France
Financial Sector Assessment Program—Detailed Assessment of Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems and for Central Counterparties

This paper discusses key findings of the Detailed Assessment of LCH.Clearnet SA Observance of the Committee on Payment and Settlement Systems/International Organization of Securities Commission (CPSS–IOSCO) Recommendations for Central Counterparties. The findings reveal that LCH.Clearnet SA displays a high level of observance of the CPSS/IOSCO recommendations. It has a sound, coherent, and transparent legal basis. It has developed an adequate risk-management framework to address financial and operational risks. LCH.Clearnet SA governance arrangements and composition of Boards and management are well defined and adequately staffed.

Abstract

This paper discusses key findings of the Detailed Assessment of LCH.Clearnet SA Observance of the Committee on Payment and Settlement Systems/International Organization of Securities Commission (CPSS–IOSCO) Recommendations for Central Counterparties. The findings reveal that LCH.Clearnet SA displays a high level of observance of the CPSS/IOSCO recommendations. It has a sound, coherent, and transparent legal basis. It has developed an adequate risk-management framework to address financial and operational risks. LCH.Clearnet SA governance arrangements and composition of Boards and management are well defined and adequately staffed.

I. Executive Summary

LCH.Clearnet SA displays a high level of observance of the CPSS/IOSCO recommendations. It has a sound, coherent, and transparent legal basis. It has developed an adequate risk-management framework to address financial and operational risks. The participant default rules and procedures, which are publicly available, are comprehensive. Participant assets, as well as the CCP’s collaterals, are kept safely in supervised banks and regulated securities depositories. The liquidity risk is minimized by settling the cash in central bank money and having access to central bank facilities, including liquidity. LCH.Clearnet SA governance arrangements and composition of Boards and management are well defined and adequately staffed.

LCH.Clearnet SA has managed well the challenges of the financial crisis, and enhancement of its functionalities will further contribute to financial stability. It has dealt promptly with the default of some major participants. It has also managed effectively the risk of increased price volatility, including of sovereign debts. Nevertheless, LCH.Clearnet SA resilience could further be strengthened by monitoring and measuring its exposures continuously throughout the business day and intensifying the use of stress testing and back-testing mechanism. To further enhance the protection of customers’ assets in the event of default, LCH.Clearnet SA should introduce an operational segregation mechanism between the proprietary assets and clients’ assets for all fixed-income products. LCH.Clearnet SA should strengthen its control on the IT companies that supply and operate the infrastructure, and formalize the external audit of these companies. The selection criteria for Board members and the mitigation of conflict of interests should be formalized and enhanced. The current ongoing reorganization of ownership structure and the realignment of business lines should not compromise that LCH.Clearnet SA retains the necessary level of independence to meet its regulatory obligations as a distinct legal entity.

The regulatory and oversight framework is comprehensive and effective. As a credit institution, LCH.Clearnet SA is subject to the supervision of the Autorité du Contrôle Prudentiel (ACP), as a Clearing House to the regulation of the Autorité des Marchés Financiers (AMF), and as a clearing and settlement system for financial instruments to the oversight of Banque de France (BDF). The authorities’ objectives, policies, and roles are well defined and made public. Nevertheless, BDF should be empowered to issue regulations and undertake measures to enforce its oversight responsibility effectively. Enforcement of supervisory and oversight framework can be further improved by increasing the intensity of on-site inspections, including the participation of staff from all relevant authorities. The cooperation and coordination between domestic competent authorities have a solid legal basis, including the exchange of confidential information. Cross-border cooperation with relevant foreign authorities is well developed and seems to be implemented effectively, including the existence of comprehensive Memoranda of Understanding (MOUs), and a college that meets on a regular basis.

II. Information and Methodology Used for Assessment

1. The assessment of LCH.Clearnet SA against the CPSS/IOSCO Recommendation for Central Counterparties (RCCP) was undertaken in the context of the IMF’s Financial Sector Assessment Program (FSAP) Update for France in January and June, 2011. The assessor was Elias Kazarian of the IMF’s Monetary and Capital Markets Department. At the request of BDF, LCH.Clearnet SA conducted a self-assessment against the European System of Central Banks and the Committee of European Securities Regulators (ESCB\CESR) Recommendations, which are identical to the RCCP in 2011.1

2. LCH.Clearnet SA provides clearing services to several European markets. For this reason, BDF, as a ‘lead overseer’, invited other competent authorities in France, Belgium, The Netherlands, and Portugal to cooperate in the preparation of the assessment of LCH.Clearnet SA aspects that are of common interest. In addition, information was exchanged between the French and Italian authorities within the context of the self-assessment, on the link between LCH.Clearnet SA and the Italian CCP, Cassa di Compensazione e Garanzia (CC&G).

