Transition to SOFR discounting 

in SwapClear

Subject to ongoing legal and regulatory review
2

Subject to ongoing legal and regulatory review

Transition to SOFR discounting in SwapClear – Contents

1. Overall process design

Summary approach

Timeline

Value compensation via cash payments (purpose, methodology, booking)

Risk compensation via compensating swaps (purpose, methodology, booking)

2. Compensating swap 

close-out (auction) process

Communicating opt-out decisions 

Important opt-out considerations

Auction participation

Bidding logistics

Auction cost allocation

Auction proceeds cap and the partial fill scenario

3. Client checklist Checklist of common items for review
SOFR discounting 

Overall process design
Summary of LCH’s planned approach

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Subject to ongoing legal and regulatory review

In support of the ARRC Paced Transition Plan, LCH plans to transition to SOFR discounting for USD products as follows: 

1. LCH plans to change the discounting and PAI/PAA(*) on all SwapClear USD-discounted products (including inflation, 

MXN and non-deliverable currencies(**)) from Fed-Funds to SOFR;

2. LCH plans to apply cash and swap compensation to all accounts with open USD-discounted positions (including 

inflation, MXN and non-deliverable currencies(**)) on the conversion date;

3. Client accounts will be able to elect for cash-only compensation by notifying LCH via their Clearing Broker;

4. A cash settlement (auction) process will be used to close out the unwanted compensating swaps and to provide a 

reference for cash compensation calculations across the whole service;

5. LCH is targeting a conversion date of 16th October 2020.

The above process has been designed to meet the industry-wide objective to transition the cleared swap market to SOFR 

without compromising market stability or causing unnecessary disruption. 

The design is intended to be resilient in a wide range of scenarios, operationally tractable yet with a reasonable degree of 

flexibility for customers with specific needs. 

Key design decisions have been subject to extensive consultation with our members and clients and have been 

communicated broadly to the market.

(*) Price Alignment Interest/Price Alignment Amount

(**) The eight non-deliverable currencies are KRW, CNY, INR, BRL, COP, CLP, THB, TWD
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Date Step

Saturday 6

th June 2020 Full operational test of end-to-end processes.

Friday 31st July 2020 LCH to finalise and publish list auction participants.

Friday 31st July 2020 LCH to publish auction proceeds cap array.

Friday 4th Sep 2020 Notification to LCH of elections for clients opting out of compensating swaps 

(and into LCH close-out process).

Monday 7th Sep 2020 LCH to publish indicative size of portfolio.

Wednesday 14th Oct 2020 Calculation of final compensating swap notionals based on EOD portfolio.

Friday 16th Oct 2020 Auction event. 

Calculation of cash compensation amounts based on EOD portfolio.

Saturday 17th Oct 2020 Booking of cash compensation amounts, compensation swaps and CSP 

proceeds.

Monday 19th Oct 2020 All new trades cleared at start of day.

Implementation of SOFR discounting at opening.

Incorporation of cash compensation amounts into ITD margin processing.

Tuesday 20th Oct 2020 Settlement of compensation amounts and auction proceeds.

New trades reported to trade repository.

Proposed timeline

Subject to ongoing legal and regulatory review
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Purpose The discounting change will give rise to gains and losses in respect of the valuation of USD-discounted 

portfolios. To address this, LCH plans to support cash compensation by introducing offsetting fees 

payable to/from the relevant accounts at the point of conversion.

Methodology Cash compensation amounts will be calculated using the mid prices from the cash settlement auction to 

derive the SOFR curve (as a spread to the existing USD Fed Funds curve). All USD discounted future cash 

flows (as calibrated under the Fed Funds discounting regime) are held constant and the compensation 

amount is calculated as the differential between the present value of these cash flows under the Fed 

Funds discount regime versus the SOFR discount regime:

Cash compensation amount = σi NetCashflowi × DFi

Fed Funds − DFiSOFR

∙

1

DFPayment Date

SOFR

Non-deliverable swaps will be subject to a similar calculation and the relevant compensating amount will 

be combined with the other US dollar compensation amounts into a single payment.

Any Mexican Peso swaps positions will be subject to an FX-adjusted compensation calculation for which 

payment will be made in Mexican Pesos separately.

