Swapclear
SwapClear was launched in September 1999 to provide clearing for plain vanilla interest rate swaps of up to 10 years maturity in USD, EUR, JPY and GBP. The range of products, currencies and tenors cleared has since been expanded. SwapClear was developed via a consultative process, with over 30 banks engaged in risk, legal, operations and IT working groups to design the service.
In clearing swaps, the Clearing House becomes the central counterparty to, and has responsibility for, the corresponding trade obligations arising from each half of the original bilaterally negotiated trade. This principle is known as registration and is the same role that the Clearing House performs in the clearing of exchange traded derivatives.
SwapClear offers the inter-bank swap market a facility that aims to free up credit lines, reduce risk and use of capital, thus increasing return on investment and trading opportunities.
These benefits depend on the individual bank, but are likely to include:
- lower counterparty risk
- lower operational risk
- reduced credit line utilisation
- reduced regulatory capital requirements
- more secure and standardised collateral handling procedures
- standardised processing of swaps, simplifying documentation and operations, enabling back offices to handle higher volumes at lower cost
- fewer payments
The major benefit provided to banks by SwapClear is the ability to net several counterparty swap books multilaterally into a single account with the Clearing House, which becomes the counterparty to every trade registered with SwapClear. As a result, current bilateral netting arrangements are replaced with more efficient multilateral netting. On the basis of the Clearing House's experience, the effect of multilateral netting can reduce exposures by up to 90% when compared to bilateral netting.
Multilateral netting is at the heart of central clearing and delivers the greatest benefit in terms of reduced credit risk, significantly beyond that available from bilateral netting and collateralisation.
Credit risk is reduced through the use of variation margin. Daily margining effectively reduces the risk horizon to a single trading day, with the result that banks are no longer concerned with the probability of default over the life of a swap book, but only over the next business day.
Improved Return on Capital
The combination of multilateral netting and margining effectively eliminates credit risk for those transactions cleared through SwapClear. Hence, provisions for expected credit loss may be written back to P & L. Similarly, unexpected credit loss becomes the major part of risk capital. Clearing through SwapClear effectively reduces this to zero, thereby generating significant improvements in return on capital. Taken together, these savings can improve return on capital by up to 1.5%, a 10-15% increase.