Central counterparty for equities

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Central counterpar ty

for equities

(Phase 1)

September 2000

Service

implementation guide

CCP serv. impl. cover 13/9/00 2:52 PM Page 1

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This document has been produced by CRESTCo Limited, London Stock Exchange plc and The London Clearing House Limited to assist users of their services. While it has been prepared on the basis of the best information available, the authors accept no liability for decisions taken, or systems work carried out by any party, based on this document. This document does not form part of the contractual documentation between any of its authors and their customers.

© September 2000 CRESTCo Limited, registered in England and Wales No 2878738, London Stock Exchange plc, registered in England and Wales No 2075721, and The London Clearing House Limited, registered in England and Wales No 25932.

The CREST logo is a trademark of CRESTCo Limited. SETS, SEAQ and the London Stock Exchange crest and logo are trademarks

Project contacts

CRESTCo

www.crestco.co.uk

Relationship Managers:

Wholesale Markets Warren Alsop Tel: 020 7849 0029

Email: [email protected] Retail Brokers Charles Pugh Tel: 020 7849 0153

Email: [email protected] Custodians and Software Houses Vincent Wick Tel: 020 7849 0076

Email: [email protected] Head of Client Services Jennifer Parker Tel:020 7849 0388

Email: [email protected] If you wish to be added to the CREST mailing list, please contact CRESTCo publications at [email protected] (telephone 020 7849 0001) or visit the CRESTCo website.

London Clearing House

www.lch.co.uk

Central Counterparty for Equities Enquiries Tel: 020 7426 7154

Email: [email protected] Service Implementation Manager Peter Arnold Tel: 020 7426 7089

Email: [email protected] If you wish to be added to, or removed from, the email distribution list for this project, please send an email to [email protected]

London Stock Exchange

www.londonstockexchange.com

Business Development Tel: 020 7797 3456

Email:businessdevelopment@ londonstockexchange.com Technical Information Desk Tel: 020 7797 3939

Member Firm Implementation Ursula Acheson Tel: 020 7797 1466

Email: [email protected] If you wish to be added to, or removed from, the London Stock Exchange mailing list for this project, please send an email to [email protected]

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INTRODUCTION

1.1 Purpose of this guide

The Central Counterparty (CCP) for Equities service is a joint project between CRESTCo, London Clearing House (LCH) and the London Stock Exchange (the Exchange). The primary objectives in the first phase are to introduce post trade anonymity for trading on the Stock Exchange Electronic Trading Service (SETS)1_{and to improve the management of counterparty}

risk. The second phase of the project will include the introduction of optional multilateral settlement netting. A fuller description of CCP for Equities can be found in the Service Outline. A list of other published and planned documents relating to the project is given in Appendix D. This Service Implementation Guide (the Guide) is intended to provide a guide to the main steps that market participants will need to make in preparation for the launch of the service. The intended launch date is 26 February 2001. The Guide does not address all regulatory issues that may arise in connection with the service as it has been prepared before the necessary changes to the Exchange, LCH and FSA/SFA rules to support CCP for Equities are finalised; these changes will be publicised by the project when they become available.

The Guide is being published simultaneously on the CRESTCo, LCH and Exchange websites, and can be downloaded from them at http://www.crestco.co.uk, http://www.lch.co.uk and http://www.londonstockexchange.com. An Implementation Questions and Answers document will also be published on these sites in September.

If you have any views or questions on the Guide, please direct these to one of the contacts named at the front of this document.

1.2 How to use this guide

The following table indicates which sections of this guide are relevant for different groups of readers.

Market participants that have not yet decided which roles they will undertake in the CCP for Equities environment should read all sections.

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Section Scope Readership 1: Introduction Description of this guide All readers. 2: Key Decisions Key decisions for a firm on

how to participate in the service

All readers. 3: Non-Clearing

Members

Preparation check-list for Non-Clearing Members (NCMs)

Trading firms not intending to become clearing members. 4: Clearing Members Preparation check-list for LCH

members: General Clearing Members (GCMs) and Individual Clearing Members (ICMs)

Firms intending to become clearing members, whether they trade or not. This includes both self-clearers and general clearers.

5: General Clearing Members

Additional issues for General Clearing Members (GCMs) only

Firms that will act as a general clearer for other firms (related or third party).

6: Settlement Settlement issues Operations departments of trading firms and settlement agents.

7: Implementation Timetable

Key events leading up to the live date

All readers. 8: Testing Summary of the member

testing programme

All readers.

9: Training Summary of training All readers.

10: Stamp Duty Stamp duty issues for clearing members

Clearing members. 11: Regulatory Issues Summary of current regulatory

position

All readers. Appendices

A. New CREST Participants

Details of how to become a new CREST User and the participant types available

Firms that need to become CREST users.

B. New LCH Members Details of how to become a member of LCH

Firms that need to become LCH members.

