LCH: The other side of the mirror

Nevertheless, she admits: “Nothing prepared me really for LCH. It was like moving to the other side of the mirror”.

Girolami rejects the suggestion that she is a poacher turned gamekeeper. “We do not regulate the market; we do two very important things. Firstly, we ensure the smooth functioning of the financial system by remaining resilient and through very robust risk management.

“Secondly, we partner with market participants to help them optimise capital efficiencies through very efficient risk management. I think ‘partner’ is the crucial word in understanding our unique role.” The word partner certainly features a lot in LCH’s own self-description. 

In Girolami’s view, LCH “has both a mission and a purpose”.

She explains: “Our very strong sense of purpose is to keep financial markets safe. This involves standing in the middle of transactions and removing a lot of the risk from the system. This means market participants benefit from more effective counterparty risk management and consequently significant capital and operational efficiencies.”

Girolami has three main priorities at the moment. One is to facilitate the market’s transition from US-dollar LIBOR to the risk-free reference rate SOFR (Secured Overnight Financing Rate). LCH has undertaken an enormous amount of work in supporting firms to enable a seamless transition scheduled to take place across two conversion events in April and May 2023. 

The second is to support EU pension scheme arrangements (PSAs to use the official phrasing) as they prepare to comply with the European Markets Infrastructure Regulation (EMIR) swaps clearing obligation, due to enter into force on 19 June 2023, and their collateral transformation needs as a result of the requirement to post cash as variation margin at the central clearing counterparty (CCP). 

“We are working to ensure a smooth ending of the exemption, ensuring that all EU pension funds have the necessary information and access to liquidity to effectively comply with the regulation.” 

The third priority, is to support EU firms as they work their way through the latest EMIR 3 proposals, which intend to make changes to current clearing practices across Europe.

Swaps clearing migration

The exemption of EU PSAs from a long-standing clearing obligation is due to expire in June. For the time being, the UK has taken the decision to delay removing the exemption for its own pension funds to June 2025. Market participants suggest this is for one of two reasons. Either because the liability-drven investments (LDI) crisis made pension funds aware of the risks inherent in the system, and the importance of access to liquidity in times of stress, or because they want more time to assess the impact and work with pension funds to understand it better. 

In the absence of the UK, the countries most affected are those with significant pension fund industries, such as the Netherlands and Denmark. According to Girolami, most of the big pension funds are ready for this transition – 36 are already clearing at LCH SwapClear. But she and her team are consulting with those at earlier stages of preparedness. “A lot of what we do takes years of preparation, and this is no exception.” 

Girolami says: “We are working with EU PSAs to support their collateral transformation needs via sponsored access to our LCH RepoClear SA service. We believe that cleared repo is the connective tissue between their investment strategies, of which high-quality liquid assets are a large part, and the swaps clearing requirement.

“I think that is addressing some of the initial concerns that firms have had around the availability of cash. For example, our LCH SA sponsored clearing service for EU government debt transactions has reached a total of €1trn in nominal cleared in Q1 2023.”

Girolami believes that bringing more market participants into clearing will significantly improve access to liquidity, increase capital efficiencies, and remove counterparty risk. 

Market participants also note that EU regulators may have lifted this exemption because they recognise how clearing can reduce systemic risk and strengthen stability in financial markets – vital in the aftermath of the Credit Suisse and SVB failures. Regulators struggle to understand what is happening if they see only a fraction of what is getting cleared – clearing enables greater transparency.

Girolami reiterates her support. “It is definitely progress and provides intrinsic stability and the removal of credit risks. As such it is prudent risk management.”

EMIR 3 

Girolami is also spending time with EU pension funds that are concerned about the EMIR 3 proposals, which would require them, along with other EU firms subject to the clearing obligation, to have an active account with an EU CCP for specific asset classes. This includes euro and Polish zloty interest rate swaps. 

In her opinion, if mandated, the requirements would significantly undermine their ability to access liquidity, efficiently manage risk and operate efficiently. Furthermore, they would impose additional risk and costs for pension holders. Failure to acknowledge this would also compromise EU financial stability and competitiveness. 

According to Girolami: “At no time has the importance of access to cleared liquidity and robust risk management been more acute than during recent market events.” 

She adds that “LCH continues to engage with policy makers in the EU to ensure EU firms have continued, unfettered access to global markets”.

An earlier version of this article used an incorrect headline, which has now been changed