Review of CCP collateral rules - letters of credit

Privacy statement

1: Overview

1.1. This consultation paper (CP) seeks views on the Bank of England’s proposals for updated rules that would permit central counterparties (CCPs) to accept uncollateralised letters of credit (LOCs) as collateral as well as the risk mitigants that CCPs would be required to implement if they chose to accept this type of collateral.

Interaction with UK CCP Rulebook

1.2. In June 2025, the Bank consulted on the draft UK CCP Rulebook (UK CCP Rulebook consultation) as part of the repeal and replace of UK EMIR with Bank rules. The Bank expects to publish its policy response and rules in 2026 Q4.

1.3. These rules will come into effect once HM Treasury (HMT) repeals Titles III to V of UK EMIR and the associated technical standards. From that point, the relevant CCP-facing requirements currently set out in UK EMIR will be replaced with Bank rules and they will no longer form part of the regulatory framework for CCPs. Accordingly, unless otherwise stated, references in this CP to the existing regulatory framework applicable to CCPs should be understood as references to the Bank's proposed rules set out in the UK CCP Rulebook consultation.

Background

1.4. Collateral is a critical part of CCPs’ risk management frameworks and is crucial to their resilience. CCPs collect two forms of collateral from clearing members: initial margin and variation margin. Initial margin is posted to cover potential future losses in the event of a clearing member default and if market prices move before the CCP is able to close out or hedge the defaulter’s positions. Variation margin is posted daily or intraday to reflect changes in the market value of open positions. This mechanism helps protect other market participants and minimises the risk of contagion spreading across the system in the event of a clearing member’s default.

1.5. A clearing member’s collateral represents the first line of defence in the default waterfall, which sets out the financial resources that would be used to absorb losses arising from a clearing member’s default. It is therefore important that collateral is high quality and can be realised quickly and at a reliable value. Otherwise, losses may be more likely to exceed defaulter’s contributions, increasing the likelihood that CCPs need to draw on mutualised resources through the default waterfall. Non-defaulting clearing members may then be required to replenish those resources, potentially creating additional liquidity pressures, particularly during periods of market stress.

1.6. The existing regulatory framework set out in the Collateral Part of the draft UK CCP Rulebook require CCPs to only accept highly liquid collateral with minimal credit and market risk.^{footnote [1]} The framework also specifies the types of instruments and assets that CCPs may accept as collateral and sets out the conditions for their eligibility. Eligible collateral comprises cash as well as financial instruments, bank guarantees and gold, provided these meet the conditions set out in the proposed rules. In practice, UK-based CCPs accept a subset of these assets as initial margin collateral but typically require that variation margin is met in cash.

1.7. This consultation paper focuses on initial margin collateral and does not consider the use of LOCs in relation to variation margin. Although the existing framework does not preclude CCPs from accepting non-cash collateral for variation margin, in practice CCPs collect variation margin in cash because cash can be readily used to meet current mark-to-market exposures as they arise. The Bank is not proposing changes to this practice and does not expect CCPs to accept LOCs as variation margin. Unless otherwise stated, references in this CP to eligible collateral and LOCs should therefore be understood as relating to their use in meeting initial margin requirements.

1.8. Bank guarantees are permitted as initial margin collateral under the existing framework but are not typically used by market participants in central clearing. Although the term ‘bank guarantees’ is not defined in the proposed UK CCP Rulebook, it is generally understood to mean an irrevocable right for the named beneficiary to receive a cash payment from the issuing bank for a pre-specified amount. In the context of central clearing, bank guarantees require the issuing bank to cover – up to a specified limit – the outstanding amount of a defaulter’s margin requirement owed to the CCP.

1.9. Under the existing regulatory framework, to be eligible as collateral, bank guarantees must be issued either by a commercial bank (‘commercial bank guarantees’) or a central bank and satisfy the requirements set out in rules 5 and 6 of the proposed Collateral Part. Where a bank guarantee is issued by a central bank, it must be denominated in a currency specified in the rules, be irrevocable and unconditional and ensure that the issuing central bank cannot rely on any legal or contractual exemption or defence to withhold payment. In addition, the bank guarantee must be capable of being honoured within the liquidation period of the defaulting clearing member’s portfolio and be free from any regulatory, legal or operational constraints as well as any third-party claims.

1.10. Bank guarantees issued by commercial banks must satisfy the same requirements as those issued by central banks as well as some additional conditions. In particular, the requirement that commercial bank guarantees must be fully collateralised and are issued to guarantee a non-financial clearing member. This means that, before a bank can issue a bank guarantee, the clearing member must provide collateral to the issuing bank, typically in the form of cash, equal to 100% of the bank's potential exposure under the guarantee.

1.11. The requirement for full collateralisation significantly reduces the economic benefit of using commercial bank guarantees in central clearing. Where a commercial bank guarantee must be fully backed by cash, it is simpler and more efficient to post that cash directly to the CCP.

1.12. The requirement that commercial bank guarantees can only be posted by non-financial clearing members means that non-financial firms that clear indirectly through a clearing member as clients are unable to use them. As most non-financial firms access CCPs as clients rather than clearing members, this restriction, together with the full collateralisation requirement, substantially constrains the practical use of commercial bank guarantees as collateral.

1.13. This is particularly relevant given the important role that non-financial firms play in derivatives markets. Non-financial firms use derivatives to manage financial risks stemming from their underlying business activities.

