In the process of 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 was explained earlier in respect of the clearing
of exchange-traded derivatives.
SwapClear offers the interbank 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.
The extent of these benefits will 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.
Benefits of netting
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. It has been estimated that the effect of multilateral netting
can reduce exposures by up to 90 per cent when compared to bilat-
eral 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.
In addition, credit risk is reduced through the use of VM. Daily
margining effectively reduces the risk horizon to a single trading day,
with the result that banks are no longer concerned with the prob-
ability of default over the life of a swap book, but only over the next
business day. Portfolio analysis has indicated that SwapClear reduces
60–80 per cent of current exposures for mixed swap portfolios, i.e.
where a proportion of swaps are non-clearable.
OTC products 111
Improved return on capital
The combination of multilateral netting and margining effectively elim-
inates credit risk for those transactions cleared through SwapClear.
Freeing credit lines
As a result of the clearing house becoming the counterparty to trades
after SwapClear registration, original bilateral credit lines are freed for
other purposes. The need for the current market practice of assigning
or ‘tearing up’ swaps to free up credit lines is removed. As original
counterparties are replaced by the clearing house there is no need
to assign trades to manage credit lines. Trades required to adjust
market risk positions may be carried out with any SwapClear Dealer.
Reduced regulatory capital requirements
Many European regulators have recognised the reduced risk inherent
in cleared OTC transactions by adopting the risk treatment set out
in amendments made in 1998 to the EU Capital Adequacy Directive
(CAD II).
The CAD II allows national regulators to exempt banks from cal-
culating counterparty risk in respect of cleared OTC trades if they
meet the margin requirements of the clearing house with debt securi-
ties issued by Organisation for Economic Cooperation Developments
(OECD) governments.
Operational savings
SwapClear provides an automated facility once the matched trades
have been received. The service marks-to-market swaps and collateral
used to meet initial margin requirements, determines reset amounts,
and nets payments into a single payment or receipt per currency.
These operations should:
• Reduce users’ operational overheads
• Permit efficient utilisation of collateral
• Reduce settlement costs
• Reduce costs associated with collateralisation under bilateral
agreements.
Operational risk reduction
The BIS issued a paper in June 1999 proposing that regulatory
capital charges be extended to include operational risk.
112 Clearing and settlement of derivatives
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