Performance Bonds as acceptable collateral

Background

LCH.Clearnet Limited has historically accepted Performance Bonds as an eligible form of collateral for margin cover purposes. These Bonds, which are often referred to as Bank Guarantees, are issued to guarantee a clearing member’s initial margin and are drafted under standard wording in order to be payable upon presentation by the clearing house to the issuing commercial bank.

Regulation

From mid-2012, CFTC regulations have prescribed that Performance Bonds/Bank Guarantees should not be used as cover for any swap related margin requirements.

Forthcoming EU regulations (Section 2 of Annex I to the EMIR regulatory technical standards on requirements for central counterparties) is prescriptive in relation to the acceptance of PB’s/Bank Guarantees for margin cover purposes. Key areas are;

A commercial bank guarantee, subject to limits agreed with the competent authority, shall meet the following conditions to be accepted as collateral under Article 46(1) of Regulation (EU) No 648/2012:
(a) it is issued to guarantee a non-financial clearing member;
[...]
(e) it can be honoured, on demand, within the period of liquidation of the portfolio of the defaulting clearing member providing it without any regulatory, legal or operational constraint
[...]
(h) it is fully backed by collateral that meets the following conditions:

1. it is not subject to wrong way risk based on a correlation with the credit standing of the guarantor or the non-financial clearing member, unless that wrong way risk has been adequately mitigated by haircutting of the collateral;
2. the CCP has prompt access to it and it is bankruptcy remote in case of the simultaneous default of the clearing member and the guarantor.

1. he suitability of the guarantor has been ratified by the board of the CCP after a full assessment of the issuer and of the legal, contractual and operational framework of the guarantee in order to have a high level of comfort on the effectiveness of the guarantee, and notified to the competent authority.

Impact

The constraint that limits the use of Performance Bonds to non-financial clearing members significantly decreases the use of these instruments to an extent that LCH.Clearnet deems the increased cost of administering and monitoring their use to be unjustified.

In addition, LCH.Clearnet does not have any arrangements in place to ensure recourse to any collateral which may or may not be supporting the arrangement between the clearing member and the commercial bank.

We can confirm that, predominantly driven by forthcoming requirements under EMIR:

• Performance Bonds will no longer be eligible collateral for margin cover purposes, from close of business 1st October 2013;
• The Clearing House will not accept new Performance Bonds with immediate effect; and
• Existing Performance Bonds may only be amended subject to approval from the Clearing House Risk Department.

Clearing Members currently using Performance Bonds must arrange for alternative collateral to be provided prior to 1st October 2013 should they wish to avoid being called in cash from this date.