1.14. For example, in energy markets producers such as oil and gas companies enter into futures or forwards contracts to lock in the price at which they can sell their output in order to lock in a revenue for the energy they will deliver in the future. Energy suppliers buy energy and sell it to households and businesses. In addition, in the UK, to support consumers, their retail pricing is constrained by an energy price cap set by Ofgem. This can leave energy suppliers exposed when wholesale prices spike, compressing margins and creating acute liquidity pressure. This pressure can be intensified for smaller firms and those with a lower credit profile who may struggle to obtain liquidity. Energy suppliers hedge to protect themselves against high energy prices. At the same time, energy consumers, airlines and utilities use similar instruments to hedge against increases in energy costs.

1.15. During the energy crisis in 2022, participants of CCPs raised concerns about the narrow range of eligible collateral that can be accepted by CCPs and the impact this might have on firms’ ability to meet margin calls in times of stress amid price volatility. Box A highlights some of the liquidity pressures that firms experienced in 2022.

1.16. Stakeholder feedback suggests that, during the 2022 energy crisis, some firms responded by reducing their hedging activity to limit the immediate need to meet margin calls. These behaviours may reflect a constraint faced by many non-financial firms: most participate in clearing as clients and cannot post bank guarantees to meet CCP margin requirements. During periods of market stress, this may make it more difficult or costly to maintain hedging positions, contributing to reductions in clearing activity or hedging demand at the time when risk management is most important. From a financial stability perspective, this outcome is undesirable as reduced hedging can leave firms more exposed to adverse price movements and it increases counterparty credit risk, which in turn increases contagion risk.

1.17. In response to growing industry interest in broadening the set of eligible collateral by permitting LOCs, the Bank sought views in 2025 through the discussion section of its UK CCP rulebook consultation. Industry feedback was mixed. Respondents that supported permitting LOCs as eligible collateral noted that this could help alleviate liquidity pressures on firms and reduce the risk of firms scaling back hedging activity or shifting activity to the OTC market. Other respondents expressed cautious support, emphasising the importance of appropriate risk management safeguards to ensure the resilience of the clearing ecosystem. A few stakeholders noted that they were not supportive of permitting LOCs due to risks that may introduce. In particular, they highlighted the increased interconnectedness between CCPs and banks, which could act as a channel for risk transmission, especially if not properly risk managed. They also pointed to increased credit risk if LOCs cannot be converted into cash in a timely manner.

1.18. The Bank has carefully considered these views. In doing so, it has taken into account both the potential risks and benefits of expanding the range of collateral available to market participants to include LOCs, as well as the broader policy and regulatory developments introduced since the 2022 energy market stress episode to strengthen firms' ability to respond to liquidity shocks.

1.19. Since the 2022 energy crisis, there have been significant policy developments aimed at strengthening firms’ ability to anticipate liquidity needs, which would help reduce the risk of a reoccurrence of unexpected and significant liquidity pressures. In particular, international initiatives led by the Financial Stability Board (FSB), the Basel Committee on Bank Supervision (BCBS), the Committee on Payment and Market Infrastructure (CPMI) and the International Organization of Securities Commissions (IOSCO) have focused on improving the transparency and predictability of margin requirements and strengthening firms’ preparedness to meet margin calls during periods of stress.

1.20. The Bank is in the process of implementing these international reforms for CCPs as part of its work to replace UK EMIR with Bank’s proposed UK CCP Rulebook. Taken together, these developments should leave firms, including non-financial market participants, better equipped to prepare for, and meet, spikes in margin requirements through improved transparency, enabling better liquidity planning and stakeholder risk management practices.

1.21. Industry feedback suggests that the new CCP margin transparency requirements would improve firms’ ability to anticipate and manage their liquidity needs. However, some respondents noted that, during periods of stress, non-financial firms may still face difficulties sourcing cash or high-quality liquid assets needed to meet margin requirements as they do not typically hold large cash reserves or government bond portfolios. It was noted that, in such circumstances, greater flexibility in the range of eligible collateral could provide an additional source of liquidity and support the continued use of central clearing by non-financial participants.

1.22. In light of the feedback received, the Bank is consulting on whether to amend the existing framework to allow the acceptance of LOCs as eligible collateral for CCPs. Any such acceptance would be subject to safeguards designed to ensure that CCPs can continue to utilise collateral effectively and that the resilience of the central clearing system is maintained.

1.23. The Bank notes that it remains for CCPs to decide what they can accept as collateral within their own rulebooks. Additionally, non-financial market participants making use of this policy would remain responsible for managing their liquidity needs and would be expected to maintain robust risk management standards to ensure they can meet margin requirements under a range of market conditions, including in stress. The Bank nevertheless recognises the importance of minimising disruption during periods of market stress in support of financial stability. Permitting LOCs could reduce liquidity pressures on firms by covering some or all of their initial margin requirements. In normal times, this can mean firms need less cash to meet initial margin requirements. These benefits may extend into periods of stress where firms can continue to utilise their LOC. If initial margin requirements rise above the LOC value posted to a CCP, then the firm will now only need to find cash to cover the gap. Covering this ‘gap’ through additional finance may be comparably easier, and possibly cheaper, than if the firm was still also covering the LOC value in cash.

1.24. By reducing liquidity pressures on firms, LOCs could support firms’ ability to maintain economically beneficial hedging activity through continuing to access central clearing. Permitting the acceptance of LOCs as collateral is intended to complement, not substitute, prudent liquidity management.

1.25. This CP sets out policy proposals to update the CCP collateral framework to permit the acceptance of LOCs as collateral in the UK centrally cleared markets. This consultation is focused on commercial bank guarantees and does not propose changes to the acceptance of guarantees backed by central banks.

Scope

1.26. The proposed changes set out in this CP will apply to CCPs established in the UK. They will also apply to recognised non-UK CCPs determined by the Bank to be, or to be likely to become, systemically important to UK financial stability. Under the proposed changes, the decision to permit LOCs as collateral would remain with individual CCPs, enabling them to determine whether to accept such instruments under their internal risk management framework.