3. The assessment of LCH.Clearnet SA benefited from discussions with the ACP, AMF, and BDF, as well as LCH.Clearnet SA senior management and staff, and representatives for the participants in the system. The French authorities and the management of LCH.Clearnet SA have been cooperative in providing supplemental information and organizing additional meetings to fulfill the assessment.

III. Institutional and Market Structure

4. Since December 2003, LCH.Clearnet SA is fully owned by the holding company LCH.Clearnet Group Ltd., which is a private company limited by shares and registered in the United Kingdom (U.K.). The holding company was created as part of a merger in December 2003 to oversee the two wholly owned subsidiaries of the Group: (i) LCH.Clearnet Limited (formerly London Clearinghouse Limited); and (ii) LCH.Clearnet SA (officially “Banque Centrale de Compensation SA”). The latter became an independent legal entity at the time of the merger, having previously been part of the Euronext Group. The shareholders of the holding company are mainly its users with 83 percent of total shares (Figure 1), and the remaining part is owned by New York Stock Exchange (NYSE) Euronext (9 percent), and London Metal Exchange (8 percent).

Figure 1.
Figure 1.

France: LCH.Clearnet Group Structure

Citation: IMF Staff Country Reports 2013, 183; 10.5089/9781484339701.002.A001

5. LCH.Clearnet SA (Banque Centrale de Compensation) is a company limited by shares incorporated in France, licensed as a credit institution and, therefore, governed by French law. It has branches in Amsterdam and Brussels and a representative office in Portugal. It has developed cross-border activities in Germany, Italy, Luxembourg, and Spain.

6. This assessment covers only LCH.Clearnet SA using the CPSS/IOSCO methodology. Other aspects of the holding company will be discussed as needed.

7. LCH.Clearnet SA clears a broad range of products traded on stock exchanges, electronic trading platforms, and over-the-counter (OTC) markets. These products can be classified as follows:

  • – Listed cash products: cash equities, convertible equities, and bonds listed on the NYSE Euronext markets.

  • – Listed derivatives products: equity and commodity derivatives listed on the NYSE Euronext markets.

  • – Fixed-income products: government debt securities (Italian, French, and Spanish states) traded on electronic trading platforms such as MTS Italy, Euro MTS, Icap, and Brokertec (this segment is often called ‘bonds and repo’ in LCH.Clearnet SA’s documentation).

  • – OTC product: credit derivative Swap (CDS).

8. LCH.Clearnet SA provides CCP services to the following markets:

  • – Cash products and derivatives listed on the NYSE Euronext markets;

  • – Cash products listed on Bourse du Luxembourg;

  • – Cash products traded on Equiduct, NYSE BondMatch;

  • – Fixed-income products traded on MTS Italy, Euro MTS, Icap, Brokertec; and

  • – CDS traded over the counter.

9. LCH.Clearnet SA operates a link with CC&G, an Italian CCP, which is part of the London Stock Exchange (LSE) group.

10. Two major developments took place recently:

  • – The Board of the group initiated a “Transformation Plan” aimed at creating “One Firm” by consolidating and rationalizing some of the operations of both the French and U.K. subsidiaries. In the past, these subsidiaries operated without any business and operational integration. The transformation plan would lead to promoting the horizontal multi-asset class clearing model, and enhancing the risk and collateral management capability within LCH.Clearnet Group Ltd. As part of the transformation, fixed-income clearing will be the first business line, currently provided by the French CCP, to be cleared on the single platform, which is located in London.

  • – In March 2012, the LSE Group offered a bid to acquire at least 50 percent, and up to 60 percent, of LCH.Clearnet Group Ltd share capital. The transaction is expected to be completed by the fourth quarter of 2012, subject to regulatory approvals, including competition clearance.

11. Key figures on the activities of LCH.Clearnet SA are provided in Table 1.

Table 1.

France: Key Statistics of LCH.Clearnet SA, 2008–2011

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Source: LCH.Clearnet SA.

Notional amount for derivative products.

