2012/13 Assessment of ASX Clearing and Settlement Facilities B1.2 ASX Clear (Futures)

Standard 6: Margin

A central counterparty should cover its credit exposures to its participants for all products through an effective margin system that is risk based and regularly reviewed.

Rating: Broadly observed

ASX Clear (Futures) applies initial and variation margin to derivatives exposures, using margin systems that are tailored to the particular attributes of the cleared products (CCP Standard 6.1). Timely price data are available for most products subject to ASX Clear (Futures)' margin systems, and ASX Clear (Futures) applies appropriate models to estimate prices when timely and reliable data are not available (CCP Standard 6.2). ASX Clear (Futures)' margin models ensure that initial margin meets a single-tailed confidence level of at least 99 per cent of the estimated distribution of future exposure, applying appropriate and conservative assumptions regarding close-out periods, product risks, portfolio effects and product offsets to limit the need for procyclical changes (CCP Standards 6.3, 6.5). In addition, ASX Clear (Futures) applies variation margin to derivatives positions daily, and may call intraday margin in the event of significant market movements (CCP Standard 6.4).

ASX Clear (Futures) conducts daily checks of initial margin against variation margin requirements and performs an annual review of margin policy. ASX Clear (Futures) implemented an enhanced backtesting regime in July 2013, but is still in the process of implementing its standards for comprehensive validation of its margin models, and developing its approach to sensitivity analysis of those models (CCP Standards 6.6, 6.7). The operating hours of ASX Clear (Futures)' margin systems are consistent with those of related payment and settlement systems in Australia (CCP Standard 6.8). In anticipation of the Bank's supplementary interpretation of CCP Standard 6.3, ASX Clear (Futures) applies a 99.5 per cent confidence interval and a longer (five day) close-out period to its calibration of margin for OTC derivatives (see Section 3.7).

The Bank notes the following steps that ASX Clear (Futures) should take to fully observe CCP Standard 6:

• Implement plans to conduct monthly sensitivity analysis of material model assumptions (CCP Standard 6.6).

The Bank will also monitor annual validation and ongoing review of margin and stress-testing models under the ASX Model Validation Standard, and the implementation and further enhancement of the new margin backtesting regime (CCP Standards 6.6, 6.7).

Based on this information, the Bank's assessment is that ASX Clear (Futures) has broadly observed the requirements of CCP Standard 6 during the 2012/13 Assessment period. ASX Clear (Futures)' margin system is described in further detail under the following sub-standards.

6.1 A central counterparty should have a margin system that establishes margin levels commensurate with the risks and particular attributes of each product, portfolio and market it serves.

ASX Clear (Futures) applies initial and variation margin to all derivatives products.

Exchange-traded derivatives

ASX Clear (Futures) has adopted the widely used CME SPAN methodology for calculation of initial margin. For exchange-traded derivatives products, initial margin is calibrated so as to cover three standard deviations of the 60-day historical distribution of price movements. ASX Clear (Futures) also evaluates margin rates against multiple look-back periods, incorporating both short- and long-term periods (7 business days, 120 business days and 12 months). Margin calculations are based on a two-day close-out period, based on what ASX considers to be a conservative estimate of the time required to close out the exchange-traded positions.^[1] Initial margin provides cover in the event that a participant defaults and an adverse price change occurs before the CCP can close out the participant's positions. All margin rates are reviewed on a three-monthly cycle, supplemented with ad hoc reviews during especially volatile market conditions. ASX Clear (Futures) also levies variation margin on positions to cover gains or losses arising from price movements over the preceding day.

OTC derivatives

ASX Clear (Futures) margins OTC derivatives portfolios, including interest rate futures that participants have allocated for cross-margining, using a historical VaR model. The VaR margining system is calibrated so as to cover three standard deviations of the five-year historical distribution of five-day price movements. By calculating initial margin requirements on a portfolio basis using the historical distribution of price movements, this methodology adjusts for observed price volatility and correlation. The five-day close-out period reflects the lower liquidity in OTC derivatives markets. This approach is closely aligned with the methodology used at existing international OTC derivatives CCPs.

6.2 A central counterparty should have a reliable source of timely price data for its margin system. A central counterparty should also have procedures and sound valuation models for addressing circumstances in which pricing data are not readily available or reliable.

ASX Clear (Futures) has access to timely price data for its exchange-traded products.

To value OTC derivatives products it clears, ASX Clear (Futures) uses a range of BBSW, ICAP and Reuters pricing points, as well as the official cash rate, pricing from 90-day bank bill futures contracts, and swap yields for contracts greater than three years. These sources provide sufficient pricing points to value the OTC derivatives products that ASX Clear (Futures) clears, even when some pricing data are not readily available or reliable. Participants will be given all information necessary to create the end-of-day yield curve, and independently calculate the net present value of any contract. Although the system can accommodate hourly updated pricing, ASX Clear (Futures) is implementing a system of manually ‘approved’ prices, and will focus on end-of-day and midday updates to ensure that valuation is based on prices that accurately reflect market pricing. ASX Clear (Futures) will consider introducing more frequent price updates as the service develops.

