RepoClear has a robust and proven risk and default management framework
RepoClear’s risk management aims to ensure that any Clearing Member default can be handled with the existing resources and with minimal disruption to the market.
In order to best maintain the safety and stability of Clearing Members, the service has built a framework of safeguards, underpinned by robust risk models.
The various layers of protection are intended to ensure that we have adequate financial resources to protect trades which are cleared at LCH and the collateral posted against them.
Risk management and settlement is at the core of everything we do at here at RepoClear.
It starts with the onboarding process where we verify that a new Clearing Member has the capabilities to participate in the market and to risk manage their positions.
That philosophy then runs through every step of the clearing process at LCH, all the way to the settlement of a Clearing Member default.
As our first line of defence, RepoClear sets stringent and transparent eligibility requirements for prospective Clearing Members.
The Margin Framework
LCH has a comprehensive framework for determining initial and variation margin requirements.
Initial margin requirements are calculated to cover the risks and costs associated with the close-out of a defaulted Clearing Member’s positions, while variation margin requirements are calculated to meet the daily mark-to-market movements in the value of a Clearing Member’s positions.
Following a Clearing Member’s default, our default waterfall model dictates that the Clearing Member's posted margin and default fund contributions are the first resources to be utilised. Only after these resources are exhausted across all services and LCH’s own ‘skin-in-the-game’ is applied, would non-defaulting Clearing Members begin to experience losses.
Below, we go into more detail as to how we would manage a Clearing Member default.
RepoClear maintains a rigorous default management process.
The process is tested regularly in ‘fire drills’ which involve Clearing Members and LCH mimicking a live Clearing Member default. The default management process was last successfully used during the default of Maple Bank GmbH in February 2016.
Our default management process follows three steps to reduce the risk of a defaulted Clearing Member’s outstanding positions.
Risk Neutralisation: After a Clearing Member default, the Default Management Group (DMG), which is comprised of LCH staff and senior representatives of the Clearing Members, is convened. The DMG provides guidance and advice with respect to the default management process, including advising on any hedges that would need to be undertaken on the defaulter's portfolio.
Portfolio Auction: Once the DMG is satisfied with the risk neutralisation phase of the default management process LCH will engage in the auction phase. Invited Clearing Members will be requested to bid on the defaulter's bond and repo portfolios 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 of LCH’s ‘skin in the game’, the funded default fund contributions of solvent RepoClear members are used.
RepoClear’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 in the LCH rulebook will be triggered, with the ultimate aim of allowing the service to continue.