2012/13 Assessment of ASX Clearing and Settlement Facilities B1.1 ASX Clear
Standard 4: Credit Risk
A central counterparty should effectively measure, monitor and manage its credit exposures to participants and those arising from its clearing processes. A central counterparty should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence.
Rating: Broadly observed
ASX Clear maintains a comprehensive framework for managing its credit exposures to participants (CCP Standard 4.1). Under this framework, ASX Clear regularly monitors information on participants' credit standing through financial reporting requirements, public information, and further investigation where required. Monitoring of participants' credit standing is risk based, and ASX maintains a list of participants deemed to warrant more intensive monitoring (CCP Standard 4.2). In responding to any issues identified through monitoring, ASX Clear is able to impose activity restrictions or additional controls, including calls for additional collateral (CCP Standard 4.3).
ASX Clear also monitors and measures the magnitude of exposures to participants through both daily and intraday initial and variation margin calculations (CCP Standard 4.2), and through daily stress tests to measure the effects of extreme but plausible scenarios on exposures (CCP Standard 4.5). ASX Clear holds sufficient financial resources to cover its largest potential credit exposure to any single participant and its affiliates in the extreme but plausible scenarios covered in its stress tests (CCP Standards 4.4, 4.6). This includes the capacity to call additional margin from participants that exceed pre-determined stress-test exposure limits (STELs). Responsibility for increasing financial resources in response to persistent and widespread STEL breaches that exceed available financial resources lies with the CS Boards and the ASX Limited Board (CCP Standard 4.7).
The Bank notes the following steps that ASX Clear should take to fully observe CCP Standard 4:
- Implement plans to strengthen the analysis of its capital stress-test model, through comprehensive annual validation, periodic reverse stress testing, and more detailed monthly reviews of stress-testing scenarios, models and underlying parameters and assumptions. This should include sensitivity analysis and analysis of concentration risk.
- In order to meet the requirements of CCP Standard 4.8, which comes into effect on 31 March 2014, implement mechanisms consistent with forthcoming CPSS-IOSCO guidance on recovery planning that fully address any uncovered credit losses and replenish financial resources following a participant default.
Based on this information, and noting that CCP Standard 4.8 is not yet in force, the Bank's assessment is that ASX Clear has broadly observed the requirements of CCP Standard 4 during the 2012/13 Assessment period. ASX Clear's approach to managing its credit risk is described in further detail under the following sub-standards.
4.1 A central counterparty should establish a robust framework to manage its credit exposures to its participants and the credit risks arising from its clearing processes. Credit exposures may arise from current exposures, potential future exposures, or both.
ASX Clear maintains a comprehensive framework for managing credit exposures to its participants, including a stress-testing regime (see CCP Standards 4.5 to 4.7), the use of variation margin to mark positions to market (see CCP Standard 6) and the maintenance of financial resources. These financial resources comprise initial margin (see CCP Standard 6), other collateral calls based on participants' positions, and fully paid up pooled financial resources of $250 million, which are invested in high-quality liquid assets. ASX Clear also has access to $300 million of promissory resources from participants if required (see CCP Standard 4.8).
4.2 A central counterparty should identify sources of credit risk, routinely measure and monitor credit exposures, and use appropriate risk management tools to control these risks. To assist in this process, a central counterparty should ensure it has the capacity to calculate exposures to participants on a timely basis as required, and to receive and review timely and accurate information on participants' credit standing.
ASX Clear's Clearing Risk Management (CRM) unit is responsible for monitoring participants' credit standing and credit exposures to participants.
Within CRM, the Exposure Risk Management team monitors day-to-day developments in, among other things, open positions, market price moves and settlement obligations to the CCPs. Participants' positions are marked to market and ASX Clear calculates initial and variation (or mark-to-market) margin requirements on both cash-equity transactions and derivative contracts at the end of each business day. When market movements exceed certain thresholds, ASX Clear calculates and, where appropriate, calls intraday margin on derivatives positions reflecting both price movements and changes in participant positions (see CCP Standard 6.4). ASX Clear conducts daily stress testing to monitor the effects of extreme but plausible scenarios on participants' portfolios. Where stress-test results are above a defined limit, AIM is called (see CCP Standard 4.4).
Within CRM, the Counterparty Risk Assessment team is responsible for the ongoing monitoring, assessment and investigation of matters relating to financial requirements (including participants' monthly financial statements) for any issues of concern. CRM is also responsible for determining and reviewing participants' credit standing, drawing in part on information provided by participants in regular financial returns to ASX. ASX determines an Internal Credit Rating (ICR) for each participant. The ICR takes into account the participant's external credit rating, if available, or that of its parent if either that parent provides a formal guarantee to the CCP or the participant carries the parental corporate name. Otherwise, the rating is based on the participant's capital position (or that of its parent where that parent is unrated but provides a formal guarantee to the CCP).