6.3 A central counterparty should adopt initial margin models and parameters that are risk based and generate margin requirements sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default. Initial margin should meet an established single-tailed confidence level of at least 99 per cent with respect to the estimated distribution of future exposure. For a central counterparty that calculates margin at the portfolio level, this requirement applies to each portfolio's distribution of future exposure. For a central counterparty that calculates margin at more granular levels, such as at the sub-portfolio level or by product, the requirement should be met for corresponding distributions of future exposure. The model should: use a conservative estimate of the time horizons for the effective hedging or close out of the particular types of products cleared by the central counterparty (including in stressed market conditions); have an appropriate method for measuring credit exposure that accounts for relevant product risk factors and portfolio effects across products; and to the extent practicable and prudent, limit the need for destabilising, procyclical changes.

Exchange-traded derivatives

ASX Clear (Futures) calculates initial margin requirements using the CME SPAN methodology. The CME SPAN methodology calculates initial margin requirements that reflect the total risk of each portfolio – for ASX Clear (Futures), house and client accounts are considered separate portfolios. The key parameters in the CME SPAN methodology are the ‘price scanning range’ (PSR) and ‘volatility scanning range’ (VSR). These scanning ranges are calibrated to the distribution of price and volatility movements for a set of related contracts under normal market conditions. The scanning ranges are used to construct a set of 16 hypothetical risk scenarios used to measure the loss from a portfolio caused by a range of changes in price and volatility. For example, in one risk scenario, price increases by one-third of the PSR and volatility falls by the full VSR, while in another scenario price falls by the full PSR and volatility rises by the full VSR.

ASX Clear (Futures) sets the scanning ranges at three standard deviations (a confidence interval of 99.7 per cent) of 60 days of historical data, using the higher of one- or two-day price movements. The sample period reflects a preference for incorporating recent market conditions. The inclusion of two-day price movements reflects a conservative assumption that a defaulter's positions may take up to two days to close out. ASX also evaluates margin rates against multiple look-back periods incorporating both short- and long-term periods (7 business days, 120 business days and 12 months).

ASX Clear (Futures) also applies a series of adjustments within CME SPAN to account for correlations and specific risks. First, there is an upward adjustment to the margin requirement for a given set of related contracts, to account for less-than-perfect correlation between contracts with different expiries (known as the ‘intra-commodity spread charge’). This adjustment is based on a participant's actual net position at each expiry month multiplied by an ‘intra-commodity charge rate’, which is itself based on observed price correlations between the different expiries. The default setting is to apply a single charge rate, although for some contracts ASX utilises CME SPAN's charge-rate tiering functionality, which allows charge rates to vary depending on the temporal difference in the pair's expiries.

ASX Clear (Futures) also applies offsets designed to account for reliable and economically robust correlations across different contract types (see CCP Standard 6.5). These ‘inter-commodity spread concessions’ reflect that, while the scanning risk for each combined commodity is set based on the worst-case risk scenario for that combined commodity, it may be highly unlikely that the set of worst-case scenarios will occur simultaneously. This is particularly the case if a participant holds net long and net short positions in different combined commodities that have a robust positive correlation. The inter-commodity spread concession is calculated by applying (in a defined order) a spread ratio and concession rate to a participant's actual net positions in pairs of combined commodities. The spread ratio determines the number of net positions in one combined commodity required to offset a position in another combined commodity. The concession rate is specified as a percentage of the scanning risk for both combined commodities in the pair. For example, at ASX Clear (Futures), for 10-year bond futures relative to 90-day bank bill futures, a spread ratio of 1:4 and a concession rate of 65 per cent would mean that one net position in the 10-year bond contract is offset against four net positions in the 90-day bank bill contract, and that the concession for that pairing will be 65 per cent of the scanning risk of the combined commodities used in the offset. ASX calculates these parameters in the same manner as the price movement for the intra-commodity spread charge.

In addition, ASX Clear (Futures) applies an adjustment to cover its exposure on the day of contract expiry, since expiring positions are otherwise not included in that day's initial margin calculations. ASX also maintains a minimum margin requirement on short positions to ensure the collection of margin on deep out-of-the-money options that would otherwise return no scanning range.

