Spotlight on FX Smart Clearing with Quantile and LCH ForexClear by e-Forex

Andrew Batchelor, COO & Head of Product at LCH ForexClear (AB) and Esben Urbak, Head of Product at Quantile (EU) outline some of the key features of the FX Smart Clearing project.

What is FX Smart Clearing, and what issues influenced the decision to develop it?

AB: FX Smart Clearing was developed as a solution to help banks optimise their capital usage, reduce counterparty risk, and improve operational efficiency through selective clearing of FX forwards and swaps. The decision to develop it was driven by feedback from market participants, influenced by the regulatory changes to the Standardised Approach for Counterparty Credit Risk (SA-CCR) and the Capital Requirements Regulation (CRR) that imposed stricter capital requirements on banks for bilateral OTC derivatives trades. FX exposures were particularly impacted by the introduction of SA-CCR.

How does FX Smart Clearing help to solve many of the capital challenges of SA-CCR, and what other benefits does it deliver?

AB: FX Smart Clearing helps to solve many of the capital challenges of SA-CCR by enabling banks to clear their FX forwards trades through a CCP, in an optimised fashion, ensuring reduction in financial resource requirements. This reduces the SA-CCR exposure, lowering capital requirements versus equivalent bilateral positions, for both risk-weighted assets (RWA) as well as the leverage ration (LR) calculation. In addition, FX Smart Clearing provides several other benefits, including reduced counterparty risk, operational efficiency, multilateral netting, increased opportunities for trade compression and increased access to liquidity.

What have been some of the key milestones on the FX Smart Clearing journey so far?

EU: There have been several significant milestones in the Optimised Backloading and FX Smart Clearing journey to date. The first milestone was the successful collaboration between LCH ForexClear and Quantile in realising the potential of the service and developing the proposed solution. Significant work went into seeking feedback from the industry and designing the specs, data flows and outputs before we were ready to engage members and clients for the first proof-of-concept (PoC) run. The delivery of this run was the next significant milestone, and it generated a compelling case for the service and its ability to meaningfully reduce capital requirements for all participants. Since then, milestones have included another successful PoC, with increased benefits and work on further enhancements to streamline the process. We look forward to continuing the FX Smart Clearing and Optimised Backloading journey with a live service in due course.

How does Quantile’s Optimised Backloading service help to facilitate FX Smart Clearing?

EU: Quantile’s Optimised Backloading service is a key component of FX Smart Clearing, as it delivers the optimal solution for participants by selectively moving existing uncleared trades into the clearing house and putting on new risk, which optimises the participant’s financial resources (margin and capital). This approach ensures trades are not blindly backloaded but, instead, are intelligently selected to reduce risk and minimise the resources banks must hold. Optimisation can be customised to suit each participant’s exact requirements – they can choose their maximum risk change, maximum resource change, currency pairs traded and trading partners. With the help of Quantile’s algorithms, the backloaded portfolios can also be compressed to significantly reduce trade count and notional. The service is operationally efficient and includes full STP booking.

LCH ForexClear recently partnered with Quantile to deliver the first proof-of-concept (PoC) runs for FX Smart Clearing with a third party. What were the results?

EU: Further to the initial PoC run in late 2022, which successfully demonstrated the potential of the service, in February 2023, we delivered the latest PoC with 19 participating entities. Results were very positive, demonstrating that the service can significantly reduce counterparty risk and improve capital efficiency for participants. They showed an average 51% improvement in capital reduction without increasing IM significantly – a metric that has the scope to increase to greater than 70% as the clearing network and eligible products grow. $2.7 trillion of notional was identified for backloading, of which 71% could be further compressed. Feedback from participants has been very positive, with most looking to build infrastructure to connect to the live service in the coming months.

A vital component of the FX Smart Clearing project is an enhanced trade registration process at LCH ForexClear. Please tell us more about that.

AB: The enhanced trade registration process allows Approved Trade Selection Providers (ATSPs) to submit pre-approved trade packages directly to LCH ForexClear. Margin requirements are then calculated on a net basis, allowing LCH ForexClear members to significantly benefit from pre-funding optimisation – if required. This solution provides an all-or-nothing process, avoiding a partial novation of recommended packages. The workflow is facilitated through MQueue connectivity and includes the use of standardised data fields and automated data validation checks to help remove the operational risks and costs associated with current standard trade booking and clearing processes. Post approval of a run, participating banks will be notified directly with Financial Product Markup Language clearing confirmation and optimisation run reporting.

Please talk us through the product road map for FX Smart Clearing and what the next developments are likely to be during the course of this year.

AB: The next step in FX Smart Clearing is to schedule a production trial run, which we are planning for mid June 2023, with a few banks that have shown interest to work through initial production runs. Then in August 2023, subject to appropriate regulatory notifications, our full-scale technical release will allow banks to clear in bulk, which should continue to improve the capital savings. Looking ahead and as seen in the recent Quantile PoC, FX Smart Clearing should be able to yield greater benefit from increased FX options (and NDF) clearing volumes, given a larger pool of risk. Further out, the expansion of the service to support additional currency pairs and extended maturities is planned for Q1 2024, subject to regulatory review. Banks interested in FX Smart Clearing should be getting in contact with us now, so as to plan for their build to the service.

What are your expectations regarding future enhancements to FX Smart Clearing?

AB: Future enhancements to FX Smart Clearing are likely to focus on improving operational efficiency, widening the product scope and increasing network participation, driving further potential for capital reduction, and increasing access to liquidity through clearing. Additionally, ongoing collaboration with banks and other stakeholders is expected to drive further innovation and adoption of the service – this is the power of the LCH ForexClear network!