CRM also coordinates a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list is based on a range of factors, such as: concentration risk; concerns emerging from a specific event or media report; significant changes in a participant's own share price, bond yield or credit default swap price; ICR downgrades; calls for AIM; operational issues; compliance issues; or issues arising from ASX's routine review of financial returns, for example regular losses or breaches of minimum capital requirements. The assessment of watch list factors monitored by CRM, ASX Compliance and the Operations Division is coordinated by the CROCC. Based on such an assessment, ASX Clear may decide to place restrictions on a participant's trading, clearing and settlement activities (see CCP Standard 4.3). During the 2012/13 Assessment period, three participants were included on the watch list, but all had resigned as ASX Clear members by the end of the period.
As part of a broad review of ASX's concentration risk policy due to be finalised in early 2014, ASX Clear has been considering steps to enhance its monitoring of concentration of participant positions in particular market segments. This monitoring is intended to identify situations where a participant's share of positions in a market segment is sufficiently large that it could create complications in closing out or transferring these positions if the participant were to default.
For details of ASX Clear's other participation requirements and participant monitoring arrangements, see CCP Standard 17.
4.3 A central counterparty should have the authority to impose activity restrictions or additional credit risk controls on a participant in situations where the central counterparty determines that the participant's credit standing may be in doubt.
Participants on ASX's watch list may be subject to trading restrictions, or additional credit risk controls such as additional margins, higher capital requirements, additional capital reporting or a reduced STEL. CRM will typically also carry out a detailed credit review. As an example, during the Assessment period, one participant was placed on the CRM watch list after it was unable to meet a contributions and additional collateral (CAC) call (see CCP Standard 4.4). As a result, this participant: was required to provide additional general cover; had conditions placed on its trading and clearing participation; had its STEL significantly reduced; and was subject to an external audit requiring an assessment of its risk management framework.
ASX Clear may also call capital-based position limit (CBPL) AIM from participants with large portfolios (measured by initial margin requirements) relative to their capital. ASX Clear may also call AIM from participants where it has other counterparty credit risk concerns.
4.4 A central counterparty should cover its current and potential future exposures to each participant fully with a high degree of confidence using margin and other prefunded financial resources (see CCP Standard 5 on collateral and CCP Standard 6 on margin). In addition, a central counterparty that is involved in activities with a more complex risk profile or that is systemically important in multiple jurisdictions should maintain additional financial resources to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. All other central counterparties should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. In all cases, a central counterparty should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount of total financial resources it maintains.
In June and July 2013, ASX raised $553 million of capital by means of a stock entitlement offer. Funds from this capital raising were not used to increase ASX Clear's total pooled financial resources; however, on 28 June 2013 $100 million was used to repay a principal-reducing subordinated commercial bank loan to ASXCC that in turn had funded a subordinated loan to ASX Clear, which previously formed part of ASX Clear's prefunded pooled risk resources. At the same time, the ASXCC subordinated loan to ASX Clear was replaced by equity. Following the capital raising, ASX Clear's $250 million of prefunded financial resources consist of: own equity ($103.5 million); funds held in a restricted capital reserve ($71.5 million); and fully drawn subordinated loans from ASXCC (totalling $75 million), which are ultimately funded by a subordinated loan from ASX Limited ($75 million). ASX Clear also has the right under its Operating Rules and Procedures to levy its participants up to $300 million collectively in ‘Emergency Assessments’ should a loss caused by a participant's default exceed its other resources.
ASX Clear conducts daily stress tests to ensure that the level of its prefunded financial resources is sufficient to cover the default of the participant and its affiliates that would potentially cause the largest aggregate credit exposure to the CCP under a wide range of scenarios (see CCP Standards 4.5 to 4.7). Since they are not prefunded, Emergency Assessments are not taken into account (either by ASX or the Bank) when assessing ASX Clear's ability to cover such a default. ASX Clear's capital stress test model was updated in June 2013 to take into account the joint default of a participant and its affiliates; previously only single participant defaults were considered. Since ASX Clear clears only transactions in cash securities and equity derivatives, the Bank does not consider that ASX Clear is involved in activities with a complex risk profile. Further, since ASX Clear clears only domestic products, has a largely domestic participant base and does not require recognition in other jurisdictions, the Bank's assessment is that ASX Clear is not systemically important in multiple jurisdictions.
Under ASX Clear's AIM methodology, 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 (see CCP Standard 4.7). The AIM methodology replaced the previous CAC methodology in June 2013. The CAC methodology was used prior to the introduction of initial margining for cash equities, and differed from AIM in that the portion of the amount called for STEL breaches relating to cash market positions took the form of pooled ‘contributions’. In contrast, collateral posted under the AIM methodology can be applied only to losses related to the participant subject to the AIM call.
