The decision to start with G10 currencies was because of the volume of trade relative to other currency blocks as well as higher liquidity in those currency pairs, the clearer said.
“We’ll start with the most liquid currencies, so nominally the G10s, because one of our first considerations is managing liquidity risk in a default situation,” says Wells.
“As requested by our members, the service will cover all products mandated for clearing by the regulations – thus options and non-deliverables, with forwards being accepted as hedges to the options.”
Wells has spent three years preparing LCH for the launch. “Our members want us to do this,” the former global head of spot FX and forwards at Citi tells EuromoneyFXNews. “They’ve worked with us to design the service.”
Wells says LCH’s platform – provisionally named ForexClear – is on track to launch by year-end, pending final discussions with members and regulators.
LCH proved robust when Lehman Brothers collapsed and defaulted, successfully isolating the bank's $9tr interest-rate swap portfolio of 66,000 trades.
LCH last reviewed FX clearing in 2004, concluding that the largest counterparty risk in the currency markets – settlement risk – was already well catered for by CLS Bank. The Dodd-Frank Act has changed the rules, including options in the mandatory clearing requirement, but not forwards.
LCH, however, is not alone. CME Group is building a rival offering.
The US futures exchange began clearing non-deliverable Chilean peso forwards on May 16. “It’s the first step in our broader initiative to provide clearing services for a wide range of FX products later this year,” says Craig LeVeille, CME director of FX products.
LCH's pricing model will be similar to its existing dual structure. High volume traders will be offered a flat fee. Smaller users will pay tiered fees, according to usage. “You pay for what you do,” Wells says. “It’s a very similar model to SwapClear,” LCH’s interest-rate clearing platform.
Designing a clearing system for FX options isn’t without its challenges. The most time-consuming element of the LCH.Clearnet’s feasibility study has been how to calculate margin requirements for trades, Wells says. The process is more difficult for non-linear products, such as over-the-counter options, compared to exchange-traded contracts because of the availability of market data.
“We’ll gather price information from our members,” says Wells, “and then scrub and aggregate the rates to feed into our risk models. These then define the margin required."