Booking LCH plans to book the compensating amount on a new 1 USD Fed Funds notional swap (T+2 settlement)

for all USD and non-deliverable products in every Member and Client clearing account (visible as a new

trade as per existing reporting specifications).

For MXN TIIE swaps LCH plans to book the compensating amount on a new 1 MXN notional swap (T+2

settlement) for every Member and Client account (visible as a new trade as per existing reporting

specifications).

Booking will take place on Saturday October 17th 2020. Trade level breakdown will be available to ensure

correct attribution is possible for any users wishing to break the fee down to a detailed level.

Value compensation via cash payments

Subject to ongoing legal and regulatory review
7

Purpose The transition will give rise to a change in discounting risk from Fed Funds to SOFR. The compensating 

swaps are intended to neutralise the change in discounting risk and provide protection against any price 

movements during or after the compensation process.

Methodology LCH will evaluate the change in discounting risk as a result of the switch from Fed-Funds to SOFR 

discounting and calculate the overall SOFR risk ladder under both regimes. The difference between risk 

ladders is the change in discounting risk which LCH plans to compensate for. 

The required compensating risk will be aggregated into compensating swap tenors: 2Y, 5Y, 10Y, 15Y, 20 

and 30Y. Any bucket between these main pillar points will be allocated to the nearest two pillars in 

proportion to the time difference between the relevant pillar points (e.g. 12Y risk will be allocated 60% 

to 10Y and 40% to 15Y.)

The required notional size for each compensating swap is calculated to match the required risk sensitivity 

(i.e. the delta) in each of the compensating swap tenors.

Booking Calculations will be performed at the account level for any account with USD discounting risk with 

reference to the cleared trade population as at close of business of Wednesday 15th October 2020. 

LCH plans to book the compensating swaps as a pair of outright swaps consisting of: 

i) Receive SOFR, pay fixed (inclusive of spread); and 

ii) Receive fixed, pay Fed Funds (or vice versa). 

The fixed coupon will be determined based on the standard LCH Fed Funds outright curve at COB 16th

October 2020.

Compensating swap notional will be subject to a rounding convention with small positions rounded to 

zero (meaning no compensating swap will be booked). 

On 17th October 2020, LCH will book the net compensating swaps (for T+2 settlement), each with its 

maturity-specific mid spread applied to the SOFR coupon, into each account. LCH will be the 

counterparty to these trades. 

Risk compensation via compensating swaps

Subject to ongoing legal and regulatory review
SOFR discounting

Compensating swap close-out (auction) process
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Process for client elections

➢ Client accounts will be able to opt out of the risk compensating swaps. All swaps that are opted out of by

clients will be subject to a close-out process using an auction, to be run by LCH, described in this section.

➢ Given their direct relationship with the client, it is the responsibility of Clearing Brokers to notify LCH which

of their Client accounts have elected for cash only compensation.

➢ As part of the decision-making process, clearing brokers will be required to provide the LCH risk notice to

each client, outlining the associated risks.

➢ In the absence of instruction or otherwise, LCH will provide both cash (value) and swap (risk) compensation

to each Client account.

➢ Clearing brokers should send notifications of client opt-outs securely via the LCH portal by 4

th September

2020. Brokers will receive an email confirmation in return.

➢ Opt-out decisions are made at the account level. Clients with multiple accounts may choose which

accounts they intend to opt out. Clients may not opt in or out of specific tenors.

➢ There will be materiality thresholds whereby, below certain sizes (defined earlier), an account will be

automatically provided cash only compensation.

➢ For the avoidance of doubt, opting out clients will still pay (or receive) cash compensation for the value

difference due to the discounting change

Communicating opt out decisions

Subject to ongoing legal and regulatory review
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Important considerations for opt out decisions

Subject to ongoing legal and regulatory review

Whilst clients should strongly consider swap compensation, LCH recognizes that there is a diverse set of users with

different needs. Some clients may be unable or unwilling to accept swap compensation, and we have therefore designed

a process to accommodate this.

However, it is noted that the compensating swaps are designed to

(i) hedge against any price movements during or after the compensation process; and

(ii) avoid exposure to any costs associated with the auction itself.

By electing to take cash-only compensation, a client account would not be able to benefit from these protections.

