RBA issues assessment of LCH Ltd’s SwapClear service
The Reserve Bank of Australia (RBA) today posted its annual Assessment of LCH Limited’s SwapClear service, which operates in Australia under an overseas clearing and settlement (CS) facility licence.
It details LCHLtd’s compliance with the Financial Stability Standards for Central Counterparties (CCP Standards) and with the obligation to do all other things necessary to reduce systemic risk over the 12 months to end-September 2020. As a systemically important CS facility operated under an overseas licence, LCH Ltd is subject to ongoing assessment against the CCP Standards over a rolling four-year period.
In the assessment period, LCH Ltd has either met or made progress towards meeting the regulatory priorities identified by the Bank in its previous Assessment. RBA has concluded that LCH Ltd has conducted its affairs in a manner that causes, or promotes, overall stability in the Australian financial system.
Through the year, RBA received regular updates on the technical and risk management challenges involved in extending the operating hours of the SwapClear service. LCH Ltd also continues to investigate the potential impact of business developments, including the transition to risk-free benchmarks, on its operating hours. As this work is ongoing, the Bank has carried this regulatory priority forward to the 2020/21 assessment period.
The SwapClear service is officially open from 6am UK time to 7pm New York time, but can open two hours earlier at LCH Ltd’s discretion. In practice, LCH Ltd opened the service at 4am UK time on most business days during the assessment period despite ongoing business developments and challenges associated with COVID-19.
Even so, the service remains closed for at least four hours of the Australian business day and until 3pm AEDT on Mondays during the Australian summer. Until the SwapClear service opens and trades can be novated, firms are required to manage bilateral credit risk exposures. A further extension to LCH Ltd’s operating hours would mitigate this risk. In the next assessment period, LCH Ltd is expected to deliver on its plan, and continue to provide the Bank with regular updates on its progress while maintaining the safety and resilience of its operations.
LCH Ltd has developed enhancements designed to improve the effectiveness of its PPS contingency arrangements. At this stage, the enhancements are yet to be fully embedded in its processes and scalability has not been demonstrated through a wide-scale test. Accordingly, this regulatory priority has been carried forward to the 2020/21 assessment period.
LCH Ltd operates the PPS to settle cash payments to and from participants. LCH Ltd calls funds from, or pays funds to, clearing participants across the books of PPS banks (commercial settlement banks) acting on behalf of those participants. PPS banks then make or receive payments to or from the LCH Ltd ‘concentration bank’ via the relevant real-time gross settlement system for each currency.
In the event of a PPS bank outage, LCH Ltd requires its participants to have access to contingency arrangements so that they can continue to make and receive payments. The default contingency method, direct funding, involves participants paying directly into LCH Ltd’s concentration bank account to meet calls; LCH Ltd would similarly make payments to participants directly from its concentration bank account.
During the assessment period, LCH Ltd conducted a test of improvements that have been made to its direct funding contingency arrangements with a small group of participants. Compared with previous tests, this test demonstrated a reduction in the time taken by LCH Ltd to issue and process margin calls to participants across major currencies (GBP, USD and EUR).
LCH Ltd continues to explore complementary contingencies, such as utilising existing commercial relationships or establishing backup PPS banking arrangements, to allow participants flexibility as individual circumstances may dictate.
In the next assessment period, LCH Ltd has plans to make further enhancements to its direct funding contingency arrangements and to conduct a larger test. LCH Ltd should demonstrate that its enhanced arrangements have been embedded in its processes and that it has the capacity to meet service targets in the event of a PPS bank outage.
The Bank’s practice is to set regulatory priorities where it expects LCH Ltd to conduct additional work to enhance its observance of the CCP Standards. This assessment carries over the priorities from 2019/20 regarding the extension of SwapClear’s operating hours and improvements to LCH Ltd’s PPS contingency arrangements.
In its supervision of LCH Ltd in the next 12 months, RBA will also review: how LCH Ltd manages cyber risks; a new LCH Ltd Australian legal opinion; and the governance of LCH Ltd’s model validations.