1.27. The proposals set out the conditions for accepting LOCs as eligible collateral. They are not intended to prescribe or affect the contractual arrangements between clients and clearing members. References to specific client-clearing member arrangements that support the provision of LOCs, such as the pass-through model, or collateral transformation, are included in this CP for illustrative purposes only to explain how LOCs operate in markets where they are currently accepted as collateral.

1.28. This consultation may also be of interest to other stakeholders, including:

• firms clearing or intending to clear as clearing members or as clients of clearing members within UK CCPs;
• non-UK CCPs that intend to provide clearing services in the UK, or who currently provide clearing services in the UK under post-Brexit transitional regimes, or who are recognised to provide clearing services in the UK;
• banks issuing bank guarantees or considering issuing LOCs for the purpose of meeting margin requirements; and
• industry groups and trade bodies.

Implementation and next steps

1.29. The Bank will publish the final policy in relation to proposals covered in this CP after considering feedback received in response to this consultation. The Bank proposes that the final rules will be published in 2027 H1.

1.30. The Bank proposes that there would be no implementation period and the updated rules would take effect upon coming into force of the final rules on the acceptance of LOCs as CCP collateral. An implementation period is not considered necessary as the proposals only impose new requirements on CCPs that choose to accept LOCs as collateral. Any CCPs wishing to accept LOCs would need to apply for the Bank’s permission in accordance with established supervisory processes. The final rules resulting from this CP would come into force no earlier than the date on which the UK CCP Rulebook takes effect.

1.31. This consultation closes on 15 January 2027. The Bank invites feedback on the proposals set out in this consultation. Please submit any comments or enquiries using the following CP response link or by emailing: LetterofCreditCPResponses@bankofengland.co.uk.

1.32. When providing your response, please tell us whether or not you consent to the Bank publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.33. Please also indicate in your response if you believe any of the proposals in this consultation paper are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

1.34. Your responses may be shared with HMT and the Financial Conduct Authority (FCA). This means HMT and the FCA may review the responses and may also contact you to clarify aspects of your response.

2: Proposals

Bank’s proposals

Terminology

2.1. The existing regulatory framework currently refers to ‘bank guarantees’ as a form of eligible collateral. This terminology reflects provisions retained from the onshored EU framework following the UK's withdrawal from the European Union and may not fully align with terminology commonly used in current market practice.

2.2. The Bank understands that the term ‘Letters of Credit’ is more widely used by market participants in the context of those issued by commercial banks. In addition, stakeholder feedback received in response to the UK CCP Rulebook consultation suggests that bank guarantees and LOCs may not be fully interchangeable terms, as they can differ in terms of their legal form and characteristics.

2.3. LOCs are instruments issued by commercial banks (an ‘issuing bank’) that create a right for the named beneficiary(s) to receive a cash payment from the issuing bank for up to a pre-specified amount upon request by the beneficiary. In the context of central clearing, LOCs are instruments issued by a commercial bank for a clearing member or a client to fund the payment of margin calls at the CCP. The Bank understands LOCs are typically unconditional, irrevocable and payable on demand. There are different LOC models and Box B provides an illustrative example of how LOCs typically operate in the context of central clearing.

2.4. Respondents also noted that LOCs are typically issued on the basis of internationally recognised standards and formats, such as the International Standby Practices, the Uniform Customs and Practice for Documentary Credits and the Uniform Rules for Demand Guarantees, all developed by the International Chamber of Commerce. These frameworks provide a high degree of operational consistency and legal certainty across jurisdictions.

2.5. The existence of well-established international standards and market-wide practice suggests that there are benefits in utilising these frameworks rather than seeking to develop new or bespoke approaches. To reduce legal uncertainty and better reflect industry practice, the Bank proposes to replace references to ‘commercial bank guarantees’ with ‘commercial bank letters of credit’ in the proposed Section 5 of the Collateral Part. For clarity, this CP uses the term ‘bank guarantees’ when referring to proposed rules set out in the UK CCP Rulebook consultation. The term ‘LOCs’ is used when describing the proposed approach set out in this CP.

2.6. The existing regulatory framework set out in the proposed Section 6 of the Collateral Part specifies conditions applicable to central bank guarantees. The Bank considers the existing terminology in that section to remain appropriate and does not propose making corresponding changes to Section 6.

2.7. LOCs are typically unconditional promises to pay that are triggered by a clearing member or client default. The Bank expects CCPs to draw on LOCs only following such a default and in accordance with their default management processes. However, the Bank does not expect CCPs to demonstrate a default to the issuing bank as a precondition for drawing on a LOC. LOCs should be capable of being redeemed promptly and without conditions to meet the ‘unconditional’ requirement in the existing rules. Any requirement to provide evidence of default to the issuing bank could delay access to cash and hinder the CCP’s ability to manage a default effectively. This should provide issuing banks with confidence that any drawdown reflects a default event without requiring separate evidence of default as a condition for payment. However, this does not mean that a CCP must draw on a LOC in every default scenario, as other measures may be available or appropriate in the circumstances.

2.8. To provide sufficient flexibility to accommodate a range of different clearing arrangements, the Bank does not propose to prescribe a standardised model or a template for LOCs. The Bank expects that CCPs who wish to accept LOCs as collateral develop their own robust, standardised contractual template for LOCs, which non-financial firms (also referred to as non-financial counterparties or ‘NFCs’ in this CP) and issuing banks would be required to use. Any LOCs arrangements accepted by CCPs would need to comply with the regulatory requirements. The Bank believes this would ensure legal certainty and make LOCs a reliable and robust form of collateral.

Question: Do you agree that references to ‘bank guarantees’ should be replaced with ‘letters of credit’ in the relevant Bank rules? Do you see any risks in updating the terminology?