C. New London Stock Exchange Members

Details of how to become a member of the London Stock Exchange

Firms that need to become members of the London Stock Exchange.

D. Further Information Publications, planned publications, modifications to

Service Outline

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2. KEY DECISIONS

2.1 Introduction

Market participants need to take a number of key decisions in preparation for the introduction of CCP for Equities:

• Trading firms need to decide how to structure their clearing2_{arrangements.}

• Clearing firms need to decide whether to offer general clearing services.

• Firms need to decide how client and house business will be segregated.

2.2 Clearing

Every firm trading on SETS will need to establish a direct or indirect clearing relationship with LCH in order to continue trading on SETS after the introduction of CCP for Equities.

A firm can either participate as a direct member of LCH and clear its own business, or become a Non-Clearing Member (NCM), in which case it will not have a relationship with LCH and needs to appoint a General Clearing Member (GCM) to clear its trades. This is a key decision that influences the preparations to be undertaken by firms.

A firm that decides to clear CCP for Equities business can be either an Individual Clearing Member (ICM) or a GCM. The difference is that an ICM can only clear its own trades, whereas a GCM can clear for other firms in addition to its own trades.

It should be noted that LCH considers relationships on a strict legal entity basis. Therefore, for a firm to self-clear, the same legal entity must be a member of both the Exchange and of LCH. This means that if a trading firm uses a clearer within its corporate group that is a different legal entity, then this is classified as an NCM-GCM relationship, not as an ICM. This distinction is important for the reasons discussed below:

• An ICM or GCM cannot self-clear agency business. A firm wishing to undertake agency business on SETS must appoint a GCM to clear its agency business with LCH. A trading firm can have different clearing arrangements for its agency and principal business; for example, it could be an ICM for its principal business and an NCM for agency business.

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• LCH places no restriction on an NCM in trading agency or principal business, but its GCM may do so. NCMs will need to discuss their business profiles with their proposed GCM. This approach is summarised in the following diagram:

Decisions made by a firm in respect of its clearing arrangements do not affect the choices it has for settling its transactions. A firm can chose whether to handle its own settlement, or use a settlement agent under Model A or Model B arrangements. A settlement agent may also (but is not required to) provide clearing services as a GCM.

A Model B settlement agent cannot act as a GCM for agency trades carried out by itself, or by executing brokers in its name. This may affect how some Model B settlement agents conduct their business and they may wish to consider using another part of their business to be a GCM for Model B agency business.

2.3 Segregation of house and client business

LCH enables clearing members3 to segregate house and client positions in order to meet client money rules. See the Service Outline section 7.3 for further information.

3_{The term ‘clearing member’ is used throughout this document to refer to a market participant of CCP for Equities that is acting as}

either a GCM or an ICM.

General Clearing Member

Non-Clearing Member Client Client ICM trading as principal GCM acting as principal principal principal Client GCM trading as principal NCM trading as agent or principal

Individual Clearing Member

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The SETS interface will enable trading firms to specify whether business should be allocated to house or client accounts. Further detail is set out in the Exchange’s Guidance notes for central

counterparty and Enhancing CREST; The Central Counterparty Part One.

Decisions to be made:

Firstly, trading firms need to decide whether all their business will be allocated in the same way (i.e. all house or all client), or whether they wish to specify the account allocation on a trade-by-trade basis at the point of order entry. In either case, a default account must be nominated for trades where an account is not specified. If they wish, trading firms need then never specify an allocation on an individual trade, or may override the allocation on a trade-by-trade basis as required. Trading firms should ensure they discuss this decision with their clearing member. CRESTCo, LCH and the Exchange will jointly coordinate the collation of trading firms’ nominated house or client default accounts.

Secondly, clearing members will need to decide whether they will use client money to cover margin requirements, taking into consideration that client money can be used only to cover margin on their client account.

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3. NON-CLEARING MEMBERS

3.1 Introduction

This section provides guidance for those Exchange trading firms who decide to become NCMs in relation to their SETS business.

Each NCM must appoint a GCM to clear its SETS business, whether the NCM trades as agent or principal. Each NCM must also sign up to an NCM-GCM-LCH agreement with its GCM and LCH, so that the GCM and NCM will also be bound by the LCH General Regulations, Default

Rules and Procedures (available via the LCH website). This is separate to any GCM / NCM

contractual arrangements. Some elements of the relationship between a GCM and its NCM will be governed by the agreement with LCH. However, this agreement does not cover any commercial arrangements between NCMs and GCMs, which are entirely a bilateral matter between them.

NCMs need not be members of LCH and most will not be. Although SETS will confirm each trade with LCH as counterparty, this reflects only the market side counterparty for settlement purposes. The principal to all trades entered into by an NCM will, by virtue of the NCM-GCM-LCH agreement, contractually always be its appointed GCM.

