The LCH.Clearnet Risk Governance Framework identifies the following risk classifications under the remit of the Risk Management department.

1. Latent market risk
2. Sovereign risk
3. Wrong way risk
4. Concentration
5. Counterparty credit risk
6. Liquidity risk
7. Settlement, payment and custody risk
8. FX risk
9. Business risk
10. Operational risk
11. Regulatory and compliance risk
12. Business continuity
13. Model risk
14. Investment risk
15. Default management

Policies are maintained covering all of these risk classifications.

Each policy identifies the high level principles and standards contained in the Risk Governance Framework and relevant regulation, and is supported by detailed annexes and procedural documentation which demonstrate how policy requirements are met.

All risk policies are reviewed at least annually by:

1. Relevant ERCo sub-committee
2. ERCo (Executive Risk Committee) – to give approval to submit to Risk Committee and Board
3. Risk Committee – review and recommend to Board for approval
4. Board - approval
5. Regulators

Initial margin for all services is calibrated to be sufficient to offset any losses under normal market conditions incurred during the close-out period of a Clearing Member default, to a 99.7% confidence level. The percentage applied is agreed by the LCH.Clearnet Board and set out in the LCH.Clearnet Risk Governance Framework which is shared with the competent authorities.

Additional margins are levied to cover position concentrations, wrong way risk, illiquid positions and Clearing Members with lower credit standing or capital support.

Margins are backtested daily for each Clearing Member and sub account against this confidence level, and reported monthly at clearing service level to regulators and at least quarterly to the Risk Committee. The table below provides service level margin backtesting results.

Margin backtesting results by service

Period: 18 months to March 2014

Model inventory

An up-to-date inventory of all models is maintained. All models are reviewed by an independent model validation team annually. Material changes and all new models are also subject to an independent validation.

The inventory and validation status are reviewed annually by the Board.

Model performance is assessed daily through portfolio backtesting.

The margin models applied to each service are identified in the sections below.

Default Funds and stress testing

Mutualised Default Funds are calibrated monthly and tested daily to be sufficient to withstand the default of the two Clearing Members giving rise to the largest losses calculated under scenarios of extreme conditions. Default Funds have a floor and a cap to ensure minimum levels of protection and avoid over-mutualisation.

Clearing Member contributions are subject to a minimum amount and re-calibrated monthly in proportion to the risk they introduce.

A proportion of CCP capital is placed ahead of non-defaulting Clearing Member contributions in the waterfall.

The waterfall structure for each of the service specific Default Funds can be viewed via the following link:

LCH.Clearnet SA Default Waterfall.

Clearing Members with large stress losses over margin are charged additional margins where the cap would otherwise be exceeded and intra-month if credit related tolerances are reached.

Analysis of stress testing and Default Fund adequacy is reviewed by the Risk Committee at least quarterly.

Cash and securities eligible to cover margin liabilities and Default Fund contributions are restricted to those with low credit, liquidity, and market risks, including cash in major currencies.

Haircuts are applied to securities to cover market, credit, concentration/liquidity, wrong way and foreign exchange risks, calculated to a 99.7% confidence level over a 3 day horizon based on a 10 year look-back period.

The LCH.Clearnet public website, linked below, lists the types of collateral currently acceptable, their haircuts and other conditions can be viewed by selecting the following link:

LCH.Clearnet SA Collateral

LCH.Clearnet SA has a right of use of margin or Default Fund contributions collected within the meaning of Article 2(1)(c) of Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements, and therefore provides for such right in its operating rules.

LCH.Clearnet SA Rulebook

LCH.Clearnet CCPs have detailed default management plans and procedures consistent with the Default Management Policy.

These provide clear criteria for when to call a Clearing Member into default and the steps to be followed in order to manage such a default event.

The policy also requires frequent default management testing or ‘firedrills’, at both product and cross product levels.

The CCP Rulebooks outline the relationship between LCH.Clearnet and Clearing Members, covering the rights and obligations of each during a Clearing Member default.

Use the following link to view the: LCH.Clearnet SA Rulebook

Investment risk arises through the investment of Clearing Member cash posted as collateral for margin liabilities and Default Fund contributions. Investments are made in such a way as to ensure that principal is protected and liquidity is available when needed, even under stressed conditions.