Question: Do you agree that Bank rules should not prescribe contractual standards for LOCs?

Question: Do you have views on whether CCPs should only be able to draw on a LOC where a clearing member defaults? If not, are there any other circumstances in which drawdown should be permitted?

Question: Are there other LOC models used by market participants beyond those described in this CP? If so, please provide details.

Market participants who are eligible to post LOCs

2.9. Market participants may access central clearing either as clearing members or as clients. Clearing members must meet the membership criteria established by a CCP, including financial, operational and risk management requirements designed to ensure they are sufficiently robust to support the clearing process. Clearing members are typically large financial institutions, such as banks and broker-dealers. Other financial firms and non-financial market participants tend to access CCPs as clients.

2.10. Under the existing framework (rule 5.1 of the draft UK CCP Rulebook), CCPs may accept commercial bank guarantees only from NFCs that are clearing members. NFCs that participate in clearing as clients are not eligible to post commercial bank guarantees. This may limit the effectiveness of the framework as, in the UK, NFCs access clearing predominantly via client arrangements. Maintaining this restriction may continue to constrain the availability of LOCs for a segment of the market that may benefit most.

2.11. The Bank proposes to amend the existing framework to allow CCPs to also accept LOCs from NFCs participating in central clearing as clients. This would enable them to use, for example, a ‘pass-through’ model, whereby a clearing member will post the client’s LOC as collateral to the CCP. This would improve the practical usage of LOCs as collateral and support the continued use of central clearing by NFCs for hedging purposes by enabling greater flexibility in how collateral obligations are met.

Question: Do you have any comments on the proposal to permit non-financial counterparties clearing as clients to also post LOCs as collateral?

Collateralisation

2.12. Under the existing framework commercial bank guarantees can be posted by clearing members to CCPs as collateral only if they are fully backed by collateral. Industry feedback indicates that this significantly limits the economic viability of commercial bank guarantees as collateral: where a bank guarantee must be fully backed by cash, the clearing member must set aside cash and pay associated fees for being issued the guarantee. In such cases, it is operationally simpler and more cost-effective to post cash directly to the CCP.

2.13. There are currently no UK-based CCPs that accept commercial bank guarantees as collateral. This indicates that, despite being permitted under the existing framework, commercial bank guarantees have not been considered as an effective form of collateral. Prior to the entry into force of EMIR in 2012, there was no requirement in the UK for commercial bank guarantees to be fully collateralised and some UK-based CCPs accepted them as initial margin collateral. The Bank is therefore proposing to remove the collateralisation requirement.

Question: Do you agree with the proposal to remove the requirement for LOCs to be fully collateralised to be eligible as CCP collateral?

Risk mitigants

2.14. The acceptance of LOCs would be subject to robust risk mitigants to ensure that they perform as a reliable form of collateral across a range of market conditions, including in periods of stress. A number of these safeguards are already embedded within the existing framework. However, these mitigants have been designed for collateralised bank guarantees and may not fully capture the risks that uncollateralised instruments could introduce to CCPs and the wider system.

2.15. To reflect the specific risk profile of LOCs, the Bank is proposing a set of targeted enhancements to the draft Collateral Part of the UK CCP Rulebook, as outlined in this Chapter, to ensure that the overall resilience of CCPs is maintained.

Eligible issuers of LOCs

2.16. Under the existing framework CCPs may only accept a commercial bank guarantee as highly liquid collateral if it has been issued by an issuer that has a low credit risk based upon an adequate internal assessment performed by the CCP employing a defined and objective methodology that does not wholly rely on external opinions and takes into consideration the risks arising from the establishment of the issuer in a particular country. The Bank is proposing to maintain this requirement and proposes an amendment to 5.1(3) of the proposed Collateral Part, to change ‘issuer’ to an ‘authorised UK credit institution or an authorised overseas credit institution’, as defined in the proposed FMI Rulebook: Glossary Instrument 2025.^{footnote [2]}

2.17. The proposed amendment intends to ensure that LOCs accepted by CCPs as collateral are issued only by commercial banks that are authorised and subject to regulation and supervision. The Bank considers this would help support the reliability of LOCs as a form of collateral. The amendment would also provide greater clarity and consistency in terminology across the proposed Collateral Part. In particular, the proposed change would limit the scope of eligible issuers of LOCs to domestic and overseas credit institutions and therefore exclude overseas financial institutions that are not ‘authorised overseas credit institutions’. The Bank’s considers that overseas firms that issue LOCs would fall within the category of authorised overseas credit institutions. The Bank welcomes views on whether market participants agree with the proposal. The Bank also welcomes views on whether there are any types of overseas institutions that currently issue LOCs for collateral purposes which are not ‘overseas credit institutions’ and would therefore be excluded as a result of this amendment. For ease, we continue to use the term ‘issuing bank’ to refer to the eligible issuers of LOCs within this CP.

2.18. The Bank is also proposing to require CCPs to monitor, on an ongoing basis, the creditworthiness of the issuing banks from which they accept LOCs and take appropriate actions where an issuer's creditworthiness deteriorates. Such actions may, for example, include imposing additional limits, restricting further acceptance of LOCs from the issuer or requiring the replacement of existing LOCs with another form of eligible collateral.

2.19. The Bank considers that ongoing monitoring of issuers' creditworthiness is necessary to ensure LOCs remain robust collateral because the risk profile of an issuer may change over time. While a LOC may satisfy eligibility requirements at the point of acceptance by a CCP, a subsequent deterioration in the issuer's financial condition could increase the risk that the LOC would not perform as expected should it need to be redeemed.