Key tasks to be undertaken by NCMs in preparation for the service are outlined below. These are split according to the organisation concerned (the Exchange, CRESTCo, LCH) and then summarised with recommended timings.

3.2 London Stock Exchange

The key steps to be undertaken by prospective NCMs with the Exchange are:

• Take note of the Exchange CCP rules consultation in October 2000 and respond if necessary.

• Once a GCM has been selected and the appropriate legal documents completed, the Exchange will need to be advised of the relevant details of the GCM and the BIC and CREST code details for which it will clear. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

• Decide about house and client account segregation prior to the start of testing (see sections 2.3 and 4.4.4).

• Consider changes to existing SETS trading systems and procedures to prepare for CCP for Equities, e.g. if house/client allocation is required on a trade-by-trade basis (see section 2.3) or concerning trade cancellation (see section 8.1 of the Service Outline).

A firm that is not an existing member of the Exchange, but which decides to join the Exchange, should also refer to Appendix C.

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3.3 CRESTCo

The key steps for an NCM to undertake in connection with CREST membership are:

• Consider at an early stage its current and future settlement arrangements in relation to SETS trades. It should be noted that changes to existing settlement arrangements might require the signing of new membership agreements with CRESTCo.

• An NCM that settles its own trades should consider the changes required to its existing CREST functionality to prepare for CCP for Equities (see the CREST Data Exchange

Manual version 8.2; Enhancing CREST; The Central Counterparty Parts One and Two

and Corporate Actions: Central Counterparty).

• NCMs that use settlement systems developed externally should discuss their system requirements for CCP for Equities with their third party software suppliers.

• NCMs that use (or intend to appoint) third party settlement agents should enter into discussions with their settlement agent (see also section 6).

• Once a GCM has been selected and the appropriate legal documents completed, CRESTCo will need to be advised of the relevant details of the GCM and the NCM’s participants for which it will clear. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

• An NCM that settles trades dealt on SETS will be required to participate in the member testing – please refer to the Member Test Strategy.

A firm that is not an existing member of CREST, but decides to join CREST, should also refer to Appendix A.

3.4 London Clearing House

The key steps for NCMs to undertake with LCH or LCH members are:

• Establish a clearing arrangement with a GCM.

• Execute an NCM-GCM-LCH agreement (a pro forma will be available from LCH in October 2000).

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3.5 Summary of events and activities for Non-Clearing Members

Activities are shown in the month by which we would recommend / expect most participants to carry them out.

Trading Settlement Clearing General

Activities Project events Sep 2000 Review current systems and practices for SETS trading Review current systems and practices for settling SETS trades Conduct discussions with potential GCMs Ratify decision to be an NCM Complete member testing questionnaire (if participating in testing) Oct 2000

Select a GCM The Exchange CCP rules consultation Nov 2000 Testing seminar Dec 2000 Decision required re: house/client segregation prior to start of member testing Sign NCM-GCM-LCH legal agreements Confirmation of the Exchange CCP rule changes Testing scripts available - plan testing Jan 2001 Member functional testing available Feb 2001 Member end-to-end testing available

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4. CLEARING MEMBERS

4.1 Introduction

This section provides guidance for those firms that are, or intend to become, clearing members, either as GCMs or ICMs.

GCMs and ICMs that conduct agency business, and must therefore act as an NCM for this business, should also read section 3. GCMs should also read section 5.

Where the legal entity intended to act as GCM or ICM is not an existing LCH member, Appendix B should also be read.

4.2 London Stock Exchange

The key steps for clearing members to undertake with the Exchange are:

• Take note of the Exchange CCP rules consultation in October 2000 and respond if necessary.

• Decide about house and client account segregation prior to the start of testing (see sections 2.3 and 4.4.4).

• Consider changes to existing SETS trading systems and procedures to prepare for CCP for Equities, e.g. if house/client allocation is required on a trade-by-trade basis (see section 2.3) or concerning trade cancellation (see section 8.1 of the Service Outline).

• Clearing members that are not currently members of the Exchange will also need to become a member of the Exchange in order to comply with criteria for LCH membership and to be subject to certain Exchange rules. Please refer to Appendix C for further details. Applications for membership of LCH and the Exchange will run in parallel and Exchange membership will be granted conditional upon the approval of LCH membership (and vice-versa).

4.3 CRESTCo

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• Once accepted as an LCH member in respect of CCP for Equities, CRESTCo will need to be advised of the relevant clearing details. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

• Decide upon the CREST functionality required in order to be a clearing member of CCP for Equities. This is described in the CREST Data Exchange Manual version 8.2, which should be read in conjunction with the CREST publications Enhancing CREST: The

Central Counterparty (Part One and Part Two), Corporate Actions: Central Counterparty and CREST Technical Newsletters.

• Development of the required software should commence early in the project cycle so that the necessary system and external testing can occur to time. Member testing will be required for all clearing member participants within CREST – please refer to the Member

Test Strategy.