Under the ASX Margin Rate Setting policy, the Manager or General Manager of ASX's CRM unit can approve adjustments to margin rates if the standard statistical analysis would result in an economically inappropriate outcome. This may be required if the backward-looking statistical analysis does not take appropriate account of expected future price movements. Other reasons for using management discretion include insufficient historical data (e.g. where a product is new), seasonality in some products, and isolated spikes in price movements that result in a distortion of statistical recommendations. The ASX Margin Rate Setting policy also allows the General Manager of Clearing Risk Policy to approve exceptions to the normal margin rate setting process based on a broader risk assessment.

OTC derivatives

ASX Clear (Futures) uses historical VaR to calculate margin requirements for OTC derivatives, based on a five-year sample period with an assumed close-out period of five days, and sets initial margin based on a 99.7 per cent confidence interval, consistent with the Bank's supplementary interpretation of this sub-standard (see Section 3.7). To ensure that the methodology remains conservative, ASX Clear (Futures) will continue to include the extreme observations from the quarter ending in December 2008 for margin calibration purposes, even when they fall outside of the five-year window.

6.4 A central counterparty should mark participant positions to market and collect variation margin at least daily to limit the build-up of current exposures. A central counterparty should have the authority and operational capacity to make intraday margin calls and payments, both scheduled and unscheduled, to participants.

Margin requirements for both futures and OTC participants are calculated overnight, with variation margins based on closing prices each day, and notified to participants the next morning. All margin obligations are settled via Austraclear and regular calls must be met by 11.00 am.

ASX Clear (Futures) may make intraday calls where there is significant erosion in the margin cover provided by individual participants. Intraday margin calls reflect changes in participants' positions and price movements.

• For exchange-traded products, intraday margin calculations are carried out routinely at 8 am and 12 pm each business day. An ad hoc calculation may also be performed if the change in price of an individual contract exceeds 100 per cent of its margin rate (the PSR in CME SPAN), as ASX Clear (Futures) tracks the price movements of all contracts in real time through the day. To determine if intraday margin is required, a nominal call amount is calculated for each portfolio of the participant (house and client) based on the combined initial and variation margin that would be due at the time of the intraday calculation. This is then compared against the total margin posted by the participant. If the margin has eroded by more than 40 per cent of total margin held, and if the nominal call amount is greater than $100,000 and the participant has not already lodged excess collateral sufficient to cover the nominal amount, then an intraday call is made. Participants are notified of the call by phone and email, and must make the payment within two hours of notification.
• For OTC derivatives positions, including cross-margined futures, ASX Clear (Futures) recalculates its exposures to participants on an approximately hourly basis. In the event that ASX Clear (Futures)' exposure to any OTC participant has risen beyond a specified threshold, intraday margin will be called (see CCP Standard 4.2).

Under ASX Clear (Futures)' AIM methodology (discussed above in relation to CCP Standard 4) a participant is required to post additional collateral should stress-test outcomes reveal that the potential loss arising from its positions, as at the close of the previous day, exceeds a predetermined STEL or if participants have large portfolios relative to their capital (see CCP Standards 4.3 and 4.7).

Where margin payments are not made by the required time, ASX will contact the participant to determine the reasons for the delayed payment. Delayed payments are commonly the result of communication or technical issues involving the participant and/or its payment provider, and early communication by ASX is intended to ensure that, in such cases, payment can still be made within a short period of the required time. Where the matter is more serious, ASX will investigate to decide whether a default event should be declared, and if so how the default should be managed (see CCP Standard 12).

6.5 In calculating margin requirements, a central counterparty may allow offsets or reductions in required margin across products that it clears or between products that it and another central counterparty clear, if the risk of one product is significantly and reliably correlated with the risk of the other product. Where a central counterparty enters into a cross-margining arrangement with one or more other central counterparties, appropriate safeguards should be put in place and steps should be taken to harmonise overall risk management systems. Prior to entering into such an arrangement, a central counterparty should consult with the Reserve Bank.

In applying the CME SPAN methodology to futures transactions, ASX allows offsets in the form of ‘inter-commodity spread concessions’ (see CCP Standard 6.3). These offsets reduce margin requirements to account for reliable and economically robust correlations observed across different ‘combined commodities’ – sets of contracts related to the same underlying. Inter-commodity spread concessions are only applied where measures of correlation between contracts exceed 30 per cent, and the correlation is based on economic fundamentals. Changes to inter-commodity spread concessions must be approved by the RQG, which considers whether changes identified by CME SPAN appropriately reflect underlying economic relationships, including through periods of market stress.

ASX Clear (Futures) also offers OTC participants the ability to choose to cross-margin specific directly cleared interest rate futures by allocating these positions to their OTC derivatives portfolio. If participants choose to do so, the allocated interest rate futures will be VaR margined, rather than margined using the CME SPAN methodology that is currently in place for exchange-traded positions. While VaR margining can result in less conservative estimates of correlations, interest rate futures in the pool under the VaR methodology will be subject to a five-day rather than a one to two day close-out assumption. As a result, ASX has indicated that, absent an offset, it expects cross-margined interest rate futures will be subject to higher margin requirements under the VaR methodology compared with the existing CME SPAN methodology.