Question: Do you agree that CCPs should accept LOCs only from authorised UK credit institutions or authorised overseas credit institutions? Are there any other domestic or overseas financial institutions that the Bank should consider including within the scope of eligible issuers? If so, please explain which institutions should be included and why.

Question: Do you agree that CCPs should monitor the creditworthiness of issuing firms they accept LOCs from on an ongoing basis?

Concentration limits and stress testing

2.20. The existing framework (rule 10.4 of the Collateral Part of the draft UK CCP Rulebook) requires CCPs to ensure that no more than 10% of its collateral that is in the form of commercial bank guarantees is guaranteed by a single credit institution, or a single financial institution that is based in a country or territory other than the UK, or by an entity that is part of the same group as the credit institution or financial institution. Where the collateral received by the CCP in the form of commercial bank guarantees is higher than 50% of the total collateral, this limit may be set up at 25%. The Bank proposes four amendments to this framework.

2.21. First, the Bank proposes a clarificatory change to rule 10.4 of the proposed Collateral Part to ensure that it more accurately reflects the original policy intent of the corresponding provision in the UK Commission Delegated Regulation (EU) No 153/2013. Rule 10.4 of the proposed Collateral Part could be interpreted as limiting exposures to a single issuer to 10% of the collateral held in the form of commercial bank guarantees. However, the original provision was intended to limit such exposures to 10% of the CCP’s total collateral posted. This unintentionally altered how the concentration limit would operate. The Bank is therefore proposing a change to clarify that the concentration limit as referred to in rule 10.4 of the proposed Collateral Part is calculated by reference to the CCPs’ total collateral posted.

2.22. Second, removing the collateralisation may give rise to additional risks, reflecting the lack of underlying assets backing the guarantee, and these risks would need to be appropriately managed. In particular, permitting LOCs as CCP collateral may increase liquidity risk at CCPs as realising the LOC’s value depends on the issuing bank meeting its payment obligation. They may also increase credit risk, as LOCs are unsecured commitments that expose CCPs to the creditworthiness of the issuing bank.

2.23. The Bank recognises that these risks would likely only impact once a CCP needs to redeem the LOC from the issuing bank. The CCP would only need to redeem the LOC in the event of the default of the clearing member (if it is the non-financial participant), or the concurrent default of the client (if it is the non-financial participant) and its clearing member, who would otherwise be expected to cover the client’s losses. The issuing bank will be subject to appropriate regulation and supervision which should support its resilience and ability to meet its payment obligations. Nonetheless, should the scenario arise where the CCP needs to redeem the LOC and the issuing bank is unable to meet its payment obligation, the impact on a CCP could be significant and could have broader financial stability implications.

2.24. These risks would therefore need to be appropriately managed to ensure that LOCs can operate as a robust and reliable form of collateral. To support this, the Bank proposes to strengthen the existing concentration limits by reducing the current 10% limit on collateral guaranteed by a single credit institution to 5%. This means that CCPs would not be able to accept LOCs issued by any single bank in excess of 5% of the total collateral held by the CCP. This would reduce concentration risk and limit the impact of the failure of an individual issuing bank on the CCP. As the current 10% limit applies only to collateral posted in the form of commercial bank guarantees, the proposed change would not affect concentration limits for other types of collateral accepted by CCPs.

2.25. Third, the Bank proposes to remove the option to increase the concentration limit to 25% that applies where commercial bank guarantees exceed 50% of total collateral. These changes aim to mitigate concentration risk by reducing CCPs’ reliance on individual issuers.

2.26. In addition, the Bank is proposing to delete the reference to ‘single financial institution that is based in a country or territory other than the UK’. This amendment is consequential to the proposed changes to rule 5.1 (3) of the proposed Collateral part. As set out in paragraph 2.15., the Bank proposes to limit eligible issuers of LOCs to authorised UK credit institutions and authorised overseas credit institutions. The proposed deletion aims to ensure that rule 10.4 of the proposed Collateral Part is consistent with the scope of eligible LOC issuers set out in Rule 5.1.

2.27. The Bank will be expecting CCPs to factor LOCs into their stress testing in line with the existing framework. This aims to ensure that stress scenarios capture the potential impact of defaults of issuing banks, delayed drawdowns or the simultaneous need to replace multiple LOCs.

2.28. CCPs should also assess whether they would continue to hold sufficient prefunded financial resources to meet the Cover 2 requirement under severe but plausible stress scenarios, including scenarios involving the failure of LOC issuers that the CCP has largest exposures to. This would help ensure that the acceptance of LOCs as collateral does not undermine the CCP's ability to manage member defaults or maintain financial resilience during periods of market stress.

Question: Do you have any comments on the proposed changes to concentration limits?

Legal safeguards

2.29. The existing framework outlines legal safeguards that commercial bank guarantees must meet to be eligible collateral. In particular, such guarantees must be irrevocable, unconditional and the issuing bank cannot rely on exemption or defence to oppose the payment of the guarantee. The issuing bank must honour the guarantee, on demand, within the liquidation period for the defaulter’s portfolio, without any regulatory, legal or operational constraint that could delay or prevent payment.

2.30. The Bank proposes to retain these requirements without change. These safeguards will continue to ensure that LOCs accepted by CCPs allow CCPs to be in a strong legal position to be able to draw on LOCs promptly and with certainty in the event of a default.

2.31. The Bank proposes two further requirements for LOCs to be eligible as collateral. First, before accepting a LOC as collateral, a CCP would be expected to carry out appropriate due diligence, which should include running validation checks with the issuer to ensure the authenticity and validity of the LOC. These validations checks could for instance include contacting the issuing bank directly to confirm that the LOC was issued by that bank, that it covers the stated amount and that it can be drawn on unconditionally and on demand in accordance with its terms. The Bank understands that similar checks are already used in other areas of the financial sector and is seeking views on whether the existing market practices could be adopted by CCPs as part of their due diligence process and what other measures may be necessary to ensure that validation checks are effective. A CCP should complete validation checks before accepting the LOC as collateral. This requirement is intended to mitigate the risk of fraud. It would also provide CCPs with greater assurance that a LOC is capable of being relied upon in a default scenario.