• Decide whether to undertake internal testing during member testing with the firms for whom the clearing member proposes to provide clearing services.

The key steps for a clearing member to undertake in connection with their own trading and their CREST membership are:

• Consider at an early stage its current and future settlement arrangements in relation to its own SETS trades. It should be noted that changes to existing settlement arrangements might require the signing of new membership agreements with CRESTCo.

• A clearing member that settles its own trades should consider the changes required to its existing CREST functionality to prepare for CCP for Equities (see the CREST Data

Exchange Manual version 8.2; Enhancing CREST; The Central Counterparty Parts One and Two and Corporate Actions: Central Counterparty).

• Clearing members that use settlement systems developed externally should discuss their system requirements for CCP for Equities with their third party software suppliers.

• Clearing members that use (or intend to appoint) third party settlement agents should enter into discussions with their settlement agent (see also section 6).

• CRESTCo will need to be advised of the relevant settlement details for the clearing member’s own trading. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

• A clearing member that settles its own trades dealt on SETS will be required to participate in the member testing as a settlement participant, in a addition to its role as a clearing member – please refer to the Member Test Strategy.

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4.4 London Clearing House

4.4.1 LCH membership

ICMs and GCMs must be an LCH member and shareholder. The cost of an LCH share is £297,619.05. Appendix B sets out further detail of how to become an LCH member. The criteria to be met are as described in section 4.4.2.

LCH membership documentation requires careful review and completing the LCH application process can take a potential member several weeks. Following receipt of a completed application, LCH approval may take a further one to two months as both LCH Risk Committee and LCH Board approval is required. It is therefore recommended that prospective LCH members start the application process as early as possible as it can take approximately three months to complete. The new version of the Application for Share Purchase and

Membership will be available in October 2000.

4.4.2 LCH membership extension

If a prospective ICM or GCM already has an LCH membership in the name of the same legal entity, it will not be required to purchase an additional LCH share. However, the existing LCH membership must be extended to include CCP for Equities. In order to do this, there are certain criteria that must be met. These are detailed in the Service Outline and repeated here:

• A member must be an authorised or exempt person in terms of the Financial Services Act 1986 (or relevant subsequent legislation); or be a European investment firm as defined in the Investment Services Regulations 1995. If the applicant is a bank it must, at all times, be appropriately authorised by the banking supervisors of its home country and must additionally meet any notification or authorisation requirements set by banking supervisors in the United Kingdom.

• Members must have sufficient settlement and operational arrangements to deal with the types and business they are undertaking.

• Members must have Net Capital of either £5 million for ICMs; or £10 million for GCMs. Net Capital is broadly defined as Permanent Capital (i.e. excluding accumulated profit and loss and reserves available for distribution) plus Additional Capital (e.g. other equity reserves) less Disallowables (e.g. intangible fixed assets). Members that are currently active in other markets cleared by LCH may have higher total capital requirements.

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To extend membership, LCH members will be required to complete an extension form. Once fully completed, the application can be reviewed and accepted relatively quickly. Forms to extend membership to include CCP for Equities will be available in October.

4.4.3 Default Fund contribution

Each clearing member will be required to make a contribution to LCH’s Default Fund. There will be a minimum requirement per clearing member with the actual amount based on the activity of each member in relation to other clearing members. LCH is currently considering the detail of this calculation and whether the size of the Default Fund needs to be increased in relation to CCP for Equities business. Implementation of such a change to the Default Fund would require a ballot of all LCH members.

Members should ensure they have obtained internal approval for Default Fund contribution payment in good time before payment is due. We recommend this be in place by the end of January 2000.

4.4.4 LCH member accounts

LCH member accounts are assigned a unique three letter mnemonic and then further classified into house (H) and client (C) financial and position-keeping accounts (see section 2.3 for further discussion of house and client accounts).

Where an ICM or GCM is an existing LCH member, it should decide whether to set up separate member accounts for its CCP for Equities business, or to use existing accounts currently used for other markets (e.g. IPE, LIFFE, LME, LCH RepoClear, LCH SwapClear or Tradepoint).

In making this decision, the following should be considered:

• If accounts are shared, any collateral lodged to a shared account can be allocated against margin requirements in any relevant markets (with two exceptions - US Dollar securities may not cover equity-related margins and equities may only cover equity-related margins). If accounts are not shared, collateral can only be used within each specific market.

• If accounts are shared, liabilities resulting from CCP for Equities business can be reduced by any cash credits in other relevant markets, including any credit variation margin from IPE, LIFFE, LCH RepoClear or LCH SwapClear. Credit contingent variation margin from CCP for Equities will not be available to offset debits created as a result of margining processes on other markets (please refer to the Description of the LCH ERA Margining Algorithm).

