LCH.Clearnet: LSOC with Excess Explained

The introduction of mandatory buy-side clearing has caused a seismic shift in the derivatives market structure. While the sell-side had been clearing swaps and other derivatives for many years, the process was new for most buy-side customers. While comfortable with the principles behind clearing, many customers were wary of the existing “omnibus” model for collateral segregation due to “fellow customer risk” concerns. In response, the U.S. Commodity Futures Trading Commission (CFTC) introduced the LSOC (Legally Segregated, Operationally Commingled) model for segregation of cleared swaps customer collateral, which prohibits derivatives clearing organizations (DCOs) from using the value of collateral from one customer of a futures commission merchant (FCM) to cover another customer’s losses.

The highlights of the paper are:

• Ability to hold excess collateral at the CCP
• Decreases prospect of swap portfolio liquidation
• Increases likelihood of porting
• Potential for rapid asset value recovery

The full paper is here.

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