2.32. Second, certain LOC models may give rise to additional liquidity risks. For example, some pass-through LOC arrangements, where both the clearing member and the CCP are named as beneficiaries, may allow the clearing member to draw on the LOC in the event of a client default where the clearing member is responsible for covering the client’s losses. In such cases, the clearing member could exercise its rights to the LOC, reducing or exhausting the LOC amount available to the CCP should the clearing member also default. If not appropriately mitigated, these arrangements give rise to liquidity risk.

2.33. To mitigate this risk, the Bank proposes to require CCPs to ensure that any drawdown of an LOC by a clearing member is subject to the CCP’s prior consent. Clearing members remain responsible for posting adequate collateral at all times. Following any drawdown, the clearing member is responsible for restoring the collateral posted to the CCP to its original level. This helps ensure that an appropriate amount of collateral is available to the CCP in the event of a clearing member default.

2.34. The Bank notes that the issuance of LOCs give rise to prudential capital requirements for issuing banks, which would absorb losses for the issuer in the event the recipient of a LOC defaults. The Prudential Regulation Authority (PRA) considers that LOCs of the type described in this CP would have the character of credit substitutes. Under the PRA’s implementation of the Basel 3.1 standards, irrevocable standby letters of credit having the character of credit substitutes will be subject to a 100% credit conversion factor.^{footnote [3]}

2.35. Accepting LOCs in omnibus accounts may give rise to additional considerations. In the event of a clearing member default and porting is not successful, the CCP would liquidate clients’ positions. Collateral in the account may be used to cover losses in accordance with the default management and client asset arrangements. The Bank welcomes views on whether the use of LOCs in omnibus accounts could give rise to additional risks and how these risks could be managed.

2.36. Another consideration relates to the transferability of LOCs where clients’ positions are ported. In these circumstances, changes to the LOC may be needed if a back-up clearing member wishes to become a beneficiary of a LOC in lieu of the defaulted clearing member. The Bank recognises that such arrangements would be addressed contractually between the relevant parties, and the process may involve coordination between clients, clearing members and issuing banks within the timeframes available for porting. The Bank also notes that it remains the responsibility of market participants to meet margin requirements and manage their collateral, including in the event of porting. The Bank welcomes views on whether this could create challenges in practice and how they could be managed.

Question: Do you have views on the proposed changes to require CCPs to undertake due diligence, including validation checks with the issuer confirming the authenticity and validity of LOCs? What validation checks should CCPs perform to ensure that a LOC is authentic to mitigate the risk of fraud?

Question: Do you agree the clearing member should be permitted to draw on LOCs as a joint beneficiary only with the prior consent of the CCP?

Question: Do you consider that the use of LOCs in omnibus accounts could give rise to additional risks? Please explain any risks that could arise and how they could be managed.

Question: Do you see any challenges associated with the transfer or replacing of LOCs in the context of porting? If so, how could they be managed?

Question: Do you consider there to be any residual or other risks which could arise from permitting CCPs to accept LOCs as collateral, taking into account the proposed risk mitigants, if so, please set this out?
Question: Are there any unintended implications or implementation barriers arising from the proposed requirements that the Bank should consider?

3: Legal requirements

The Bank’s objectives analysis

3.1. The Bank considers that permitting LOCs as eligible collateral would support its financial stability objective by reducing liquidity pressures on non-financial participants active in central clearing. By lowering the amount of cash needed to meet margin requirements, LOCs could help firms maintain access to central clearing and continue hedging activity.

3.2. In normal market conditions, the impact on financial stability is expected to be broadly neutral, however allowing LOCs for business-as-usual use would help ensure they are in place during stressed market conditions. As firms may struggle to obtain new LOCs in stress, existing LOCs could provide a reliable source of collateral when liquidity pressures are most acute.

3.3. The acceptance of LOCs can give rise to specific risks which, if not properly managed, could have implications for financial stability. The proposed mitigants are intended to address these risks by ensuring that LOCs are a robust form of collateral and can perform effectively across a wide range of market conditions, including during periods of stress.

3.4. The proposed changes would also advance the Bank’s secondary innovation objective, which requires us to act in a way that facilitates innovation in the provision of FMI services with a view to improving their quality, efficiency and economy. The Bank considers that the proposals would improve the quality of clearing services by increasing the flexibility of collateral arrangements available to clearing members and their clients, particularly NFCs. The proposed changes would also improve economic efficiency by reducing the costs associated with meeting margin requirements, thereby lowering the cost of accessing central clearing and so supporting hedging activity.

‘Have regards’ and recommendations analysis

3.5. In developing these proposals, the Bank has had regard to all the matters it is required to have regard to, including the ‘have regards’ set out under the Bank of England Act. The Bank has also had regard to the factors it is required to consider, including the importance of facilitating innovation, set out by the government in its remit letter of 1 July 2025.

‘Have regards’

3.6. The following factors, to which the Bank is required to have regard, were most significant in the Bank’s analysis of the proposal:

3.7. The need to use the Bank’s resources in the most efficient and economical way: Under the proposed rule 13.4 of the UK CCP Rulebook, a CCP must obtain the Bank’s permission before accepting a new type of collateral. The proposed draft statement of policy on supervisory processes sets out the relevant process. The Bank would therefore expect CCPs seeking to accept LOCs as collateral to apply for permission as established within this existing framework. The Bank is not proposing to introduce a separate permission regime for LOCs. This approach would support the efficient use of supervisory resources by relying on established process for the assessment of new types of collateral.