• If accounts are shared, there will be only one set of banking reports and although there will be separate information in relation to the different markets, LCH will combine the net call or pay across markets. Members may have to calculate manually and reallocate this pay or call across their business if their own internal procedures require this. It may also be difficult to allocate costs for the use of collateral, as this will not be apportioned across markets on a pro rata basis. If accounts are not shared, separate banking reports will be available and

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separate calls or pays will be produced on the Protected Payments System (PPS) (see section 4.4.5).

• If members open new member accounts, they will not be able to use existing IPE, LIFFE, LME or Tradepoint reporting mechanisms for report retrieval, but will need to use an extranet connection. Existing LCH RepoClear and LCH SwapClear extranet connections can be used.

4.4.5 LCH PPS accounts

All LCH members must open PPS bank accounts for all currencies in which they may incur cash movements. There is a choice of 16 PPS banks that members may use for PPS bank accounts. These are listed in LCH’s General Regulations, Default, Rules and Procedures available from LCH (or on the LCH website). If an existing LCH member elects to open a new member account with LCH, it may either re-use existing PPS accounts or elect to open new PPS accounts.

4.4.6 PPS mandates

In order to give LCH access to a member’s PPS accounts for margin calls and Default Fund contributions, the member must fill in an account mandate form, send it to their PPS Bank (different banks can be used for different currencies) and provide a copy to LCH Operations/Service Delivery department. Even if a member decides to use an existing PPS account, new mandates will be required if the member establishes new member accounts.

4.4.7 Account structure

There are a number of options for utilisation of collateral and PPS movements within member accounts. LCH will discuss these options with each member and ascertain their preferences. Members should contact Siobhan White of LCH Treasury Operations on 020 7426 7044 in January 2001, to initiate this discussion.

4.4.8 LCH Form of Charge

If a clearing member wishes to use securities as collateral to cover initial and variation margin requirements (see the appendix to the Service Outline for a list of acceptable collateral), it must execute a charge in favour of LCH. If no such charge is currently in place, the member will

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4.4.9 LCH banking reporting

LCH provides banking reports to clearing members showing margin liabilities, cash payments and movements, interest payments, valuations, balances and Default Fund contributions on their house, client and Default Fund accounts. Members who intend to clear CCP for Equities business through their existing member accounts will be able to access LCH banking reports through the same route that they currently use (i.e. using their existing mnemonic). New LCH members, or existing members who create new member accounts (i.e. a new mnemonic) will need to use LCH’s extranet to access their banking reports.

LCH’s extranet is a secure reporting website using internet technology which is only accessible via a dedicated leased line between LCH and the member. Clearing members should allow 10 weeks elapsed time to complete the installation. The member carries the cost of the lines and equipment. A standard implementation currently costs approximately £10,500 to install plus £18,450 per annum. Further details can be obtained from LCH.

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4.5 Summary of events and activities for clearing members

Activities are shown in the month by which we would recommend / expect most participants to carry them out.

Trading & Settlement

Clearing General Activities Project events

Sep 2000 Review current systems and practices for SETS trading and settlement Decide on membership and member account structure. Start clearing functionality development: Ref CREST DEX 8.2 Appoint project manager (if not earlier) Complete member testing questionnaire Margin seminar Oct 2000 Review LCH membership and membership extension documents.

Order lines for extranet if required. The Exchange CCP rules consultation Nov 2000 Arrange membership of the Exchange (if not a member)

Apply for new LCH membership if required Testing seminar Dec 2000 Decision required re: house/client segregation (for own trades) prior to start of testing

Approve Default Fund contribution internally Install extranet if required

Set up new clearing member participants in CREST

CREST new user trialling

Testing scripts available - plan testing

CREST software house trialling (if necessary)

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5. GENERAL CLEARING MEMBERS

5.1 Additional steps for General Clearing Members

In addition to the steps defined in section 4, GCMs will need to:

• Establish terms for clearing trades and communicate these to potential NCM clients.

• Ensure that an NCM-GCM-LCH agreement has been signed with each NCM for whom it intends to clear. The pro forma document will be available in October 2000.

• The Exchange needs to be advised of the NCMs that the GCM will clear for, along with the type of service they will be providing to each NCM. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

• The Exchange needs to be provided with the level of authority required and the identity of the individuals who, in the event that it is necessary, will be able to authorise the removal of an NCM’s outstanding orders and block its access to CCP for Equities. Again, CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

GCMs must have net capital of at least £10 million (compared with at least £5 million for an ICM).

Although the work that GCMs and their software suppliers must do appears little different from that for an ICM, preparation should begin sooner due to the key role that GCMs will perform in CCP for Equities.