Cross-margining recognises the economic relationship between AUD IRS and AUD interest rate futures and, to the extent that positions are indeed offsetting, would be expected to result in a reduction in the amount of initial margin required relative to the case in which positions were margined independently. Notwithstanding the economic relationship between AUD IRS and AUD interest rate futures, analysis of historical data demonstrates that the basis does vary over time, particularly during times of stress. This observed change of basis is captured through the VaR margining process. The robustness of the empirical relationship between AUD IRS and AUD interest rate futures in stressed market conditions is addressed through the introduction of stress-test scenarios that capture basis risk, as discussed above under Standard 4.6.

ASX Clear (Futures) does not currently have any cross-margining arrangements with any other CCP, although at a later date ASX plans to reconsider introducing margin offsets between certain contracts cleared by ASX Clear (Futures) and ASX Clear.

6.6 A central counterparty should analyse and monitor its model performance and overall margin coverage by conducting rigorous daily backtesting and at least monthly, and more frequent where appropriate, sensitivity analysis. A central counterparty should regularly conduct an assessment of the theoretical and empirical properties of its margin model for all products it clears. In conducting sensitivity analysis of the model's coverage, a central counterparty should take into account a wide range of parameters and assumptions that reflect possible market conditions, including the most volatile periods that have been experienced by the markets it serves and extreme changes in the correlations between prices.

CRM conducts daily checks of initial margin requirements against observed variation margin calls. Mark-to-market price movements that exceed particular thresholds relative to initial margin coverage trigger additional actions. Variation margin calls that exceed 30 per cent of initial margin trigger a discussion with the participant and are brought to management's attention, while calls that exceed 50 per cent constitute a margin breach that will require further investigation of margin settings.

Under the new Model Validation Standard, daily backtesting for exchange-traded products has been enhanced so as to test whether the margining models reliably cover price movements to a 99 per cent confidence interval. Initial margin collected from each participant is compared against variation margin collected over the following one or two days, depending on which is the larger amount. Where variation margin is greater than initial margin an ‘exception’ is recorded. CRM compares the number of exceptions to the expected number of exceptions, based on a 99 per cent confidence interval. The magnitude of exceptions is also reviewed. ASX Clear (Futures) applies a similar approach to the backtesting of margin for OTC derivatives transactions, although this backtesting is performed against a 99.5 per cent confidence interval and an assumed five-day close-out period (see CCP Standard 6.3).

As part of its broader review of model validation procedures, ASX is considering extending its backtesting approach to the analysis of hypothetical portfolios, in order to decompose exceptions caused by a change in participant position from those that may reveal a shortfall in margin coverage, and thereby further ensure the robustness of the margining model. The Bank will monitor the progress of work to further enhance backtesting over the coming Assessment period.

As well as enhancing its daily margin backtesting, ASX intends to conduct monthly sensitivity analysis of all material model assumptions including the look-back period used in backtesting, the liquidation (close-out) period, and the confidence interval used. The Bank will monitor developments over the coming period.

6.7 A central counterparty should regularly review and validate its margin system.

ASX Clear (Futures)' margin methodologies will also be subject to a comprehensive annual validation and ongoing review under ASX's Model Validation Standard (see CCP Standard 4.5). The RQG will be responsible for performing the regular reviews of models, while Internal Audit will coordinate the independent validation process, including the use of external experts where this is deemed necessary by the RQG. This independent validation process will occur annually.

At ASX, the margining process is governed by a Margin Rate Setting policy, which is reviewed annually, with material changes approved by the CS Boards. The authorisation and documentation process for margin parameter changes and guidelines for the application of management discretion are also reviewed annually. ASX publishes detailed margining information on its website, including descriptions of the margining methodology, schedules of margin rates, and daily SPAN margin parameter files – allowing participants to perform margin calculations on hypothetical or actual portfolios.

6.8 In designing its margin system, a central counterparty should consider the operating hours of payment and settlement systems in the markets in which it operates.

ASX Clear (Futures) primarily provides clearing services for the Australian-based ASX 24 market and, from July 2013 the Australian dollar-denominated OTC interest rate swap market (although live transactions are yet to occur). ASX Clear (Futures)' timetables for margin calculation and collection are consistent with the operating hours of the relevant payment and settlement systems (Austraclear and the Reserve Bank Information and Transfer System (RITS)).

Footnote

ASX Clear (Futures) performs margin rate calculations using both one- and two-day periods, and uses the worst-case result. [1]