Risk Management

Clearing Members may post government securities issued by the following nations in order to meet their initial margin obligations: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Luxembourg, Netherlands, Norway, Singapore, Spain, Sweden, United Kingdom and United States.

Clearing Members may also post certain types of mortgage-backed securities guaranteed by the US government, US and European government agency debt and certain securities issued under government guaranteed credit schemes.

The protection of our Clearing Members and their clients informs absolutely all our thinking as to risk and collateral management at EquityClear.

EquityClear offers three different types of client account which are each compliant with the European Market Infrastructure Regulation (EMIR).

AssetOmni: This is an account that a Clearing Member opens with LCH in respect of one or more of its clients. The account reflects ‘omnibus client segregation’ under EMIR. LCH will record the positions the Clearing Member has entered into, in respect of each such client, together with any associated collateral, to the account. If the Clearing Member defaults (a) the positions and collateral recorded to the account may (subject to certain conditions) port together to a backup Clearing Member, and (b) failing that, LCH may apply the collateral to any amounts owing on the account (but not to amounts owing on any other account).

AssetSeg: This is an account that a Clearing Member opens with LCH in respect of a single client. The account reflects ‘individual client segregation’ under EMIR. LCH will record the positions the Clearing Member has entered into, in respect of such client, together with any associated collateral, to the account. If the Clearing Member defaults (a) the positions and collateral recorded to the account may (subject to certain conditions) port together to a backup Clearing Member, and (b) failing that, LCH may apply the collateral to any amounts owing on the account (but not to amounts owing on any other account).

Indirect Accounts: There are two different types of Indirect Account:

• Indirect Net Account - This is an account which a Clearing Member opens with LCH in respect of one or more clients who are, in turn, each providing clearing services to their clients. The account reflects ‘omnibus client segregation’ under EMIR and operates in a very similar way to the AssetOmni account, except that LCH does not know the identity of each client within the account.
• Indirect Gross Account - This is an account which a Clearing Member opens with LCH in respect of a single client who is, in turn, providing clearing services to its clients. The account reflects ‘individual client segregation’ under EMIR and operates in a very similar way to the AssetSeg account, but with certain characteristics resulting from applicable European legislation, including that LCH will determine initial margin and variation margin requirements on a ‘gross’ basis for this account. This means that such requirements will be determined, separately, in respect of the positions referable to a particular indirect client, rather than on a net basis across all positions registered to the account.

EquityClear’s default management procedures are in place to resolve the default of a Clearing Member in the fastest manner possible with the minimum level of disruption to non-defaulting Clearing Members and the market as a whole.

We follow a clearly prescribed framework to ensure that all stakeholders are aware of our contingency procedures and are familiar with our process in the event that default procedures have to be activated.

EquityClear’s default management process follows four steps to reduce the risk of the defaulted Clearing Member’s outstanding positions:

Client Porting: LCH immediately seeks to port positions and collateral recorded to a client account to backup Clearing Members. Where porting of such positions and collateral is unsuccessful, LCH will manage them in accordance with the following steps.

Risk Neutralisation: The Default Management Group (DMG) will be convened within 1 hour of the default notification. The DMG is composed of LCH staff and senior representatives from the Clearing Members. The DMG provides guidance and advice with respect to the Default Management Process, which may include adding hedges to the portfolio or going straight to the close out phase.

Risk Close Out: Depending on the advice of the DMG, LCH may close out the portfolio via an auction process with its Clearing Members or execute close out of positions on exchanges. The resultant effect will be to return LCH to a “flat book”.

Loss Attribution: In the event that losses are greater than the financial resources of the defaulting Clearing Member and LCH’s ‘skin in the game’, the funded default fund contributions of solvent EquityClear members are used.

EquityClear’s default waterfall establishes the order in which the financial resources of a defaulted Clearing Member, LCH itself and the solvent Clearing Members are applied during a default resolution.

A defaulting Clearing Member’s posted margin is the first asset to be applied in managing the default, followed by the defaulting Clearing Member’s default fund contributions.

If these assets prove insufficient to settle the default, LCH’s ‘skin in the game’ is applied next. It is only after all of these resources are exhausted that default fund contributions from non-defaulting Clearing Members are used to close out the portfolio.

In the extremely unlikely event that such resources are consumed, additional safety procedures as provided under the LCH rulebook will be triggered, with the ultimate aim of allowing the service to continue.