5.2 Suggested time table for additional GCM activities

Trading Clearing

Sep 2000 Discussions with NCMs underway

Consider GCM specific member test questions, e.g. possible co-operation with NCM testing Confirm GCM terms and start to sign up NCMs

Oct 2000 Due diligence of legal documents and

membership agreements underway Nov 2000

Dec 2000 Provide the Exchange with the authority details for removal of an NCM’s orders and access to CCP for Equities

GCM to sign NCM-GCM-LCH agreements and apply for Exchange membership

Jan 2001 Feb 2001

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6. SETTLEMENT

6.1 Issues affecting all CREST settlement participants

Any settlement participant in CREST that is settling SETS trades with LCH should:

• Consider the changes required to its existing CREST functionality to prepare for CCP for Equities (see the CREST Data Exchange Manual version 8.2; Enhancing CREST; The

Central Counterparty Parts One and Two and Corporate Actions: Central Counterparty).

• If it uses settlement systems developed externally, it should discuss its system requirements for CCP for Equities with its third party software suppliers.

• Participate in the member testing (see the Member Test Strategy).

6.2 Issues affecting settlement agents

In addition to the above, specific considerations apply to settlement agents and to the brokers who settle their SETS trades using a third party settlement agent. By way of summary, ‘Model A’ settlement agents provide back office settlement services to the brokers on whose behalf they settle, and settle transactions in the name of their brokers. In contrast, ‘Model B’ settlement agents not only provide back office settlement services, but also settle transactions in their own name.

• Model A and Model B settlement agents can choose whether to offer clearing services to their broker clients.

• Brokers who trade on SETS and have in place Model A settlement arrangements will need to establish clearing arrangements.

• Brokers who trade on SETS and have in place Model B settlement arrangements will not need to establish their own clearing arrangements, as in this scenario the NCM will be the Model B settlement agent itself. Therefore it is the Model B settlement agent that will have to establish clearing arrangements.

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6.3 Suggested time table for settlement activities

Trading Settlement General Activities Project events

Sep 2000

Review current systems and

practices for settling SETS trades Complete member testing questionnaire Oct 2000 The Exchange CCP rules consultation Nov 2000 Model B clearers required to clarify their settlement responsibilities to the Exchange Provide clearing member participant details to CRESTCo for dealing firms which do not have arrangements in place already Testing seminar Dec 2000 Confirmation of the Exchange CCP rule changes Testing scripts

available - plan testing Jan 2001 Member functional testing Feb 2001 Member end-to-end testing

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7. IMPLEMENTATION TIME TABLE

The timing of key project events through to the intended live date of 26 February 2001 is: Oct 2000 London Stock Exchange CCP rules consultation

Nov/Dec 2000 Circulation of further test documentation Testing seminar

Dec 2000 CREST new user trialling

Optional testing for Exchange members commences Software house testing

Jan/Feb 2001 Member testing Feb 2001 End to end testing 26 Feb 2001 Intended live date

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8. TESTING

Member testing for CCP for Equities will be provided jointly by the Exchange, LCH and CRESTCo. More information on the overall member testing programme is available in the

Member Test Strategy document.

Five types of member testing will be supported:

• CREST new user trialling will be available in December 2000 for new CREST members.

• London Stock Exchange Customer Development Service will be available from December 2000, for firms and software houses with host-to-host links with the Exchange, to support testing of their own systems if required.

• CREST software house trialling for recognised software houses and in-house developers will be available in December 2000.

• Scripted functional member testing of the service will occur in January and February 2001.

• Unscripted end-to-end testing, in conjunction with LCH and CRESTCo will be available mid February 2001.

Firms using market access workstation products to trade on SETS should contact their workstation provider to discuss the arrangements for testing and rollout of any new trading software.

The Member Test Strategy and subsequent documents with further information on testing, including details of the Testing Seminar, will be made available on the CRESTCo, LCH and Exchange websites.

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9. TRAINING

As the service has been designed to re-use the existing infrastructure with minimum impact on members, no formal or market-wide training is anticipated.

Seminars on the LCH margin algorithm have been held in September, a testing seminar will be arranged in November and other seminars may be arranged subject to demand.

Standard training courses for users of CREST are available through The Securities Institute (contact Securities Institute Client Services, telephone 020 7645 0680, email [email protected]).

LCH will offer training courses for both new and existing members that will inform and update on how LCH operates. The training, which will include coverage of LCH banking reports, margin calls and payment, is recommended for relevant personnel shortly before the service is launched next year.

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10. STAMP DUTY

The introduction of CCP for Equities is not intended to alter the existing Stamp Duty or Stamp Duty Reserve Tax burden on the industry in either UK or Irish securities. However, the burden would increase if new intermediaries in the contractual chain are not specifically relieved by existing legislation or by amendments to such legislation. One such intermediary is LCH, which is in discussion with both the Inland Revenue in the UK and the department of Revenue Commissioners in Ireland, who have both indicated their intention to relieve LCH’s transactions. The inclusion of GCMs in the contractual chain that may not already be relieved under existing legislation may also increase the tax burden. CREST, LCH and the Exchange are discussing this issue with the Irish and UK Revenue departments in order to seek to ensure that an unnecessary tax burden does not arise. Members that already qualify for relief should take tax advice to ensure that relief would equally apply to transactions that they may wish to clear.

