RepoClear

A Central Counterparty for Repo

LCH: Corporate Overview
The LCH Group
LCH is a leading multi-asset class clearing house, serving a broad number of major exchanges and platforms as
well as a range of OTC markets. LCH's commitment to the horizontal model supports clearing across multiple
markets, exchanges, venues and geographies.

Corporate and Regulatory Structure

RepoClear Service
RepoClear is a market leading service clearing cash bond and repo trades across a number of European
markets. Operating since 1999, it provides an essential, centralized clearing and netting facility for its members.

2
The RepoClear Service
RepoClear Services & Products

RepoClear
LCH Ltd LCH SA

Cash Bonds and Repos on UK Government Bond 12 European government bond markets cleared
Market Cleared in addition to General Collateral • Interoperable link for Italian government bond
product in Term £GC market segment between LCH SA and CC&G
In addition:
• Sponsored Clearing client model in place
€GCPlus
• General Collateral clearing service of Euro cash
liquidity supported by two standardised baskets
based on ECB eligible securities

Key features:
• Anonymous trading via electronic platforms or bilaterally via voice broker or inter-office
• Clearing of eligible cash bond and repo transactions
• Multi-lateral netting of all settlement obligations

4
Balance Sheet Netting

Repos are 'on balance sheet' transactions.

Many major repo market participants have found that their usage of repos is constrained as
a result, as each bilateral repo trade requires allocation of balance sheet. The use of LCH as
a central counterparty maximises the possibility for banks to net for balance sheet, thereby
facilitating longer term repo trading in particular.

Market participants are recommended to consult their own professional advisers regarding the applicability
of balance sheet netting rules to their individual organisations

5
Balance Sheet Netting: The Cornerstones
Key pillars supporting balance sheet netting are:

End-leg settlement dates Must be settling with

must coincide and the same
settlement, if not on a net
counterparty
basis then must be
simultaneous Same Same
Settlement Counterparty
Date

Same
Settlement Same
Location Currency
Must settle at the Cash amounts
same I/CSD must be in the
same currency

6
Risk Management

Setting the standards for Risk Management

• LCH’s robust risk management framework provides its clearing members with exceptional levels of
protection. Both the soundness of its risk management approach and the resilience of its systems have
been proven in recent times.
• As demand for robust clearing services continues to grow, LCH is committed to setting and maintaining the
highest standards across all asset classes cleared.
• The driving force behind our risk management activities is a dedicated team of risk managers, who share a
wealth of experience and a convincing record of successfully managed defaults – including Lehman
Brothers in September 2008 and MF Global in 2011.

LCH has successfully managed many defaults:

• Drexel Burnham Lambert - 1990 • Lehman Brothers International (Europe) - 2008

• Woodhouse Drake and Carey (Commodities) • Lehman Brothers Special Financing Inc - 2008
Limited – 1991
• MF Global UK Ltd – 2011
• Baring Brothers & Co Limited – 1995
• Cyprus Popular Bank Co Ltd – 2013
• Griffin Trading Company – 1998
• Maple Bank - 2016

7
Margining and Risk Management

• Standard initial margin (IM) is designed to ensure that LCH has sufficient funds to
cover potential losses in the event of the default of one of its Clearing Members
in normal market conditions

• IM protects LCH against potential losses that may occur between the time that
variation margin (VM) is last paid and when LCH expects to hedge/liquidate a
defaulted portfolio

• Risks not covered in the VaR model are subject to additional margins

8
The Core of IM: VaR

• Initial Margin is based on an Expected Shortfall VaR calculation

• Its basic outline is

• A 10 year (2500 days) look-back period - Intended to cover at least one economic cycle for historical
events

• Set a 99.7% confidence level to ensure enough margin is held to cover the potential loss of any
member’s portfolio under normal market conditions, over a 5 day holding period.

• The historical returns are calculated on a 5-day overlapping holding basis, each return is then scaled
by a volatility based function in order to align them with current market conditions.