3.8. The principle that a burden or restriction which is imposed on a person, or on the carrying on of an activity, should be proportionate to the benefits, considered in general terms, which are expected to result from the imposition of that burden or restriction: There would be no obligation for CCPs to accept LOCs as collateral; each CCP would decide whether accepting LOCs aligns with their own risk appetite and risk management framework. The proposed amendments are therefore targeted and proportionate to address the incremental risks arising from the lack of collateralisation associated with LOCs, while limiting additional operational and compliance burden.

3.9. The desirability of sustainable growth in the economy of the United Kingdom in the medium or long term: Permitting LOCs as collateral would incentivise greater participation by non-financial firms in central clearing, enabling them to manage risk more efficiently and effectively than in bilateral markets. In turn, this would help reduce the likelihood of disruption to real economy firms in response to adverse market movements. By facilitating more effective hedging, the proposal could lower the risk of losses that might otherwise arise where firms remain unhedged or where risk management is less robust, thereby supporting the resilience of the UK economy. The proposal would also reduce other liquid assets committed to central clearing, allowing non-financial firms to deploy those assets towards productive economic activity, such as investments in infrastructure, rather than holding them to meet collateral requirements.

3.10. The desirability where appropriate of the Bank exercising its FMI functions in a way that recognises differences in the nature of, and objective of, businesses carried on by different persons: We have considered that while CCPs operate in different markets and asset classes, the nature of their businesses are not fundamentally different, and so it is appropriate to set a consistent approach that would apply to any CCP that wishes to expand the scope of collateral. Acceptance of LOCs would remain optional and CCPs may choose not to accept this form of collateral where it does not align with their business model, risk appetite, or the nature of their activities. Given that the acceptance of LOCs as collateral would be limited to non-financial firms, in practice only CCPs that clear products used by those participants would be likely to accept LOCs as collateral.

3.11. The principle that the Bank should exercise its functions as transparently as possible: CCPs would need to seek the Bank’s approval to be able to accept LOCs as eligible collateral in line with the supervisory process relating to model reviews. To ensure transparency, the statement of policy on supervisory processes sets out what information CCPs would need to submit and factors that the Bank will consider.

3.12. The desirability of facilitating fair and reasonable access to FMI services: This policy change supports fair and open access to CCPs by encouraging greater participation by providing non-financial clearing members and clients with another option for meeting margin calls, including during times of stress or volatile pricing.

HMT remit letter recommendations^{footnote [4]}

3.13. In the remit letter from the Chancellor of the Exchequer to the Bank on 1 July 2025, the Chancellor recommended that the FMIC should have regard – in the exercise of its FMI functions – to the government’s policy towards the financial services sector. As part of this the FMIC should have regard to:

• The vital role UK FMIs play in protecting and upholding the financial stability of the UK, as well as other global markets.
• The importance of actively facilitating innovation in FMIs so that incumbents and new entrants are able to innovate responsibly and scale up new technology and processes in the UK.
• The role of proportionate regulation in facilitating growth.
• Streamlining administrative burdens and processes for FMIs to offer new products and services where possible, while maintaining high regulatory standards.
• Maintaining and enhancing the UK’s position as a world-leading global finance hub and demonstrating continued leadership in global regulatory fora.

3.14. We have had regard to the letter and the recommendations contained in it. We consider that our proposals in this CP reflect an appropriate balance of these objectives and a more proportionate approach to regulation.

3.15. The importance of actively facilitating innovation in FMIs so that incumbents and new entrants are able to innovate responsibly and scale up new technology and processes in the UK: By permitting CCPs to accept additional types of collateral, the proposal could encourage the development of more efficient collateral and liquidity management practices, supporting the efficiency and quality of services provided by CCPs.

3.16. The role of proportionate regulation in facilitating growth. By removing the requirement for LOCs to be fully collateralised, while retaining appropriate risk mitigants, the proposal seeks to address a constraint on the acceptance of LOCs as collateral by NFCs. This could reduce liquidity pressures on non-financial firms, enabling them to continue to manage commercial risks through cleared derivatives markets. In doing so, the proposal would support economic activity while maintaining the resilience of CCP risk management frameworks.

Equality and diversity

3.17. The Bank considers that the proposals do not have equality and diversity implications.

Cost benefit analysis

Overview

3.18. The Bank has undertaken cost benefit analysis (CBA) for its proposals in line with the approach set out in the Bank’s approach to cost benefit analysis and has consulted the CBA Panel (‘the Panel’). In line with this approach, the Bank has used a Standard Cost Model to quantify direct costs to firms based on standardised industry data for staff costs and estimates of staff time needed to implement proposals.

3.19. Our baseline scenario for the CBA is the current framework, under which LOCs are not permitted as CCP collateral. The Bank considers that the overall costs and benefits of intervention through this policy outweigh those of maintaining the current framework.

CBA Panel feedback

3.20. The Bank consulted the CBA Panel on 10 September 2026. The Panel provided advice on framing the proposed policy impacts. The Panel acknowledged the voluntary nature of the policy proposal and focused its feedback on the broader market implications associated with this policy as part of the CBA. In particular, the Panel advised that the Bank structures its analysis along the lines of considering the private costs and benefits associated with the policy as well as the public costs and benefits, rather than strictly by industry participant. The CBA section has been modified to address the Panel’s feedback.

Private benefits and costs

3.21. When considering private benefits and costs to CCPs and market participants, the Bank considered both one-off ‘implementation’ costs, including familiarisation costs, and any ongoing costs incurred to maintain compliance in future years. The Bank also considered the wider public benefits and costs to financial stability.