IV. Regulatory Structure

12. LCH.Clearnet SA is incorporated in France and operates under French law. By law, a Clearing Housein France must have a credit institution statute and be licensed and supervised by the banking supervisory authority, ACP. It is a credit institution within the meaning of the European Directive 2006/48/EC dated June 14, 2006 (“Banking Directive”). As a clearing entity, it is regulated by the securities regulator, AMF, which approves its operating rules. As a clearing and settlement system for financial instruments, LCH.Clearnet SA is overseen by the central bank, BDF.

13. LCH.Clearnet SA is also subject to the regulation and oversight of the Dutch, Belgian, and Portuguese competent authorities. It provides clearing services for NYSE Euronext Amsterdam, NYSE Euronext Brussels, and NYSE Euronext Lisbon to coordinate the regulation and oversight of LCH.Clearnet SA, Memorandum of Understandings (MOUs) have been signed between the National Bank of Belgium (NBB) and Financial Services Market Authority, De Nederlandsche Bank, and Nederlandsche Autoriteit Financiële Markten; and Banco de Portugal and the Comissão do Mercado de Valores Mobiliários. A college has been set up for this purpose.

14. LCH.Clearnet SA is also licensed as a Recognized Overseas Clearinghouse (ROCH) by the Financial Service Authority (FSA) in the United Kingdom. An MOU is signed by all involved authorities, including France, Belgium, the Netherlands, Portugal, and the United Kingdom, for exchange of information at the level of the LCH.Clearnet Group Ltd (Table 2).

Table 2.

France: Summary of MOUs Between Involved Domestic and Foreign Authorities

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Source: Banque de France.
Table 3.

France: Collection of Assessment Results of LCH.Clearnet SA by Assessment Category

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Table 4.

France: Detailed Assessment of Observance of the LCH.Clearnet SA of the CPSS-IOSCO Recommendations for Central Counterparties

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Table 5.

France: Actions to Improve Compliance

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Table 6.

France: Further Recommended Actions

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15. For the link between LCH.Clearnet SA and the Italian CC&G, an MOU is signed by the French authorities and the relevant authorities in Italy-Banca d’Italia (BDI) and Consob.

16. Table 2 summarizes the MOUs between the involved domestic and foreign competent authorities.

V. Main Findings

Legal Framework (Rec. 1)

17. LCH.Clearnet SA activities are governed by a consistent and solid set of laws, regulations, and rules. In particular, the legal framework supports the enforcement of transactions, netting procedures, and protection of customer assets. There are adequate rules for addressing the event of a participant default, including the effective use of collateral. The implementation of the settlement finality and collateral directives provide a solid protection both in France and other European Economic Area (EEA) countries.

Participation requirements (Rec. 2)

18. LCH.Clearnet SA access and exit criteria are well defined and publicly disclosed. LCH.Clearnet SA’s participation requirements are objective and clearly stated on its website. They do not limit access on grounds other than risks. Only regulated credit institutions and investment firms are eligible to become clearing members. Furthermore, participants should meet financial resources and operational reliability. LCH.Clearnet SA monitors participants’ compliance on a regular basis

Financial risk management (Rec. 3–6)

19. LCH.Clearnet SA has a comprehensive risk-management framework. It monitors its participants’ exposures at least once a day and conducts intraday margin calls. It employs several tools to limit its exposures to potential losses from defaulting participants, including a high level of required capital, margin requirements, and contributions to the clearing fund. LCH.Clearnet SA can also require additional financial resources from participants in situations where unusual prices levels are detected. Recently, LCH.Clearnet SA developed dedicated risk-management procedures to handle sovereign debt. Nevertheless, LCH.Clearnet SA should measure its exposure continuously throughout the business day; i.e., an exposure is calculated continuously intraday once the positions, the participants, or the prices of the products have changed.

Custody and investment risks (Rec. 7)

20. Cash and securities are kept safe in the central bank account and in national and international central securities depositories. LCH.Clearnet SA has an account in TARGET-2. LCH.Clearnet SA investment policy is conservative by investing in highly rated government instruments. It ensures that its overall credit exposure to any individual issuer remains within acceptable concentration limits by the daily monitoring procedures.

Operational risk (Rec. 8)

21. LCH.Clearnet SA business continuity arrangements are well developed and cover all aspects of its operation and communication networks. As a credit institution, LCH.Clearnet SA has implemented the Operational Risk Framework of Basel II Capital Accord requirements. The Operational Risk Management is an ongoing process based on a formalized methodology. The monitoring of operational risks and loss events is performed through a dedicated tool. Contingency plans and back-up facilities are regularly tested and maintained to ensure the resilience of LCH.Clearnet SA. A simulation exercise with market participants should be carried out annually. Furthermore, the relevant authorities should formalize the assessment of the operational risk, including onsite inspections, of the insourcing company that develops and manages the largest part of LCH.Clearnet SA activities.

