The central clearing backlash continues

This follows comments by the BIS and major corporates that highlight possible systemic, cash and liquidity risks associated to central clearing systems for over-the-counter derivatives and mandatory posting of collateral (FX Week, September 21, October 5).

Ironically, also on Friday, the Canadian Foreign Exchange Committee released its minutes from a meeting held on September 30 in Toronto that involved guest speakers Simon Grensted, Simon Wheatley and Gavin Wells at LCH.Clearnet.

The LCH representatives discussed the advantages in terms of managing counterparty risk of a clearinghouse becoming the legal counterparty to both sides of the trade, thereby assuming the counterparty risk and guaranteeing every trade.

The presenters noted LCH.Clearnet has a default management process in place in the event of a counterparty default that begins with the initial collection of margin or collateral from every clearinghouse member, and involves stress-testing and 'dry runs' of the default resolution mechanisms. This process was activated during the Lehman Bros bankruptcy and all the Lehman trades backed by the clearinghouse were unwound without loss to the LCH.Clearnet member counterparties. That said, there are risks that other clearing houses haven't got their systems in check (see page 6).

More recently, it has been argued that there could be cost savings if the new Basel II revised capital requirements on OTC derivatives trades go through.

In a discussion after the presentation, the CFEC members echoed the views of the Bank of England Joint Standing Committee on Foreign Exchange, but said any solutions should be tailored to the unique nature of FX markets and acknowledge that FX performed well during the recent financial crisis (FX Week, September 28).

The topic will be discussed in the next global meeting of FX committees in December 2 in Singapore.

Saima Farooqi, Editor