James Pearson

LCH ForexClear Viewpoints from the leading provider of OTC FX clearing services

May 2023 in Supplements

LCH ForexClear delivers unmatched capital and operational efficiencies, including the flexibility and choice of both US and European clearing models. LCH ForexClear launched in 2012 and was developed in partnership with market participants, with a primary objective to offer global currency markets a dedicated service for clearing FX products, primarily in response to the uncleared margin rules (UMR) implemented post the 2008 financial crisis. More recently, capital efficiency under SA-CCR has further increased demand for clearing, given the benefits it provides. We spoke to its CEO JamesPearson to discover how the service it offers has since expanded and what’s behind the dramatic growth in its cleared volumes.

What range of clearing services does LCH ForexClear now offer?

LCH ForexClear offers participants the ability to clear nondeliverable and deliverable portfolios in a wide range of the most traded FX currencies – 25 non-deliverable forward currency pairs (15 Emerging Market and 10 G10 pairs) and eight deliverable currency pairs clearing in FX spot, forwards, and options – with additional benefits realised by cross-margining across these portfolios. Physical settlement of deliverable FX products (FX options and associated hedge trades) is supported through a collaboration that utilises the CLS infrastructure.

Members and clients have access to an online margin simulation tool which provides detailed yet digestible analyses that highlight the impact of clearing a portfolio on future margin requirements. When members and clients are onboarded, they will have the ability to perform a range of functions to optimise their cleared portfolios – for example, portfolio transfers and risk-free compression. FX clearing is supported by a wide range of margin, trade and collateral reporting to suit individual needs, and participants have access to a Client Services team with 24-hour coverage across APAC, EMEA and the Americas.

Where are you seeing the growth in interest in FX clearing?

Focusing on sell-side participants first, there is a wide and varied selection of interest in clearing at this time. Typical demand and the highest volume, of course, stems from the banks. Given that the largest international banks are broadly clearing their entire portfolios of clearing eligible NDFs to optimise both margin and capital, we are now seeing interest in clearing NDF portfolios from jurisdictionspecific players, with the greatest focus from Singaporean, Indian and Korean banks. Additionally, there is increased engagement from a wider geographic footprint, including Germany, Spain, the US, Australia, Canada and Scandinavia. Even though each sell-side participant may have different capital and margin constraints, all are also starting to understand the operational and counterparty credit benefits that a CCP can offer by removing any counterparty risk they would have against their bilateral counterparties and netting their exposures against a single counterparty, with a much lower risk weight.

When we consider the concept of deliverable forwards clearing, we see interest from a much wider set of banks, given the size of the market. We are already actively clearing vanilla FX options with a selection of our bank members, with volume growth doubling by the end of Q1 2023 versus end of 2022. Having the ability to clear deliverable forwards at scale, in an optimised, or selective fashion, will likely be the point at which FX clearing becomes far more widespread.

Moving to the buy-side, the largest driver for NDF clearing at this point is managing UMR requirements to post initial margin (IM) for larger FX derivative portfolios. Instead of posting IM with multiple counterparties, liquidity and margin can be managed more efficiently by collapsing these margin requirements against multiple counterparties into one single net amount with LCH ForexClear. Equally, a flexible clearing approach can be used to manage the IM threshold requirements dictated by UMR rules.Any trades cleared do not count towards AANA calculations either, making clearing a useful tool in managing UMR thresholds.

Buy-side participants are not obligated by the capital rules that banks adhere to, but of course, they are the recipients of associated pricing impacts passed on by their banks. Clearing ensures that buy-side transactions are not contributing to bank capital costs, and pricing can be negotiated as a result.

What new products and services are you now focusing on developing and delivering?

In consultation with our members, LCH ForexClear is always looking to add or enhance new products and services that can provide our members and clients further efficiency and flexibility in managing currency risk. We are actively working on several exciting new projects that are set to significantly enhance the service.

In parallel, LCH ForexClear is working closely with CLS to make the clearingto- settlement journey more efficient for all, streamlining the settlement process, as well as reducing barriers to entry and operational inefficiencies.

FX Smart Clearing – As already discussed, this initiative will allow members to benefit from both the expertise of third-party optimisation providers and the substantial benefits clearing FX forwards can offer for capital reduction, yielding the most efficient portfolio for resource management. FX Smart Clearing will enable our members to realise the maximum benefits through settled-tomarket (STM) variation margin (VM) classification, multilateral netting and the lower counterparty risk weights associated with clearing.

NDF Matching*– LSEG FX will be launching NDF Matching in Q4 2023: a CLOB cleared-only venue, with all executed trades novating to LCH ForexClear.

Currency and tenor expansion – LCH ForexClear is planning to expand the range of currencies and tenors that are eligible for both our deliverable and non-deliverable services. This wider scope will allow for improved portfolio optimisation possibilities achievable through clearing. This project also has scope for non-CLS currencies, including CNH.

LCH ForexClear Margin Calculator – LCH ForexClear continues to improve its margin calculation tool, with several enhancements planned for the GUI, including new functionality for intraday simulations and compression, and plans to introduce a REST API in 2023.

Overall, we are committed to delivering innovative and efficient solutions that meet the evolving needs of our members and clients in the rapidly evolving FX market. We are excited about the development of these new products and services and look forward to bringing them to market soon.

LCH ForexClear sees itself as the stronghold in centrally cleared OTC FX markets, with risk management central to everything you do. Please tell us more about that philosophy and some of the state-of-the-art safeguards you have designed to protect your clearing members and their clients as well as to maintain the stability of the global financial system.

Risk management is at the core of everything we do at LCH ForexClear. Even before we agree to admit a new entity as a clearing member, we ensure it has the capabilities to meet our exacting risk management standards. That philosophy runs right through every step of the clearing process.

LCH ForexClear’s expert risk management service is built across various pillars, each maintained and governed by the most stringent of criteria. Focusing on risk models in the first instance, these stateof- the-art risk models ensure that the right blend of quantitative and qualitative judgment is used, to protect cleared trades and collateral posted alongside them. Given the markets we clear, LCH ForexClear models are designed and calibrated to cover a wide array of risks, for example, from global crises to the idiosyncrasies of individual Emerging Market economies whose currencies we clear.

From an operational and resilience perspective, we remain open and accept trades 24/5.5, providing real-time decisions on the collateral efficiency of trades submitted to clearing. Our change process is efficient yet robust, with a widespread Quality Assurance programme that minimises disruption events for our members and clients.

LCH ForexClear is highly regulated and regularly scrutinises and reviews its own processes and models. This recurring self-reflection, coupled with a continuous improvement philosophy and active engagement with global regulators, ensures LCH ForexClear constantly evolves to better serve its members and their clients, as well as supporting the stability of the global financial system.

*Workflow that NDF Matching will offer is subject to regulatory approval.