The objective of this regime is to provide additional participant-specific cover against non-systematic spikes in individual participants' exposures. This mitigates the risk that the default of a participant with a large exposure, in more extreme market conditions than are contemplated by regular initial margin, may deplete or even exhaust prefunded pooled financial resources. By upholding the ‘defaulter pays’ principle, the AIM regime also provides an incentive for participants to manage the risk they bring to the CCP. However, it is not a substitute for holding sufficient pooled risk resources. There are potential shortcomings to relying too heavily on variable calls related to stress-test exposures, particularly given lags in the calculation and settlement of such calls (see CCP Standard 4.7).
4.5 A central counterparty should, through rigorous stress testing, determine the amount and regularly test the sufficiency of its total financial resources available in the event of a default or multiple defaults in extreme but plausible market conditions. Stress tests should be performed daily using standard and predetermined parameters and assumptions. On at least a monthly basis, a central counterparty should perform a comprehensive and thorough analysis of stress-testing scenarios, models and underlying parameters and assumptions used to ensure they are appropriate for determining the central counterparty's required level of default protection in light of current and evolving market conditions. A central counterparty should perform this analysis of stress testing more frequently when the products cleared or markets served display high volatility, become less liquid, or when the size or concentration of positions held by a central counterparty's participants increases significantly. A full validation of a central counterparty's risk management model should be performed at least annually.
ASX Clear uses daily capital stress tests to monitor risk exposures to individual participants and the adequacy of its financial resources. Capital stress tests are based on a range of scenarios covering extreme price moves and volatility shifts at the market-wide, sector and individual-stock levels (see CCP Standard 4.6). ASX Clear applies a set of underlying parameters and assumptions in performing capital stress tests, including that: profits in client accounts cannot be used to offset house losses; prices may rebound following a large fall; price and volatility move independently; and the close-out period is one day.[1] These assumptions are subject to periodic review. During the third quarter of 2013, ASX will be updating its capital stress-test methodology to incorporate enhanced sensitivity analysis based on changes to assumptions such as the number of concurrent defaults, or the timing of defaults. ASX also plans to incorporate analysis of the concentration of positions held by participants and market liquidity into a monthly review process for model scenarios. ASX has indicated that reverse stress testing will also be part of its analysis of the adequacy of margins and pooled financial resources.
ASX's Model Validation Standard requires that all models that are critical to ASX (as measured against a series of risk factors) undergo a full annual validation (see CCP Standard 2.6). Criticality to ASX is measured according to a series of factors, including the internal and external impact of the model, frequency of use, and complexity. This includes ASX's margining models and both the capital and liquidity stress-testing models. The first of these validations will be undertaken during the 2013/14 Assessment period. The validation of the models will be coordinated by Internal Audit, but external consultation will be sought where deemed necessary by the RQG.
4.6 In conducting stress testing, a central counterparty should consider the effect of a wide range of relevant stress scenarios in terms of both defaulters' positions and possible price changes in liquidation periods. Scenarios should include relevant peak historic price volatilities, shifts in other market factors such as price determinants and yield curves, multiple defaults over various time horizons, simultaneous pressures in funding and asset markets, and a spectrum of forward-looking stress scenarios in a variety of extreme but plausible market conditions.
The same set of stress tests used to judge whether a participant is required to post AIM is also used to judge the adequacy of pooled resources. Stress tests are based on 102 scenarios, each calibrated to a once in 30 year event. In order to meet these targeted probabilities, stress-test scenarios are calibrated to cover 99.987 per cent of daily price and volatility movements, based on a sample distribution constructed from 20 years of price and volatility data. Stress tests do not cover market price movements of the scale observed in the 1987 stockmarket crash, since these are deemed implausible in light of structural market changes since that time. These scenarios have to date been reviewed annually, with the most recent review conducted in December 2012. As noted in CCP Standard 4.5, review of these scenarios will move to a monthly basis over the next Assessment period.
ASX Clear uses six market-wide scenarios that cover price movements ranging from a 15 per cent decrease to a 7 per cent increase, increases in volatility of up to 150 per cent, and scenarios that combine changes in price and increases in volatility. Other scenarios cover seven broad market sectors (such as consumer staples, energy and financials), applying hypothetical extreme increases and decreases in price across these sectors, and a 150 per cent increase in volatility. Finally, stress-test scenarios are included for 26 individual stocks, chosen based on total open derivatives positions; these scenarios cover a 30 per cent increase in price, a 30 per cent decrease in price and a 250 per cent increase in volatility.