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11. REGULATORY ISSUES

This section provides an overview of certain key regulatory issues affecting CCP for Equities. CRESTCo, LCH and the Exchange are exploring these matters with the FSA and other regulatory bodies. The following list is not exhaustive or definitive and participants should seek their own legal and regulatory advice.

• Margin accounting - There will be no requirement in LCH or the Exchange rules that will oblige clearing members to pass on margin to their clients/NCMs. The capital treatment of margin payments will be confirmed by the FSA.

• Disclosure requirements - Discussions are being held with the Takeover Panel and the DTI to seek to ensure that there is no requirement to disclose positions held by LCH or GCMs as part of their ordinary clearing business.

• Default - The Exchange’s default rules are being adjusted to recognise LCH’s primacy in the event of the default of a clearing member. The proposed rule changes will be contained within the Exchange’s general CCP rules consultation.

• Transaction reporting - The Exchange proposes to amend its transaction reporting rules so as not to require transaction reports from clearing members of LCH where they are clearing another member’s business. Trading parties will be required to transaction report as normal.

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APPENDIX A - NEW CREST PARTICIPANTS

Firms have two alternatives when determining how to join CREST: to become a direct user of CREST or, accessing CREST indirectly, via sponsorship.

A direct user needs the technical capabilities to connect to CREST across one of the two secure networks available from SWIFT or Syntegra. Connection to the network is made by one or more gateways supplied by SWIFT or Syntegra.

The direct user runs one or more participants in CREST, for example: members, sponsored members, payment banks and registrars. CREST members or sponsored members are the only type of participant able to hold securities and have payment facilities in CREST. The user may structure such memberships into designated accounts in order to segregate holdings.

Clearing members will be a new participant type for CCP for Equities; they will not be able to

hold stock or make payments, but will be able to enquire against open positions with LCH and obtain margin information and CCP for Equities’ prices (see Enhancing CREST; The Central

Counterparty Parts One and Two).

The direct user may access CREST using: proprietary software developed in house or software supplied by an independent software house, which connects through to a back office system; the PC based Graphical User Interface (GUI) supplied by CRESTCo; or may use both.

Firms that choose not to invest in the technical interface to connect directly to CREST will appoint a CREST sponsor, who is a direct user and acts on their behalf in inputting messages to CREST. CREST sponsors can act on behalf of sponsored members and other types of CREST participant, including a clearing member participant.

A1. How do I join as a direct user?

To join CREST as a direct user you will need to:

• Choose your software interface - the CREST GUI or another package supplied by a third party supplier; alternatively you can build your own interface if you wish.

• Contract with one, or both, of the network providers.

• Undertake a minimum of three days trialling with CRESTCo to ensure your technical interface works correctly.

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A.2 How do I join via sponsorship?

To join CREST through a sponsor you will need to:

• Choose your sponsor.

• Ensure your sponsor has signed a sponsor’s agreement with CRESTCo.

• You may also wish to undertake a period of trialling through your sponsor to CRESTCo (with their agreement) if they have given you access to a system that connects with CREST.

A.3 How do I join CREST as a member or sponsored member?

In addition to the steps outlined in A1 (in the case of a direct member) or A2 (in the case of a sponsored member), you will need to:

• Contract with one of the CREST payment banks, for each required CREST settlement currency.

• Contract with CRESTCo by signing a membership agreement (or sponsored membership agreement).

A.4 How do I join as a CREST clearing member participant?

In addition to the steps outlined in A1 or A2, depending on the type of connectivity required to CREST, to join CREST as a clearing member participant you will need to:

• Contract with CRESTCo by signing a clearing member agreement.

Further details about CREST membership and the joining procedures are available in the Corporate section of the CRESTCo website (http://www.crestco.co.uk).

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APPENDIX B - NEW LCH MEMBERS

This appendix outlines the action that new members of LCH will need to take in addition to the steps described in sections 4 and 5. One of the main differences will be that new members should begin preparations by end September 2000 at the latest.

Full LCH Membership criteria are documented in LCH’s General Regulations, Default Rules

and Procedures documentation available from LCH or on the LCH website at

http://www.lch.co.uk. These will be updated for CCP for Equities later in the year. The following points summarise the requirements:

• An applicant must meet the requirements for LCH membership in the CCP for Equities category. These are summarised in section 4.3 of this Guide.

• Sign and return two copies of the Clearing Membership Agreement.

• An applicant must purchase an ‘A’ share in LCH, at a price of £297,619.05.

• Contribute to LCH’s Default Fund.

• Open a Protected Payments System (PPS) bank account or accounts in currencies in which it may incur settlements, and execute a mandate or mandates for House and Client account as necessary.

