Best clearing services provider of the year: LCH ForexClear

ForexClear, which LCH launched in 2012 as the world’s first 24-hour over-the-counter foreign exchange clearing service, has continued to see strong growth as market participants adopt clearing for deliverable and non-deliverable FX products following the uncleared margin rules (UMR) phased implementation in September 2016.

In non-deliverable FX, ForexClear had a record year in 2018, clearing more than $17 trillion in notional, up 55% from 2017. Meanwhile, in Q1 2019, new records were set with $48 billion cleared notional in deliverable FX, 47% more than the total deliverable FX cleared in H2 2018.

Paddy Boyle, global head of ForexClear at LCH, expects three threads of business growth over the next year.

Firstly, a dozen or so more banks will come into the scope of UMR and are keen to start clearing their non-deliverable forwards (NDFs), and in many cases their FX options too, when they are caught, particularly in 2020. LCH already clears about $75 billion a day – a fraction over half of the interbank NDF market with around 20 large banks, as well as some asset managers.

In Asia, Boyle says a significant majority of asset managers and hedge fund clients are also planning to clear a portion of their NDFs, again from September 2020.

And, in deliverable FX options, LCH also expects significant growth. “A bit like deliverable NDFs, this is basically going to become a cleared market,” says Boyle. “It is seeing broad adoption three years later than the NDF market. So far, we’re clearing in FX options what we were clearing in NDFs three years ago – two or three yards a day.”

In 2018, ForexClear launched the clearing of deliverable FX options, and their spot and forward hedges, in partnership with CLS – a first for the market. The move incorporates the first physical settlement service for cleared FX products, with 10 clearing members currently live. Looking ahead, ForexClear intends to launch the clearing of outright FX spot and forwards this year.

We are quite excited that five-year BRL NDFs could be the first place where we launch a product and it increases volume in the product materially because it’s cleared

Paddy Boyle, ForexClear at LCH

ForexClear also intends to expand its non-deliverable service to offer options on emerging market currency pairs (Brazil, India, Korea and Taiwan), and extend the current offering with new pairs and extended tenors on existing pairs in late 2019/early 2020.

In the FX options clearing service, only forwards that are hedges can currently be cleared, but LCH expects to remove that constraint.

Boyle says: “For longer-dated forwards there is quite a strong desire for clearing, because while the trades aren’t subject to margin when uncleared, they are subject to quite a lot of capital cost, and clearing allows you to reduce that.”

But the central counterparty is downbeat on the chances that it will offer a cross-currency swaps clearing service in the near future; the margin required to be posted would be more in a cleared environment than in an uncleared one where FX is not subject to initial margin.

“Broadly, we are of the view that cross-currency swaps clearing doesn’t currently make economic sense,” Boyle says.

Brazilian prospects

However, he cites a few exceptions. One concerns speculative Brazilian five-year currency swaps. Banks and macro funds in Brazil have told LCH that if the maturity was extended to five years they would trade NDFs as a substitute product to cross-currency swaps, which struggle to find a liquid prime brokerage market.

Boyle says: “We are quite excited that five-year BRL NDFs could be the first place where we launch a product and it increases volume in the product materially because it’s cleared. The same may be possible in Korea.”

He adds that when interbank FX options and hedges clear, the dynamic around clearing FX forwards and cross-currency swaps may make more sense, since margin and default fund contributions will already be made. “In FX forwards, we see the biggest benefit of clearing in the longer dates – three months to two years.”

Settled-to-market options

Another innovation has seen LCH roll out settled-to-market (STM) options, allowing participants to realise capital savings from the recognition of margin being settled on a daily basis, rather than as collateralisation of a trade. Broadly compulsory for US participants in central counterparties, the treatment is optional in Europe.

LCH has improved the offering further by giving users a more granular setting for the treatment – it can now be applied by members on a client-by-client basis rather than at portfolio level.

Boyle says LCH SwapClear allows STM to be set even lower, at trade level, “but we don’t think there will be demand for that in ForexClear, given how short-dated the trades are”.

Lastly, a trade registration fund has been added to ForexClear to reduce trade rejections due to minimum excess requirements (MER) not being met under the European model of clearing that specifies collateral must be prefunded at the outset of a trade.

Boyle says: “We launched an optional trade registration fund a couple of months back, which means members can stop posting MER. We anticipate most members are going to opt into the trade registration fund, which is a better model and has some mutualisation in it.”