Money settlements (Rec. 9)

22. LCH.Clearnet SA uses both central bank money and private settlement bank for cash processing (margin and settlement). Central bank money is used for the vast majority of euro payments, about 85 percent for cash equity segment and 100 percent for other asset segments. Euroclear Bank is used for about 10 percent of the volume of NYSE Euronext markets, and Clearstream Luxembourg is used for the settlement of transactions on Bourse de Luxembourg, although the amount is very low. Commercial bank money is also used for the settlement of margins in British pounds and U.S. dollars, which are very negligible.

Physical deliveries (Rec. 10)

23. LCH.Clearnet SA clearly identifies and manages its obligation for physical delivery. The deliveries of securities are carried out in book-entry form (dematerialized and immobilized), and delivery obligations are fulfilled via book transfer. LCH.Clearnet SA has developed comprehensive rules and instructions for the delivery of commodity contracts.

Risks in links between central counterparties (Rec. 11)

24. LCH.Clearnet SA has a link to the Italian CCP—CC&G—for the clearing of Italian government bonds. LCH.Clearnet SA has specific rules and risk methodology aimed at minimizing its risk exposures to CC&G. Both CCPs collect margins from each other based on a methodology that is applied to their members, but they do not contribute to the other’s clearing fund, in order to minimize contagion risk that may result from members’ default. The link is subject to the regulation and oversight of the relevant French and Italian competent authorities. Both central counterparties (CCPs) are designated payment systems according to Article 10 of the Settlement Finality Directive 98/26/EC, which provides legal protection to finality and collaterals.

Efficiency (Rec. 12)

25. LCH.Clearnet SA reviews its pricing and service levels, as well as capacity levels on a regular basis. It performs periodic benchmarking studies with comparable CCPs in other European countries to assess its costs and fees. An ongoing profit-and-loss analysis is conducted.

Governance (Rec. 13)

26. LCH.Clearnet SA is a wholly owned subsidiary of LCH.Clearnet Group Ltd. LCH.Clearnet SA governance arrangements and composition of the Boards are clear and publicly available on its website. The Board, which includes four independent Board members, is accountable to the shareholders. However, there is no formal selection criteria or procedure used to choose the “user representative” on the Board, so as to ensure the Board has appropriate skills and incentives. Procedures to identify and mitigate conflicts of interests should be further enhanced. A transformation plan is currently being implemented, aimed at streamlining the operations of both subsidiaries based on product lines, and some of the functionalities will be concentrated at the group level. In this context, it is crucial that the new organization does not compromise that LCH.Clearnet SA retains the necessary level of independence to meet its regulatory obligations as a distinct legal entity.

Transparency (Rec. 14)

27. LCH.Clearnet SA discloses to its clearing members and other market participants its rules, procedures, and policies on its website. These rules cover, among other things, governance issues, the rights and obligations of participants, procedures and tools for handling risks, and fees for using its services. Also, important notices and information are posted on the website. LCH.Clearnet SA has not completed and disclosed a comprehensive self-assessment following the RCCPs assessment methodology.

Regulation and oversight (Rec. 15)

28. The objectives and responsibilities of the regulators of LCH.Clearnet SA are well defined and transparent. The supervision and oversight of LCH.Clearnet SA are comprehensive and effective. LCH.Clearnet SA is regulated and supervised by several domestic and foreign authorities. Cooperation and coordination between these authorities are governed by French law and, where necessary, formalized in several MOUs.

29. A general discussion with the system operator and the regulators indicates that LCH.Clearnet SA will, in principle, be able to meet the newly revised CPSS/IOSCO principles. In particular, the new principles would not have any significant impact on LCH.Clearnet SA, and it will be able to adjust to the new requirements as far as needed.

VI. Authorities’ Response To The Assessment

The authorities did not have any comments.

1

A joint Working Group of the European System for Central Banks (ESCB) and the Committee of European Securities Regulators (CESR) developed recommendations to assess national market infrastructures. The ESCB/CESR recommendations are almost identical with the CPSS/IOSCO recommendations.

France: Financial Sector Assessment Program—Detailed Assessment of Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems and for Central Counterparties
Author: International Monetary Fund. Monetary and Capital Markets Department