SA’s supervision 16
Risk Management End of Day Price Contribution • LCH.Clearnet requires daily prices for all cleared CDS products for use in the margin calculation process. LCH.Clearnet will implement an End-of-Day dealer price contribution system, using a workflow developed with Markit, to obtain the prices to be used when calculating margin. • This workflow will also include trade creation. 17
Member Reporting
• LCH.Clearnet has created a
secure web application
(eCCW®) to provide Members
with access to the CDS Clearing
reports.
• Users can also access their CDS
related clearing files and reports
on an LCAP (Logical Clearing
Access Point).
18Achievements and Road Map
Achievements
€ 4 0 000 000 0 00
• LCH.Clearnet SA is C um ulative Volu me
V olu me
€ 37 37 1 71 6 792
the second CCP in € 3 0 000 000 0 00
Europe on CDS € 2 0 000 000 0 00
clearing and the only € 9 5 31 8 33 00 0
one to offer (1) daily
€ 1 0 000 000 0 00
and not weekly €0
A pr il 20 10 M ay 201 0 Jun e 20 10 July 2 01 0 A ugu st 20 10 Sep tem ber 20 10 Octob er 201 0 N ovem ber 20 10 D ece mbe r 20 10 Jan uar y 2 011
novation and (2) € 5 0 00 0 00 00 0
€ 4 0 00 0 00 00 0 Open in te re st
€ 3 99 1 271 0 58
upfront premium in the € 3 0 00 0 00 00 0
scope of the € 2 0 00 0 00 00 0
€ 1 0 00 0 00 00 0
guarantee. €0
Ap ril 2 01 0 M ay 2 01 0 Ju ne 2 010 Ju ly 201 0 Au gust 2 010 Sept emb er 201 0 Octob er 2 010 N ove mbe r 2 010 D ece mb er 2 010 J anu ary 201 1
19Achievements and Road Map
Road Map
• The current clearing service is focused on dealer to dealer flows
corresponding to original mandatory requirements for clearance from
regulators.
• LCH.Clearnet SA is in the course of enhancing and extending its clearing
offer for CDS products with:
Intraday Novation Model and the integration of upstream middle-wares,
Single name clearing for constituents of European indexes cleared,
Client clearing solution offering customer protection and buy side access, compliant with European and
US regulation,
(other indexes on other currencies)
• Huge regulatory roadmap in progress:
• AMF/ACP, FSA (extension of the ROCH status), CFTC (DCO application) ... SEC
20Questions and Answers 21
Questions and Answers
Contacts
Tom Badman Francois Cadario
Product Implementation Manager Head of Business Management
+33 (0)1 70 37 67 69 +33 (0)1 70 37 66 94
tom.badman@lchclearnet.com
francois.cadario@lchclearnet.com
Sander Slotman
Philippe Scavizzi
Head of Product Implementation
Head of Business Development
+33 (0)1 70 37 67 24
+33 (0)1 70 37
sander.slotman@lchclearnet.com
philippe.scavizzi@lchclearnet.com
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