• Complete an account structure questionnaire from LCH Risk Department to determine how the member’s account at LCH will operate.

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APPENDIX C - LONDON STOCK EXCHANGE MEMBERSHIP

Firms wishing to act as GCMs will be required to be members of the Exchange. It is proposed that a new type of membership will be available for firms wishing to provide GCM services only. The key aspects of this are:

• A fast-track membership.

• No technical connection to the Exchange.

• No right to use the Exchange’s facilities to transact its own business and no trade or transaction reporting obligations.

C.1 New London Stock Exchange members

Firms which wish to act as GCMs only and which do not intend to trade on the Exchange’s markets must:

• Complete the Exchange’s application form (this will be available following completion of the Exchange’s consultation on its rule changes).

• Be a member of LCH.

• Meet the Exchange’s suitability criteria (full details of the Exchange’s suitability criteria will be available following completion of the Exchange’s consultation on its rules changes). Firms that intend to trade on the Exchange’s markets will be required to apply for full membership. Details of how to apply for full membership are available on the Exchange’s website at www.londonstockexchange.com. An application form is available on request.

C.2 Existing London Stock Exchange members

Existing member firms that wish to also act as GCMs should note the following:

• The firm will need approval for a change to its business profile.

• The firm will be required to be a member of LCH.

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• The firm will need to provide details of its clearing member for its SETS business, along with its settlement arrangements. CRESTCo, LCH and the Exchange will jointly coordinate the collation of this information.

For further details on the Exchange membership application process (and approval process for changing clearing arrangements) please contact Rachael Keenan in the Market Access team on 020 7797 3483.

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APPENDIX D - FURTHER INFORMATION

D.1 Published Documents

Previous publications relating to this project are:

• Central Counterparty for SETS: Service Outline

• Member Test Strategy

• CREST Newsletters and Technical Newsletters

• CREST White Books

− Enhancing CREST: The Central Counterparty (Part One)

− Enhancing CREST: The Central Counterparty (Part Two)

− CREST - Corporate Actions: Central Counterparty

• CREST Data Exchange Manual Version 8.2

• Description of the LCH ERA (Equity Risk Analysis) Margining Algorithm

• LCH ERA Technical Information Pack (TIP)

• London Stock Exchange Guidance notes for central counterparty

The Service Outline and Member Test Strategy are available on all the websites given at the front of this Guide; CREST documents can be obtained via the CRESTCo site; LCH documents from the LCH site, and the Guidance notes for central counterparty from the Exchange’s site. The documents are also available on request from the contacts given at the front of this Guide. The CREST publications will assist CREST participants to develop their CREST interfaces to support CCP for Equities and assess the impact of the development upon their operations.

The Description of the LCH ERA Margining Algorithm and the Technical Information Pack will assist LCH members and software suppliers to develop system solutions that replicate the algorithm for reconciliation purposes.

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D.2 Planned Publications

Planned publications and other documents relating to this project include: September 2000 Member Test Check-Lists

Service Implementation Questions and Answers

London Stock Exchange: Trading and Information Services Technical Specifications (Issue 7)

October 2000 PC ERA: LCH software tool to calculate LCH ERA margins London Stock Exchange CCP Rule Revision (for consultation) November 2000 Test plan / scripts for CREST New Users and for software houses

London Stock Exchange CCP Rule Revision (confirmed) December 2000 Member Testing scripts / plans

January 2001 List of the actual securities affected by CCP for Equities

The Trading and Information Services Technical Specifications will assist the Exchange's member firms and software houses in the review of current systems and practices for SETS Trading.

D.3 Service Outline Alterations

Please note the following changes to the information provided in the Service Outline:

• LCH banking reporting will be available through LCH mechanisms (not via CREST) and LCH parameters (reference data used to calculate margin) will be available via the LCH website (not via CREST).

• LCH will make routine intra-day margin calls.

• There is a fourth criteria that members must meet to become a member of LCH for this service - they must either be a member of the London Stock Exchange or be in the process of applying to become one. Applications for membership of LCH and the Exchange will run in parallel and LCH membership will be granted conditional upon the approval of Exchange membership (and vice-versa). Refer to section 7.2. of the Service Outline.

• Tariffs have been announced at 20 pence per trade side.

• As US Dollar securities may not be used as cover for CCP for Equities business, the last row in the haircut table in the Appendix should be removed.

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The London Clearing House Limited Aldgate House 33 Aldgate High Street London EC3N 1EA Tel: 020 7426 7000 www.lch.co.uk CRESTCo Limited 33 Cannon Street London EC4M 5SB Tel: 020 7849 0000 www.crestco.co.uk

London Stock Exchange plc Old Broad Street

London EC2N 1HP Telephone: 020 7797 1000 www.londonstockexchange.com CCP serv. impl. cover 13/9/00 2:52 PM Page 4

Central counterparty for equities