1. Panel Session: OTC derivatives clearing arrangements
Joint Bank of England / ECB Conference on
‘Payments and monetary and financial stability’
12-13 November 2007
Panel Session:
OTC derivatives clearing arrangements
Simon Grensted
Managing Director, Business Development
LCH.Clearnet
©LCH.Clearnet Group Limited

2. Derivative Market Size & Growth Some clues to where new clearing products are likely to emerge However, clearing is only feasible if the multilateral risks can be managed
Key factors:
Size
Growth
Liquidity
Vanilla
Multilateral adoption
STP
Messaging
Price sources
Potential to backload
Ability to auction a defaulter’s portfolio

3. SwapClear notionals Notionals have grown in line with the market; we were told it would be too complex, not feasible, it is not, others will follow…
Size (October 07): $103trillion
Circa $3trillion per month
STP : ~89% in T+0 or T+1

4. STP is a key benefit SwapClear is an STP only system, manual intervention is for exceptions only; we got there through rigorous multilateral implementation and testing.

5. What makes OTC clearing worth doing but difficult?
Benefits
Clearing offers a highly scalable processing environment, everyone is bound to a consistent model
Multilateral netting brings improvements over bilateral netting
Collateral and guarantee arrangements save Credit Capital and Basle II regulatory capital
Strong business case for user adoption and clearing houses to build services.
Its not that easy
Many OTC services are really about clearing off exchange trades (particularly energy and equities derivatives).
Pricing illiquid trades eg out of the money options
The real OTC world is divided into many shapes and sizes
Real OTC trades can be very complex.
Clearing works for the volume/vanilla trades
Now imagine a portfolio of complex trades.
Some illiquidity
Price dislocations
Concentration risks
LTCM and other defaults have moved the industry forward in learning about defaults and how to manage them
Pricing trades, then portfolios is vital to risk management.
Multilateral risk introduces new problems to solve
LCH.Clearnet has taken a conservative (services are not open to all) and industry partnership approach to default management

6. Clearing Membership Structures General Clearing Members are vital to LCH.Clearnet’s credit risk intermediation. The model is more complex when you look at the GCM structures and organisations
GCM
GCM
GCM
GCM

7. Clearing Membership Structures GCMs carry the risk of their client defaulting. LCH.Clearnet has different structures across markets
TYPE A
TYPE D
BANK
TRADING
BANK
SUB
CLIENT
TRADER
CLIENT
TRADER
GCM
SUB
CLIENT
TRADER
BANK
SUB
RELATED BANK SUBS
ACCESSING CLEARING
DIRECTLY
BANK SUB
OFFERING GCM SERVICES
Futures
OTC
BANK
TYPE B
TYPE C
GCM
&
TRADER
GCM
&
TRADER
SUB
CLIENT
TRADER
CLIENT
TRADER
TRADING OWN BOOK
AND OFFERING SERVICES
TO SUBS
CLIENT
TRADER
GCM OFFERING
GLOBAL CLEARING FACILITIES

8. IRS Notional distributions It is a highly concentrated market, 86% of the total in 38 banks with portfolios of more than $1trillion
65% of total notional in top 10

9. What next? Standards in post trade infrastructure
Convergence with the DTCC warehouse
More work to be planned out between our working groups
Ultimately we would like to see consistent layered models where processes are consistent and services can be implemented consistently across abroad range of derivatives
First step
Deriv/SERV interface for IRS trades into SwapClear

10. LCH.Clearnet Contacts Amsterdam London Brussels Paris Porto
Simon Grensted
Managing Director,
Business Development
+ 44 (0)