Consequences of opting out of compensating swaps

Where a client decides to elect out of the compensating swaps, then the swaps that it would have received but for the 

election will be liquidated through an auction mechanism, run by LCH. This is likely to result in a cash payment from the 

client’s account, representing a proportionate share of any auction costs (being the bid-mid spread).

If there are insufficient bids for the opted out portfolio within a predetermined range (the ‘auction proceeds cap’), opted 

out clients will, notwithstanding their election to receive cash only, still receive part or all of their compensating swap 

allocation. Clients should discuss this eventuality with their clearing broker and/or execution counterparty(ies). 

Clients should discuss their options with their clearing member and take external legal, financial or other professional 

advice, as appropriate.

Please note that the inclusion of a compensation mechanism as part of LCH’s transition to SOFR discounting was a central 

element of consultation feedback during the design phase of the LCH process.
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Auction participation

Subject to ongoing legal and regulatory review

Participation

Members who are large, active participants in the USD swaps market will be required to bid in the auction. LCH has 

defined the threshold for requiring auction participation as those member groups having cleared at least $1 trillion 

notional of USD-denominated swaps at LCH in Q1 2020. There are 16 member groups above this threshold. 

All auction participants will be expected to demonstrate connectivity to LCH’s auction platform which is based on the 

existing LCH Portal. 

Auction participants are expected to be US primary dealers with relevant operational experience and subject to 

supervisory oversight. Clients wishing to provide liquidity into the auction should contact these banks who can 

intermediate. 

Calculating the opted out portfolio

For the client accounts opting out, the compensating swap positions will be aggregated and netted into six single 

compensating swaps across all such client portfolio, to become the auction portfolio.

LCH will calculate an indicative size of the auction portfolio and publish to auction participants on 7th September 2020. 

Final sizes will be confirmed on 15th October 2020.
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Bidding logistics

Subject to ongoing legal and regulatory review

Auctions will be held during the morning of 16th October 

2020 (in New York business hours). The bidding for each of 

the six compensating swaps will be separate (i.e. LCH will 

not support bids for packages of trades).

For each auction, LCH will show the full size of the position 

being auctioned and will ask for tradeable quotes from the 

auction participants.

Bids will be submitted via the LCH auction platform. 

Auction participants will access the auction platform via a 

web portal which displays a schedule of auctions for the 

day.

Auction participants will be permitted to provide prices in 

two formats: an ‘order book’, or an ‘all or nothing’ price. 

Auction participants may supply quotes in one or both 

formats, as below. The minimum requirement is to bid for 

10% of each auction swap. 

In the order book approach, auction participants provide 

differentiated pricing for a defined proportion of the 

compensating swap being offered. With the all or nothing 

bid, an auction participant shows a price which is valid if 

and only if they are allocated the full size. 

Example bid

Bank BANK1

Order Book

BID OFFER

Up to 10% X bp X bp

10-25% X bp X bp

25-50% X bp X bp

50-75% X bp X bp

75-100% X bp X bp

All Or Nothing

BID OFFER

100% Only X bp X bp
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Auction cost allocation

Subject to ongoing legal and regulatory review

Determining the auction winner(s)

Initially, all bids in the order book format will be aggregated and 

arranged in descending order (or offers in ascending order, 

depending on the direction of the swap being auctioned). LCH 

will work down this list until enough bids have been accumulated 

to cover the full size of the auction. The last bid (or offer) is then 

the market clearing price, i.e. the best price at which there are 

enough partial bids to cover the full auction size in aggregate.

The market clearing price from the order book bids is then 

compared with the best all or nothing bid. If there is a better all 

or nothing bid, that bidder will be the sole auction winner . 

Otherwise, the order book bidders will be declared the winners 

and the auction swap will be allocated to them. Note that all 

winners will be allocated the swap using the same market 

clearing price.

Note that the swaps themselves will be ‘at market’, i.e. the rates 

used will be the auction mid price, not the market clearing price 

paid by the auction winners.

Allocation of swaps to the auction winners 

All bidders who bid higher than the market clearing price will be 

allocated the full share that they bid for. Bidders who bid the 

market clearing price will be allocated a share of the remainder 

in proportion to the size of bid they made at that level.

