LCH SA, London Stock Exchange Group’s European clearer, will provide a new segregated clearing service for digital asset derivatives venue, GFO-X, as more trading in the asset class is expected to move to regulated venues.
In April this year LCH DigitalAssetClear said it will provide clearing services for cash-settled Bitcoin index futures and options contracts traded on GFO-X, a venue approved as a multilateral trading facility by the UK Financial Conduct Authority. The service is expected to go live in the fourth quarter of 2023.
Frank Soussan, Head of LCH DigitalAssetClear, told Markets Media: “Upcoming regulations will push more trading into the regulated side of the market. We want to make sure that GFX-O and LCH are established when growth occurs and volumes switch from the unregulated to regulated venues.”
Soussan added that an average of $35bn of Bitcoin futures are traded on a daily basis today, but only $2bn on regulated venues, so there is plenty of room to grow.
LCH started working on DigitalAssetClear at the start of 2022 to assess whether it could launch a crypto derivatives clearing service that would be attractive for market participants while complying with regulations and the clearer’s risk management standards.
“GFO-X approached us and we very quickly realised that they were experts in this asset class,” Soussan added. “The venue focuses exclusively on digital assets so have lots of experience to bring to the table, and they realised the LCH brand and reputation for sound and robust risk management framework would bring a lot of credibility to this offering.”
Arnab Sen, chief executive and co-founder of GFO-X, said in a statement that recent market events in the trading of digital assets have highlighted the need for a safe, regulated venue where large financial institutions can trade at scale, while keeping their clients’ assets protected.
“As the UK’s first regulated and centrally cleared trading venue focused entirely on digital asset futures and options, our joint vision is to ensure digital asset derivatives’ trading and clearing requirements and growing demand can be met within a secure, highly regulated environment,” added Sen.
LCH SA is mostly using its existing risk framework as it applies quite well to digital assets, although there are some specificities to the asset class that were included in the clearer’s mapping work according to Soussan.
“There is volatility in the crypto space but it is not much bigger than the volatility we have observed, for example, in some single stocks,“ he said.
GFO-X’s Bitcoin index futures and options contracts are based on the GFO-X/Coin Metrics Bitcoin Reference Rate, a regulatory compliant reference rate of the U.S. dollar price of Bitcoin. Firms will be able to trade futures and options on the Bitcoin reference index directly.
Soussan continued that having contracts based on a well-constructed Bitcoin reference rate significantly mitigates the idiosyncratic risk of having a single price source for the underlying asset.
“One point which is really important is that in the new service contracts are cash settled,” he added. “The CCP will never hold the physical assets which removes the custody risk and the associated reputational risk that exists in the crypto space.”
Segregation
When assessing whether to launch the new clearing service, LCH put together a consultative working group with a range of market participants and very quickly found that the key was segregating the assets. As a result LCH wanted to ensure there could not be any contagion from a financial risk perspective, from a default perspective or operational risk perspective to its other clearing services.
“One of the unique selling points of our offering is segregation of the default fund as we wanted to make sure we prevented contagion,” said Soussan.
There is also no co-mingling from a margin perspective between DigitalAssetClear and LCH’s other clearing services, and the new service has a dedicated testing framework and code management. There has been a lot of interest from market participants according to Soussan as they need additional supply of digital assets. He believes having a new trading venue and a new pool of liquidity in the market will also enable arbitrage which opens up lots of potential new activity.
LCH’s model is open access so the firm could clear for other venues.
“There have been existing offerings in the US since 2017, and institutional investors in Europe are also looking for this service,” Soussan added.
He continued that this initiative is showing the strategy that LCH SA has adopted for the past few years to make the CCP less European-centric and more global.
“We have onboarded members from around the world and we are also expanding into the US,” Soussan said.
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