Stock Exchange Notice N54/00

London Stock Exchange
23 October 2000


For the attention of the
chairman/senior partner/compliance officer,
all member firms                                                        N54/00

STOCK EXCHANGE NOTICE
 
CONSULTATION ON PROPOSED RULE AMENDMENTS

INTRODUCTION OF CENTRAL COUNTERPARTY

This Notice should be read in conjunction with the rules, regulations and
procedures of CRESTCo (www.crestco.co.uk) and the London Clearing House
(www.lch.co.uk) in relation to central counterparty provisions. 

Introduction

1. As announced on 8 March 2000, the Exchange, CRESTCo and the London Clearing
House ('LCH') are jointly developing a central counterparty service.  This
Notice consults on proposed rules and guidance required for implementation. 
The intended implementation date for the central counterparty and effective
date for these rules is 26 February 2001. 

2. The central counterparty will fundamentally change the clearing and
settlement process for order book trades in central counterparty securities. 
A summary of the changes required to the Rules of the London Stock Exchange is
set out in paragraphs 18 to 32 below, following an overview of the new
features brought about by the introduction of the central counterparty in
paragraphs 4 to 17.

Scope 

3. The central counterparty service will be provided for all automatically
executed trades in both order book and SEAQ securities (SEAQ Auctions), save
for those classes of security or individual securities specifically excluded
by the Exchange.  These will be confirmed before the service is introduced. 
SEATS PLUS transactions will not be included.

CENTRAL COUNTERPARTY - NEW FEATURES

Membership

4. A member firm must have a direct or indirect clearing relationship with LCH
in order to conduct transactions in central counterparty securities on the
order book.

5. Firms will have to be members of both the London Stock Exchange and LCH to
clear on Exchange transactions directly through LCH.  Accordingly, two new
categories of member firm will be created to facilitate the clearing of
business through the central counterparty.  These are General Clearing Members
('GCMs') and Individual Clearing Members ('ICMs'). 

6. Save for transactions conducted as agent (see paragraphs 11 to 13 of this
Notice), an ICM will be able to assume the clearing obligations for trades
resulting from its own transactions and a GCM will be able to assume the
clearing obligations for trades resulting from its own transactions and
transactions of other member firms.

7. A member firm which uses another member firm to clear that business is
categorised as a Non Clearing Member ('NCM') for the purposes of that
business. 

Contractual arrangements

8. When two orders in central counterparty securities are matched
electronically in the trading system such matching will constitute the
acceptance of an open offer (from LCH) by each of the member firms which
entered the matching orders.

9. The open offer will be such that, subject to compliance with the relevant
LCH regulations by the NCMs, GCMs or ICMs involved, LCH will register the
transaction and interpose itself as central counterparty.  This will result in
the creation of a contract between LCH and the clearing member and, in the
case of an NCM trade, a back to back contract between the GCM and the NCM (as
principal or agent for its client).  All of these contracts are referred to as
central counterparty contracts.

Failure of registration

10. If a central counterparty transaction fails to be registered by LCH due to
it not meeting the LCH eligibility criteria, the Exchange, having been
informed of that event by LCH, will contact the parties to the matched order
so that they can settle the transaction bilaterally.  The time of the
transaction will be the time at which the order was executed on the Exchange
trading system.

Agency Trading

11. LCH requires that for all central counterparty contracts it enters into
with clearing members, the clearing member must act as principal.  This means
that clearing member firms trading as agent cannot themselves clear that
business with LCH.  Member firms acting as agent must therefore use a separate
legal entity as a clearing member of LCH to clear that business.  The clearing
entity can be part of the same group as the member firm, which may continue to
handle all other aspects of the transaction, including settlement.

12. An ICM or GCM should not submit an order in a central counterparty
security with a dealing capacity of agent unless it uses a separate GCM to
clear that business.  Any trade resulting from an order submitted as agent in
error, will be rejected by CRESTCo who will contact LCH.  

13. The transaction will be deemed to be a principal transaction and the
member firm will be obliged to settle it on that basis.  CRESTCo will
re-submit the transaction to LCH for registration as a central counterparty
transaction at the time of the original transaction.

Settlement

14. The process of settlement of a central counterparty transaction is
separate from the clearing process.  Member firms may settle transactions in
the same way as today by using a CREST instruction matched with LCH, either
directly or via their settlement agent or GCM acting as settlement agent in
accordance with the rules.  As today, the settlement instruction may be used
as the transaction report by the member firm matching the trade on the order
book.

15. CREST will automatically create an instruction for the member firm or its
settlement agent to match with LCH, in accordance with the standing data it
holds in relation to central counterparty transactions.  

16. Member firms must give the Exchange 21 days notice of any proposed changes
to their settlement or clearing arrangements in accordance with rule 1.23.  

House/Client indicator

17. LCH rules allow their members to have two accounts in order to separate
the clearing of their proprietary business from their customer business. 
These are described as house and client accounts respectively.  This
separation is designed for the convenience of participants' client money
arrangements and does not alter LCH's principal relationship with the clearing
member.

