BoE consults on letters of credit as CCP collateral for initial margin

The Bank of England (BoE) has published a consultation paper setting out proposals for updated rules that would permit central counterparties (CCPs) to accept uncollateralised letters of credit (LOCs) as collateral. The consultation also covers the risk mitigants that CCPs would have to implement if they chose to accept this type of collateral. The proposals relate to initial margin only, and the BoE does not expect CCPs to accept LOCs as variation margin. Any CCPs wishing to accept LOCs would need to apply for the BoE's permission in the usual way; the BoE is not proposing a separate permission regime for LOCs.

The proposed changes would be implemented in the Collateral Part of the UK CCP Rulebook (currently still in draft). Key proposals include:

• References to "commercial bank guarantees" would be replaced with "commercial bank letters of credit", which is the terminology generally used by market participants.
• Currently, CCPs can only accept commercial bank guarantees from non-financial counterparties (NFCs) that are clearing members. The consultation proposes allowing CCPs to accept LOCs from NFCs that clear as clients, for example through a "pass-through" model.
• The requirement for LOCs to be fully collateralised would be removed.
• Current draft rule 5.1(2) would be amended so that acceptable LOCs would need to be issued by authorised UK credit institutions or authorised overseas credit institutions.
• CCPs would be required to monitor each issuer's creditworthiness on an ongoing basis.
• The single-issuer limit would fall from 10% to 5% of the CCP's total collateral.
• Current draft rule 10.4(2) allows CCPs to increase the current 10% single-issuer limit to 25%, where commercial bank guarantees constitute over 50% of the CCP's total collateral. This rule would be deleted.
• CCPs would also have to run validation checks with the issuer before accepting an LOC.
• To qualify as highly liquid collateral, an LOC that names both the CCP and the clearing member (posting on behalf of the client) as beneficiaries would need to require the CCP's consent before the clearing member could redeem it.

The Bank also expects CCPs to factor LOCs into their stress testing, including scenarios where the LOC issuers to which they have the largest exposures fail.

The deadline for responses is 15 January 2027. The BoE proposes to publish the final rules in the first half of 2027, with no implementation period. The rules would come into force no earlier than the date on which the UK CCP Rulebook takes effect. The BoE considers that an implementation period is not necessary as the proposals only impose new requirements on CCPs that choose to accept LOCs as collateral.

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