• The scaling is floored at percentiles of long term volatility and short term volatility

• It includes the risk towards the underlying bonds and the risk towards the repo and discount rate for
ongoing and forward trades

9
Repo VaR Model Parameters

Parameters
Holding Period 5 days
Look-Back Period 2500 days
Confidence Level (aim) 99.7%
Risk Measure for IM Expected Shortfall
Scenario Generation One tailed
Volatility Scaling EWMA
Key Risk Factors •Zero Coupon Sovereign
curves
•OIS Zero Curves
•Repo Zero Curves
•FX Rates

10
Initial Margin vs. Haircuts

• Collateral haircuts are commonly used in B2B transactions as a form of margin:

Bank A wishes to borrow €100mn cash but is required by its counterparty, Bank B, to deliver €105.26mn value of
bond X as collateral.
This provides Bank B with a 5 % haircut to cover the change in value of bond X post the default of Bank A

• RepoClear Initial margin provides protection against price movements in Bond X

in much the same way as a haircut but is administered differently.
Bank A trades with Bank B (probably anonymously via an ATS) to lend €100mn cash against €100mn value
of bond X
Bank A delivers €100mn value of Bond X to LCH on a DVP basis.
LCH determine that a 5% initial margin is required for the trade today. This margin of €5mn is covered
independently to the DVP settlement of the trade itself.
• The level of initial margin can – and does – change throughout the term of a trade.

11
Additional Margin

• Reasons for additional margin:

• High stress testing losses (High portfolio sensitivities)
• Concentration/liquidity risk
• Idiosyncratic risk
• Sovereign credit risk (including wrong way risk)
• Credit Risk
• Settlement Liquidity concentrations
• Any other if needed

12
Default Management Process
RepoClear Default Management Group (RDMG) to advise throughout default management process

Phase 1: Identify
defaulting Clearing Phase 2: Prepare for Phase 4: Loss
Phase 3: Auction process
Member’s portfolio & auction attribution
resources

The default management process follows the steps above:

1. The defaulting Clearing Member’s RepoClear portfolio and its composition will be
determined.
2. The RepoClear DMG will convene and advise on the best way to neutralise risk and how
the portfolio should be split into a set of auction portfolios. The DMG to advise on an
initial subset of RepoClear Clearing Members to participate in the portfolio auction.
3. The auction process will be carried out, in which the selected RepoClear Clearing
Members will have the opportunity to bid for the auction portfolio(s). Invited Clearing
Members will not be obligated to bid.
4. If, once the auction process has completed, the total losses to RepoClear are greater
than the financial resources of the defaulter and the relevant proportion of LCH capital,
the remaining losses will be allocated, pro-rata, to all of the non-defaulting RepoClear
Clearing Members in proportion to their Default Fund contribution

13
Default Waterfalls

14
This document has been provided to you for informational purposes only and is intended as a broad overview of certain aspects of the RepoClear service and of proposed changes to
such services. This document does not, and does not purport to, contain a detailed description of any aspect of the RepoClear service or any other topics discussed in this document,
and it has not been prepared for any specific person. This document does not, and does not seek to, constitute advice of any nature. You may not rely upon the contents of this
document under any circumstance and should seek your own independent legal, investment, tax and other advice. The information and any opinion contained in this document do
not constitute a recommendation or offer with respect to any derivative contract, financial instrument, security or service. [Link] Group Limited and its group of companies
(“LCH”) do not make any representation, warranty or guarantee (whether express or implied) that the contents of this document are accurate, complete or up-to-date, and make no
commitment to offer any particular product or service. LCH shall not have any liability for any losses, claims, demands, actions, proceedings, damages, costs or expenses arising out of,
or in any way connected with, the information contained in this document, except that LCH accepts liability for personal injury or death caused by its negligence, for any fraud or wilful
misrepresentation on its part, and for any other liability which cannot be excluded by applicable law.

Copyright © LCH 2017. All rights reserved. RepoClear is a registered trademark of LCH.

The information contained in this document is confidential. By reading this document, each recipient agrees to treat it in a confidential manner and will not, directly or indirectly,
disclose or permit the disclosure of any information in this document to any other person (other than its regulators or professional advisers who have been informed of the
confidential nature of the information) without the prior written consent of LCH.