The largest stress-test exposures are commonly generated by market-wide price movements, i.e. the market down 15 per cent or market up scenarios. However, small or medium-sized participants often record their largest stress-test results against single-stock stress-test scenarios where they have concentrated positions in a single stock.
4.7 A central counterparty should have clearly documented and effective rules and procedures to report stress-test information to appropriate decision-makers and ensure that additional financial resources are obtained on a timely basis in the event that projected stress-test losses exceed available financial resources. Where projected stress-test losses of a single or only a few participants exceed available financial resources, it may be appropriate to increase non-pooled financial resources; otherwise, where projected stress-test losses are frequent and consistently widely dispersed across participants, clear processes should be in place to augment pooled financial resources.
Capital stress-test exposures are regularly reported to ASX management, the CS Boards and the Bank. Participant stress-test losses are used to gauge the adequacy of ASX Clear's available financial resources, with widespread and/or large STEL breaches an indicator that resources may need to be increased. STEL breaches are reported to management and persistent breaches are escalated in the first instance to the RQG and CALCO. The CS Boards and ASX Limited Board are responsible for approving any increase to pooled financial resources where this is considered necessary (see below).
Each participant in ASX Clear is allocated a STEL based on its ICR. A-, B-, C-, D- and E-rated participants are allocated STELs of $250 million, $200 million, $80 million, $40 million and $10 million, respectively. In April 2013, ASX Clear reduced the STEL available to C-rated participants (previously $125 million), while in June 2013 it made changes to the STELs of several participants that are part of corporate groups. Under the latter changes, where a group of participants are affiliated (i.e. part of the same corporate group), STELs are set such that the sum of affiliated participants' STELs is equal to or lower than ASX Clear's prefunded financial resources. This means that ASX Clear's combined exposure to these affiliated participants cannot increase above its available financial resources without triggering an AIM call (see below). As there are only a limited number of affiliated participant groups with combined ICR-based STELs that would exceed ASX Clear's prefunded financial resources, ASX Clear allows these groups to elect how the required reduction in STELs is distributed across the group.
Where a participant's projected stress-test losses exceed its STEL, ASX will make an AIM call. Typically AIM calls are made on participants by 9.30 am and must be settled within two hours, either via the transfer of cash in Austraclear, or, under exceptional circumstances and as a transitional measure over the first three years of cash equity margining, through the provision of a bank guarantee from an approved authorised deposit-taking institution (ADI). In normal market conditions, highly rated (i.e. A-rated and B-rated) participants are eligible for discounts on the additional collateral called. However, these discounts have not applied since April 2010 because ASX has not considered market conditions to be normal.
In deciding whether ASX Clear has sufficient pooled financial resources, ASX considers the size, frequency, duration and distribution of additional collateral calls across participants. This process is documented in guidance on the circumstances in which ASX would consider increasing ASX Clear's pooled resources. ASX Clear would consider increasing its pooled resources if stress-test results in excess of pooled resources were persistent and widespread. In other cases, ASX Clear would generally rely on additional collateral collected under the AIM regime.
4.8 A central counterparty should establish explicit rules and procedures that address fully any credit losses it may face as a result of any individual or combined default among its participants with respect to any of their obligations to the central counterparty. These rules and procedures should address how potentially uncovered credit losses would be allocated, including the repayment of any funds a central counterparty may borrow from liquidity providers. These rules and procedures should also indicate the central counterparty's process to replenish any financial resources that the central counterparty may employ during a stress event, so that the central counterparty can continue to operate in a safe and sound manner.
CCP Standard 4.8 comes into effect on 31 March 2014.
Currently, if ASX Clear's prefunded pooled financial resources are insufficient to fully cover its credit losses following a participant default, ASX Clear may call up to $300 million in Emergency Assessments from surviving participants to cover residual losses. ASX has documented a process for making decisions regarding replenishment of a CCP's pooled financial resources following any draw down arising from a participant default. Responsibility for determining if the resources will be replenished and, if so, how this should be achieved, ultimately lies with the ASX Limited Board, which would make this decision in consultation with the ASX Clear Board. ASX has documented replenishment intentions, which include several options; the particular approach taken to replenishment will depend on the specific circumstances, including the severity of the loss and the market environment (see CCP Standard 12.1). ASX Limited has also committed to maintaining a certain level of equity capital in ASX Clear (including via ASXCC), provided certain conditions are met, including that the CCP is solvent.
Following the release of finalised CPSS-IOSCO guidance on recovery planning, expected in late 2013, ASX Clear will consider additional mechanisms to fully allocate credit losses and processes for replenishing financial resources following a participant default.
Footnote
Protection of client funds under the Corporations Act is discussed further under CCP Standard 14. [1]