CENTRAL COUNTERPARTY RULES

18. As a result of the introduction of the central counterparty, changes to
the Exchange's rules and guidance are required.  These relate to membership,
transaction reporting, default, corporate actions, contra processing,
house/client indicators and buying-in.

London Stock Exchange Membership

19. In order to clear on Exchange business, clearing members of LCH will also
need to be members of the London Stock Exchange.  A special category of
membership for new member firms wishing only to act as a GCM has been
introduced.  An existing London Stock Exchange member firm that wishes to
become a GCM or ICM should contact the Exchange's Market Access unit
(telephone [phone], or STX 33483) for advice on how to proceed.  

20. Such member firms must either be LCH clearing members or have applied to
become LCH clearing members and have been accepted in principle by LCH.

21. An existing London Stock Exchange member firm that wishes to become an NCM
will need to provide the Exchange with confirmation of its clearing
arrangements in order to continue to conduct transactions in central
counterparty securities on the order book. 

Transaction reporting

22. The underlying buying and selling parties to a central counterparty
transaction will be required to transaction report as today.  There will be no
requirement for other intermediary parties involved in central counterparty
transactions to submit transaction reports.  

23. Any collateral movements made for the purposes of meeting LCH's margin
requirements, involving securities falling within Stock Exchange rule 2.1,
will need to be transaction reported.  This will ensure that any relevant
Stamp Duty Reserve Tax relief can be obtained.  New markers are being
introduced to distinguish these reports as central counterparty collateral
movements.  Details are set out in the revised transaction reporting guidance
in attachment 3 to this Notice.

Default 

24. In order to comply with the Companies Act 1989, both the Exchange and LCH
are required to have default rules.  The following approach with regard to
default procedures for central counterparty transactions has been agreed. 

25. Where the Exchange declares a clearing member in default, it is envisaged
that the member firm would also be declared in default by LCH and vice versa. 
Stock Exchange market contracts ('contracts') for the purposes of Chapter 15
of the rules will include all central counterparty contracts.  The parties to
each relevant contract will be treated as follows.

26. In the event of a NCM default, all contracts to which the defaulting
member is a party will be dealt with under Chapter 15 of the Stock Exchange
rules.  For any NCM, ICM or GCM default, relevant agency contracts will be
dealt with under new rules allowing the GCM which is clearing the transaction
to either settle the transaction with the underlying client on the original
terms or close out the transaction by dealing in the market.  Contracts
between the defaulting party's clearing member, who is always a principal, and
LCH will stand.  

27. In the event of a clearing member default, contracts between the clearing
member and LCH will be dealt with under LCH rules.  In the first instance, LCH
will allow them to settle or transfer them to another clearing member.  If
this is not possible, LCH will close out the positions and contracts between
the clearing member and NCMs will be dealt with under Stock Exchange rules. 

Corporate actions

28. Member firms should refer to the CREST white book entitled 'Corporate
Actions: Central Counterparty' dated July 2000, for details of corporate
action processing. The Exchange has adapted its rules relating to the
time-scales for buyers' instructions in relation to optional events, so that
where LCH has mandated a last instruction date for electronic instructions, to
be implemented by CREST on its behalf, this is reflected in the Stock Exchange
rules.  

29. The rules which stagger buyers' instructions for elections where the
seller is a market maker have been extended to apply to any seller acting as
principal, in order to give those firms the extra time to pass on instructions
currently afforded to market makers only.  

Contra processing

30. Since the identity of the member firm matching an order is anonymous, a
new process has been introduced for contra transactions.  This process is
co-ordinated by the Exchange due to post-trade anonymity.

House / client indicators

31. The Exchange has introduced rules requiring member firms to identify, at
the point of order entry, whether the trade will be allocated to a house or
client account within LCH.  This has been done by introducing a number of new
dealing capacity indicators into the trading system.  A member firm may
arrange for all of its agency and/or principal business to be allocated to a
default house or client account.

Buying-in

32. The Exchange will continue to operate buying-in for central counterparty
transactions.  Some changes to the current procedures are required as a
consequence of post-trade anonymity.  Amended buying-in guidance notes will be
issued in due course.

CONSULTATION

33. Member firms are invited to comment on the proposed rule and guidance
changes set out in the attachments to this Notice by 23 November 2000.  A
further Notice will be issued at the end of the consultation period.




Andrew McStravick
Head of Market Operations

Any comments or queries on the general operation of the central counterparty
should be addressed to contacts as set out in the Service Implementation Guide
which is available at www.londonstockexchange.com/techlib/ and also from the
websites of CRESTCo and LCH.

Any comments or queries on this Notice should be addressed to Regulatory
Development, telephone [phone] (STX 33663) or 
Email: [e-mail].

This Stock Exchange Notice will be available on the website at
www.londonstockexchange.com/regulation/notices/


List of Attachments

Attachment 1 - proposed rules changes for central counterparty provisions
Attachment 2 - amendments to SETS guide
Attachment 3 - amendments to transaction reporting guide
Attachment 4 - amendments to domestic equity and AIM guide