To deal with this:

• All investment counterparties meet minimum credit standards according to an internal credit assessment
• All investments meet minimum credit criteria, and must be explicitly Government guaranteed
• The average term of the investment portfolio is consistent with regulatory standards
• Unsecured investments are limited to <5% of the cash portfolio and must be no more than one week in term

LCH.Clearnet Group CCPs review the counterparty risk of its Clearing Members and other counterparties by continually monitoring market indicators and financial information.

An Internal Credit Scoring (ICS) framework assesses clearing counterparty credit risk using the following inputs:

• Financial analysis
• External ratings and market implied ratings
• Expected default frequency
• Operational capability assessment

The rating model is validated at least annually and the rating scale is continuously monitored for performance.

A minimum credit score is set for joining a clearing service and the same entry requirement is applied to existing Clearing Members looking to join another service within LCH.Clearnet.

Increased margins are applied when the credit score deteriorates below the entry level. Other actions may include reduced credit tolerances and forced reduction of exposures.

More detailed information on membership, including entry criteria, the application process and current membership, for each of the Group CCPs can be viewed here.

Matters concerning significant risks faced by the Group’s CCPs are addressed by a Risk Committee appointed by the relevant subsidiary board.

Chaired by an Independent Non-Executive Director (INED), membership of the Risk Committee is comprised of representatives of the CCP’s users and their clients, and other INEDs. Further representatives from each CCP’s user community and senior CCP executives attend the meetings as risk experts in a non-voting capacity.

Internally, an Executive Risk Committee (ERCo) reports to the Board Risk Committees and the Executive Committee. Chaired by the Group Chief Risk Officer, membership of the ERCo comprises heads of each clearing business as well as the subsidiary CROs and senior group risk management and compliance executives.

ERCo sub-Committees separately address credit risk, market risk and asset & liability management issues. These sub-committees review all relevant matters prior to presentation to the ERCo.

Risk Committee Terms of Reference and current membership are available to view here.

A chart of the Risk Governance Committee structure is available to view here.

The key risk connected with being a Clearing Member (or client of a Clearing Member) of any LCH.Clearnet clearing service will be risk of financial loss. Some of the associated risk scenarios are described below:

• Clearing Member default – non-defaulting Clearing Members are at risk of losing Default Fund contributions and further Default Fund assessments. Each service also has a process to allocate further losses to Clearing Members of that service. In the event of service closure, replacement costs could be incurred. Clients of a defaulting Clearing Member may also incur losses or disruption to their activities as a result of the default management process. For further information please refer to:
  • Cash/derivatives/Fixed income segments/Triparty Repo:
    Rule Book : Title IV – chapter 3
    Instructions IV.3-1 (Cash and Derivatives) 
    Instruction IV.3-2 (Fixed Income)
    Instruction V.4-2 (Triparty Repo)
  • CDS segment :
    CDS Rule Book:
    • Section 3.1.9 of the CDS Rule Book; and
    • CDS Default Management Process attached as Appendix 1 to the CDS Rule Book.
• Default (insolvency) of LCH.Clearnet –For information on the applicable rules please refer to
  • Cash/derivatives/ Fixed income segments/Triparty Repo:
    Rule Book : Title I – chapter 4
  • CDS segment :
    CDS Rule Book: Chapter 3 of Title I
• In the event of market disorder, impossibility of performance, trade emergency or in cases of force majeure, Cash /derivatives /fixed income Rule Book Article 1.3.3.12 and Articles 1.3.2.5 to 1.3.2.10 or Article 1.2.10.3 and Section 1.2.11 of the CDS Rule Book, as the case may be, may apply and Clearing Members could suffer losses as a result of actions taken by LCH.Clearnet. Disclaimer: The above description is a summary of the key financial risks to which Clearing Members and/or clients of LCH.Clearnet may be exposed. This list is not exhaustive and Clearing Members and clients should review the Rulebook and carry out their own risk analysis.
  
  LCH.Clearnet SA Rulebook

The CCP Rulebooks outline the relationship between LCH.Clearnet and Clearing Members, covering the rights and obligations of each, including rules governing the following:

• default management procedures
• access to the CCP
• the contracts concluded by the CCP with Clearing Members and, where practicable, clients
• the contracts that the CCP accepts for clearing
• any interoperability arrangements
• the use of collateral and Default Fund contributions, including the liquidation of positions and collateral and the extent to which collateral is protected against third party claims

LCH.Clearnet Ltd, LCH.Clearnet SA and LCH.Clearnet LLC are distinct legal entities with their own rulebooks and processes, each available to view on this website.

The LCH.Clearnet SA Rulebook is linked below.

LCH.Clearnet SA Rulebook