3.22. The Bank notes that the proposal would not require CCPs to accept LOCs as collateral, nor would it require market participants to post them. CCPs that choose to accept LOCs and market participants that choose to post LOCs would do so because they judge that the private costs of doing so are outweighed by the benefits. Those who do not consider the costs outweigh the benefit can continue with their current arrangements.

3.23. Benefits to CCPs. Permitting LOCs as collateral, where CCPs choose to do so, would provide greater flexibility in terms of type of assets they accept as collateral and enable them to better accommodate the needs of NFCs.

3.24. Costs to CCPs. There would be one-off compliance costs for CCPs associated with familiarising themselves with the policy changes, assessing and updating their current practices against the updated requirements to comply with the policy. The largest one-off costs are expected to arise from updating the existing collateral arrangements to ensure appropriate risk mitigants are in place. This would include updating issuer concentration limits, developing CCPs’ internal policies for the selection and monitoring of issuing banks, and updating contractual arrangements, such as developing standardised LOC documentation. The Bank estimates that the total one-off costs incurred by a CCP that chooses to accept LOCs as collateral would be approximately £605,000–£620,000.

3.25. There would also be ongoing annual costs to CCPs to maintain the arrangements to comply with the requirements for LOCs. This would for instance include a cost of carrying out due diligence and running the validation checks to ensure the validity of the LOC. The Bank estimates that the baseline annual ongoing costs incurred by a CCP that chooses to accept LOCs as collateral would be approximately £3,500–£5,000. The Bank would expect ongoing costs to increase depending on the number of LOCs a CCP chooses to accept.

3.26. Benefits to market participants. Permitting LOCs would expand the range of eligible collateral available to market participants, allowing these firms to meet initial margin requirements through a broader mix of cash and non-cash assets. This would lower NFCs’ reliance on cash and could reduce the cost of accessing central clearing. Another benefit is potential cost savings. Stakeholder feedback suggests that LOCs may be less costly for NFCs than alternative liquidity arrangements. This may reflect the fact that issuing LOC does not require the issuing bank to provide cash at the time of issuance.

3.27. These benefits are likely to accrue primarily to a subset of the NFC population who view obtaining a LOC commercially viable and have a sufficiently strong credit profile to secure a LOC from banks. Stakeholder feedback indicates that the issuing banks’ appetite to issue LOCs is likely to be limited to creditworthy NFCs with whom they have established relationships.

3.28. Costs to market participants. There will be one-off compliance costs for NFCs that choose to post LOCs as eligible collateral as well as clearing members who have client clearing arrangements with NFCs. These costs would arise from familiarising themselves with the policy changes, assessing and updating current practices against the new requirements. NFCs would also incur costs associated with arranging LOCs, such as fees charged by issuing banks. These costs are expected to vary depending on the NFC’s individual circumstances, banking relationships, creditworthiness and broader market conditions, including prevailing interest rates. The Bank estimates that the total one-off for an NFC that chooses to obtain a LOC as collateral would be approximately £40,000–£55,000.

3.29. There would also be ongoing annual costs to NFCs. LOCs tend to be issued for a certain period; the NFC will continue to face costs associated with acquiring a new or renewing their existing LOC. These costs may vary depending on the individual circumstances, banking relationships, creditworthiness and broader market conditions. The Bank estimates that the baseline annual ongoing costs for an NFC that chooses to obtain a LOC as collateral would be approximately £2,500–£3,500. The Bank would expect ongoing costs to increase depending on the number of LOCs a market participant chooses to obtain and post to a CCP.

3.30. Costs to issuing banks. For issuing banks that choose to offer LOCs to NFCs under the proposed framework they will receive revenue from doing so but they will also face one-off familiarisation costs. Issuing banks may also incur ongoing costs associated with providing LOCs, including capital and risk management costs in line with the regulatory expectations they are subject to. As these costs may vary across issuing banks, the Bank has not estimated the one-off and ongoing cost to those issuing banks that would arise from the proposal.

Public benefits and costs

3.31. CCPs’ and market participants’ individual decisions on LOCs will be influenced by different cost and benefit factors to those of the Bank. In assessing the costs and benefits of the proposal, the Bank’s primary consideration is the impact on financial stability. On balance, the Bank judges that there are financial stability benefits to providing non-financial participants with the ability to use LOCs as collateral for central clearing when this is done in a way which manages the associated risks, as proposed.

3.32. The financial stability benefit is primarily through supporting NFCs participation in central clearing and hedging activity by providing NFCs with an additional means to diversify the collateral they post. The use of LOCs could also introduce risks to the CCP and to financial stability more broadly. Given CCPs’ roles in the financial system, they are expected to manage their own risk, including through the mitigants set out, and will consider their own appetite for accepting LOCs.

3.33. Acceptance of LOCs could also introduce broader risks to financial stability, including through greater interconnectedness between CCPs and the banking sector. The scale of this will likely not be apparent for individual firms involved in issuing, posting or accepting LOCs. The Bank’s proposed policy sets out risk mitigants to address this too. Taking these safeguards into account, the Bank considers that the overall financial stability benefits of the proposal would outweigh its costs.

Costs to the Bank

3.34. The Bank would incur resource costs associated with assessing applications from CCPs seeking permission to accept LOCs as collateral in line with the established supervisory process. This would typically include reviewing CCPs’ proposed collateral arrangements and their risk management frameworks. The Bank would also incur ongoing supervisory costs in monitoring the acceptance of LOCs and overseeing CCPs’ collateral arrangements to ensure they continue to comply with the requirements. These costs would arise from regular supervisory engagement, the review of relevant information and the assessment of any subsequent changes to CCPs’ collateral framework.

Question: Do you have any comments on the CBA undertaken by the Bank?

Annexes