Calculating the auction proceeds 

Auction winners will be provided with their compensating swaps 

‘at market’ with reference to the auction mid as the market 

level. This means that the fixed spread on the SOFR leg of their 

trade will be equal to the auction mid price for the relevant 

tenor.

The difference between the auction mid price (in basis point 

terms) and the price agreed with the auction winner(s) market 

clearing price (the best bid or combination of best bids, also in 

basis point terms) multiplied by the size of the auction position 

(in dv01 terms) can therefore be thought of as the auction 

proceeds. If the market clearing price is lower than the auction 

mid, this results in the need for a cash payment to the auction 

winner from the opting out client accounts. 

Allocating to individual accounts

For each individual auction, the proceeds are allocated to client 

accounts in proportion to the notional size of compensating swap 

that they have opted out of (irrespective of long/short):

ClientAllocationi

= −AuctionProceeds.

ClientNotionali

σOptOut TotalNotional

The booking of the auction proceeds will be via the same 

mechanism used for cash compensation (i.e. additional swaps 

with attached fees payable).
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Auction proceeds cap and the partial fill scenario

Subject to ongoing legal and regulatory review

In order to prevent the opting out client accounts from incurring unquantifiable costs in the auction process, LCH plans to 

cap the auction proceeds at a predetermined number of basis points. 

If the auction fails to produce sufficient bids to cover the entire auction size within this level, this will result in a partial fill 

scenario. If there are no bids within the auction proceeds cap, all clients will receive their full allocation of compensating 

swaps. 

In the partial fill scenario, each opting out account will be allocated both cash and swaps. The cash represents their share

of the auction proceeds payable to the successful bidders that were within the agreed range. 

The swaps will represent their share of the compensating swap notional for which there were insufficient bids (bids 

outside the range or no bids at all). Both calculations will be performed as a percentage of notional, as per the auction 

proceeds calculations above.

If clients subsequently require an unwind of their remaining compensating swap positions it will be their own 

responsibility to achieve this in the open market with the help of their clearing broker (as the intermediating 

counterparty). 

We are in dialogue with the clearing brokers regarding their roles and responsibilities in this process. Note that 

unwinding the compensating swaps in the open market will clearly be an option for any clients who may prefer not to put 

their compensating swaps into the auction process.

LCH does not plan to hold any further rounds of LCH-organised auctions after the initial scheduled round, even in the 

partial or no fill scenarios. LCH will confirm the level of the auction proceeds cap closer to the time that client elections 

need to be made.
Client checklist
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Estimating the size of 

key inputs

➢ Use the SMART tool to review indicative valuation changes, cash compensation and discounting risk 

changes. 

➢ Review allocations to individual trades/portfolios. Consider how you would reallocate 

compensation down to sub-portfolios if required (LCH payments will be made at the clearing 

account level). 

➢ Visit the LCH Portal to review the indicative hedge notionalsfor the compensating swaps. 

Operational process 

flows

➢ Ensure you are familiar with the proposed booking for compensating cash payments and 

compensating swaps. 

➢ Review expected timings of cash flows. Consider what reconciliations may be required.

➢ Review your needs with respect to trade messaging. LCH will communicate new cleared trades via 

Clearlink, but will not message trades to MarkitWire unless clients elect it (via ATSS 

Synchronisation). 

➢ Discuss any questions on booking or processes with your clearing broker, and LCH if appropriate. 

LCH is running a test weekend on 30th May and will make available relevant data from these tests 

to members and clients.

Compensating swap 

elections

➢ Consider benefits of swap compensation. Compensating swaps are designed to hedge against any 

price movements during or after the discounting conversion and to avoid exposure to any costs 

associated with the auction process.

➢ Review LCH technical specification for auction process.

➢ Clients should discuss their options with their clearing member and take external legal, financial or 

other professional advice, as appropriate.

➢ If electing to opt out of compensating swaps (and into the LCH cash settlement auction process), 

arrange for relevant clearing broker(s) to inform LCH by 4th September 2020.

Other resources ➢ A detailed technical description of the auction process is available [here]

➢ The LCH benchmark reform website can be found [here]

Client checklist

Subject to ongoing legal and regulatory review
17

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Subject to ongoing legal and regulatory review