LCH.Clearnet to offer SwapClear to the buy side

London-based clearing house LCH.Clearnet discusses with Risk its plans to make the SwapClear over-the-counter interest rate swaps clearing platform available to buy-side clients in the fourth quarter of this year.

Since its launch in 1999, SwapClear has only been available to the interbank community. According to LCH.Clearnet, SwapClear clears more than 60% - or $85 trillion outstanding notional - of the global interbank interest rate swaps market.

But with regulators ramping up the pressure on the derivatives industry to clear all OTC asset classes, and end users increasingly focused on counterparty risk following Lehman Brothers' collapse last September, LCH.Clearnet and its dealer members felt the time was right to extend the service. By the end of the year, the clearing house expects buy-side firms will be able to access the platform via their dealers.

"This has been under consideration for some time, but the demand for an extension of the service relates to the events of last autumn, when the importance of clearing trades became much greater," Roger Liddell, chief executive at LCH.Clearnet, told Risk. "We are fairly well through the thought process on this - we still have a few details to iron out - but thought people should know this will happen within a reasonable period of time."

According to Michele Faissola, global head of rates at Deutsche Bank, the Lehman default has ignited interest in using SwapClear among buy-side firms that simply did not exist before.

"The Lehman situation really made the buy side look a lot more closely at their counterparties, and sparked greater demand to use the service. But from our perspective, it was always our intention to see frequent interest rate derivatives users access the platform to help capture the majority of flow in this arena. This will help boost transparency and further reduce systemic risk," said Faissola. He adds dealers will also benefit from this development in terms of the collateral being posted and capital relief.

The main focus of LCH.Clearnet and the dealer members of SwapClear will be on getting large, high-frequency buy-side firms to use the platform, regardless of geographic origin. "As those high-frequency users backload their existing trades, we will be able to take a lot of risk out of the system," explained Liddell. "The process will start fairly slowly but activity should build up quickly."

In terms of the percentage of trades involving buy-side firms that could be cleared through SwapClear, Faissola predicted it would be possible to capture a similar percentage (60%) as the interbank market within two to three years.

One potentially attractive feature of SwapClear for buy-side firms is that it offers the functionality to segregate portfolios and margin. Dealer members are able to manage individual accounts separately - at a cost to the end user - or have an omnibus account for all clients.

"For the client, this will provide them with the credit security they get from clearing. The amount of credit they need to post will be based on the net risk of their portfolio," said Liddell.

A fair amount of work still needs to be done between now and the launch of the extended service. Specifically, there are issues around the transferability of portfolios - including how quickly they can be transferred - if a clearing member defaults. "The way we manage a default and the role the dealers play in standing behind the clearing house for a default is crucially important. At this time it is critical the clearing house has access to liquidity, which the dealers can provide. For this process to be watertight, they need to be fully legally committed to it," asserted Liddell.

With the opening up of SwapClear to a more diverse range of market participants, this process is not as straightforward as solely handling the interbank market. "The clearing house is going to take on the risk of unregulated counterparties potentially, such as hedge funds. So the volatility of the underlyings and probability of default is very different to the risk profile of the top 20 banks," noted Faissola.

Beyond extending the platform, both Liddell and Faissola expect the percentage of the interbank market cleared via SwapClear to grow in the coming months. Since Lehman's demise, banks have focused their efforts on identifying and backloading existing trades eligible for clearing that for one reason or another had not been processed on the platform. And, according to Liddell, LCH.Clearnet has seen interest from a greater number of banks looking to sign up.

"As they do so, their portfolios with each of the existing members gets backloaded, resulting in a rise of the percentage of trades being cleared," he said.

See also: LCH snubs DTCC merger
Geithner outlines regulations for over-the-counter market