BoE tests show LME clearing house resources depleted in extreme case

The Bank of England said on Wednesday that stress tests results saw the London Metal Exchange’s (LME) clearing house LME Base experience “full depletion of both prefunded and non-prefunded resources” in an extreme scenario.

In last year’s stress test, LME Base ran down nearly its entire default fund under a stress test of its base metals service. The BoE said the 2023 credit reverse stress test was more severe than the one applied in 2022.

The BoE said the stress tests of central counterparty clearing services went beyond historic precedent and minimum regulatory standards.

The LME said it was reviewing the findings.

“Our current risk management processes and procedures align with the requirements set out under UK EMIR, and we will continue to engage closely with the Bank in reviewing the results,” the 146-year-old exchange said in a statement.

The UK European Market Infrastructure Regulation (UK EMIR), imposes requirements to improve transparency and reduce the risks associated with the derivatives market.

The LME, the world’s biggest market for industrial metals, was forced to halt nickel trading and cancel trades in March 2022 after prices doubled to more than $100,000 per tonne in a surge sources blamed on short covering by one of the world’s top producers.

The BoE stress tests covered three central counterparties (CCPs) which operate in Britain: ICE (NYSE:ICE) Clear Europe, LCH Limited, part of London Stock Exchange Group (LON:LSEG), and LME Clear, owned by Hong Kong Exchanges and Clearing.

The results showed continued resilience at the businesses, which help clear and settle trades in financial instruments and commodities essential for the global economy, the BoE said.

A clearing house, backed by its default fund, ensures a stock, bond or derivatives trade is completed even if one side of the deal goes bust.

“The results confirm the continued resilience of UK CCPs to market stress scenarios that are of equal and greater severity than the worst-ever historical market stresses,” said Sarah Breeden, the BoE’s Deputy Governor for Financial Stability.

The BoE said the tests did not operate on a pass or fail model, and instead aimed to explore the central counterparties’ resilience to credit and liquidity shocks like those which occurred in the energy, metals and UK rates markets in 2022.

The BoE said it would use its latest findings “to support and inform its ongoing supervision and regulation of UK CCPs”.

On Tuesday, the central bank said it was considering new “fundamental rules” for securities and derivatives clearing and settlement houses as it revamps UK regulation post-Brexit.