REFILE-Swap margin rules drive FX clearing surge

(Clarifies daily volume in para 2)

LONDON, Jan 19 (IFR) - LCH is set to expand its foreign exchange clearing operations to FX options and a broader range of non-deliverable forwards later this year, after clearing volumes on its ForexClear platform jumped more than 10-fold in the last six months.

Uncleared margin rules, which went live in September for the largest dealers, have hiked the cost of bilateral derivatives exposures and driven a surge in voluntary clearing. More than 5,000 NDF trades now clear daily over ForexClear, equivalent to US$40bn average daily notional. That is up from just 400-500 daily trades prior to September.

“Uncleared margin rules have been a big driver of the growth,” said Paddy Boyle, LCH’s global head of ForexClear. “The combination of bilateral initial margin and capital requirements makes the economics of clearing compelling. Nearly all organisations already impacted by the bilateral initial margin rules are either clearing their NDFs or on the path to doing so soon.”

Figures from Clarus FT show that 35% of NDFs in the interdealer market were centrally cleared as of December, equating to around 14% of the total NDF market - up from just 2%-3% prior to September.

Often dubbed an “economic mandate” for clearing, margin rules have forced a near-complete shift away from the bilateral world in the most capital-hit products such as inflation swaps, where 90% of contracts are now cleared compared to just 10% prior to September, Clarus FT data show. LCH’s SwapClear has dominated that activity with over US$1trn notional outstanding in the contracts.

ForexClear’s Boyle expects FX derivatives to follow a similar path as more tier one entities come online alongside Europe’s margin rule implementation in February, while smaller players are brought into scope for initial margin in annual waves out to 2020.

“We expect to continue to see good volume growth in the short term,” said Boyle. “When it comes to banks in the second cohort for bilateral UMR, it’s not yet clear when they’ll start clearing, but in 18 months time we’d be surprised if they aren’t clearing the majority of their NDF trades.”

Cleared FX activity has so far been dominated by dealers pushing new trades and backloading legacy portfolios into clearing to reduce risk. That is changing, however, and recent flows have seen prime broking desks push the executing broker/prime broker (EB-PB) leg of client trades into the CCP, leaving the client/prime broker leg bilateral.

“The prime broking business model is challenged under new rules. One solution is to clear the executing broker/prime broker leg of the trade and leave the client-PB leg uncleared. This removes much of the capital and margin costs.” said Boyle.

“Those trades are hard for us to spot as they look like regular member trades in the clearing house. We’ll see more activity as prime broking desks find it expensive to continue with bilateral EB-PB trades. Some activity will move to client clearing too.”


Typically used to hedge exposure in foreign currencies that are not internationally traded, ForexClear’s initial NDF roster includes 12 emerging market currencies settled in US dollars.

The exchange hopes that the benefits of clearing could kick-start liquidity in G10 currencies. Although such contracts rarely trade bilaterally, euro, sterling, yen, Swiss franc and Australian dollar NDFs will be cleared to the platform during the first half.

Answering demands from a growing range of market participants, the firm’s long-anticipated FX options clearing service is scheduled to launch at the end of the third quarter. The firm teamed up with CLS to resolve issues around physical delivery in the event of a default.

“Along with CLS, we’ve worked closely with members and regulators to build the risk model,” said Boyle. “Members are happy with the model and we believe there’s now a critical mass to support the service.”

To ensure that any default losses stemming from one product are not applied equally across options and NDF clients, ForexClear’s default waterfall includes separate layers for each product.

The options service is seen as a necessary step on the way to a solution for cleared cross-currency swaps, which are particularly onerous from a leverage and liquidity coverage ratio perspective - now exacerbated by the margin rules.

“Cross-currency IRS swaps are the last major big interest rates product that have not started to clear, but when you look at how settlement works, it makes delivery of the cleared product very expensive,” said Jamie Gavin, head of OTC clearing for EMEA and Asia Pacific at Societe Generale.

“While originally thought to be still a long way off we know a clearinghouse is looking at developing it. FX Options will be the first step, but whether that scales to other FX products isn’t yet clear.” (Reporting by Helen Bartholomew)