2012/13 Assessment of ASX Clearing and Settlement Facilities B1.1 ASX Clear

Standard 5: Collateral

A central counterparty that requires collateral to manage its or its participants' credit exposures should accept collateral with low credit, liquidity and market risks. A central counterparty should also set and enforce appropriately conservative haircuts and concentration limits.

Rating: Observed

ASX Clear limits the assets it routinely accepts as collateral to cash, or highly liquid stocks or funds with low credit and market risks (CCP Standard 5.1). Assets accepted as collateral are commonly accepted in the Australian market and there is sufficient depth in these assets that their eligibility as collateral is not considered to have any material market impact (CCP Standard 5.2). ASX Clear applies haircuts to collateral that are calibrated to stressed market conditions, to avoid the need for procyclical adjustments (CCP Standards 5.3, 5.4). Collateral holdings are not sufficiently concentrated as to impair ASX Clear's ability to liquidate such assets quickly without significant adverse price effects (CCP Standard 5.5). ASX Clear employs well-designed and operationally flexible systems to manage collateral movements for securities and derivatives trades (CCP Standard 5.7).

The Bank will monitor the outcome of ASX's review of collateral policies, including with respect to its collateral haircutting methodology, and the implementation of its planned standard on concentration risks, during the 2013/14 Assessment period (CCP Standards 5.1, 5.3, 5.5).

Based on this information, the Bank's assessment is that ASX Clear has observed the requirements of CCP Standard 5 during the 2012/13 Assessment period. ASX Clear's collateral acceptance policies are further described under the following sub-standards.

5.1 A central counterparty should generally limit the assets it (routinely) accepts as collateral to those with low credit, liquidity and market risks.

Initial and premium margin obligations may be met by posting either cash or non-cash collateral.^[1] Non-cash collateral is subject to a haircut. Variation and intraday margin obligations, must be met by cash collateral (see CCP Standard 6).

ASX Clear specifies criteria for eligible securities collateral. Acceptable collateral includes S&P/ASX 200 index constituent stocks; exchange-traded funds that ASX Clear determines to be mature and liquid, and for which issuer risk is considered low (currently only the SPDR S&P/ASX 200 Fund); and other stocks lodged as specific cover for call options written on the same stock. The list of acceptable collateral is reviewed at least quarterly, including to reflect changes to the S&P/ASX 200 constituent list. ASX Clear prohibits the use of participant entity stock except when it is used as specific cover for a transaction in that stock, and restricts the use of related entity issued stocks to client transactions (subject to strict concentration limits) as collateral to manage the potential risk of correlated default of a participant and the collateral issuer. Collateral must be unencumbered.

ASX will be reviewing its current collateral policies and developing revised formal collateral policies and standards in the first quarter of 2014. This review will be coordinated through the CRPC as part of the wider review of the Clearing Risk Policy Framework (see CCP Standard 3). The Bank will monitor the outcome of this review.

ASX Clear currently accepts guarantees from banks with a short-term S&P credit rating of at least A-1+ as long as the bank is not a related entity of the participant. As a transitional measure for three years, following the introduction of margining for cash equities in June 2013, ASX Clear will permit participants to meet margin (including AIM) obligations, but only in exceptional circumstances and at the discretion of the CRO. ASX Clear has established a standard format for eligible bank guarantees, and any requests by banks or participants for material deviations from this format require clearance from ASX's legal unit.

5.2 In determining its collateral policies, a central counterparty should take into consideration the broad effect of these policies on the market. As part of this, a central counterparty should consider allowing the use of collateral commonly accepted in the relevant jurisdictions in which it operates.

ASX Clear takes into account market liquidity in determining the eligibility of collateral. Stocks in the S&P/ASX 200 index and the SPDR S&P/ASX 200 Fund are considered by ASX Clear to be sufficiently liquid that the eligibility of these assets as collateral will not have any material impact on market liquidity or price. The depth of liquidity in these assets also enables ASX Clear to liquidate this collateral in a timely fashion when required (see CCP Standard 5.1). Eligible collateral assets in ASX Clear are well known and understood to participants in the Australian market.

5.3 A central counterparty should establish prudent valuation practices and develop haircuts that are regularly tested and take into account stressed market conditions.

Since S&P/ASX 200 stocks and the SPDR S&P/ASX 200 fund are highly liquid, price information is readily available. ASX revalues collateral on a daily basis using end-of-day prices. If there is no price information available for a particular day (for example due to a corporate action) then ASX Clear uses the previous day's price to value the relevant asset.

ASX Clear sets haircuts to cover a fall in the collateral value of stocks over a one-day period under extreme but plausible scenarios. Haircuts are based on the largest price falls used in corresponding capital stress-test scenarios (see CCP Standard 4.6). For stocks that are not used in individual stock stress-test scenarios, the largest price fall applied in any individual stock stress-test scenario is used to determine the haircut. Collateral haircuts are intended to be reviewed annually to take into account any changes to historically observed volatility trends. The methodology applied to set collateral haircuts will be reviewed in the first quarter of 2014 as part of the broader review of collateral policies and standards.

5.4 In order to reduce the need for procyclical adjustments, a central counterparty should establish stable and conservative haircuts that are calibrated to include periods of stressed market conditions, to the extent practicable and prudent.

ASX Clear's collateral haircutting policy is designed to cover extreme but plausible scenarios based on market price and volatility movements observed in the past 20 years, which includes the extreme volatility observed during the 2008–09 financial crisis. This is intended to ensure that haircuts remain stable over the business cycle, even in stressed market conditions.

5.5 A central counterparty should avoid concentrated holdings of certain assets where this would significantly impair the ability to liquidate such assets quickly without significant adverse price effects.

Currently, ASX Clear does not have formal limits on concentrations of collateral in particular assets. Over the Assessment period, the maximum holding of non-cash collateral was $4.5 billion; this was used to meet less than $1 billion of collateral requirements, after haircuts, with the remaining amount representing excess collateral lodged by participants or their clients. For most of the Assessment period around 30 per cent of margin requirements were met by cash collateral; however, this proportion rose to around half following the introduction of cash market margining in June 2013, as participants posted additional cash collateral to cover anticipated peaks in margin requirements. During the Assessment period, ASX began a review of concentration risks, including risks associated with the concentration of collateral holdings. ASX intends to finalise a standard setting out its approach to monitoring and managing concentration risks in the first quarter of 2014.

5.6 A central counterparty that accepts cross-border collateral should mitigate the risks associated with its use and ensure that the collateral can be used in a timely manner.

ASX Clear does not accept any cross-border or foreign currency collateral.

5.7 A central counterparty should use a collateral management system that is well designed and operationally flexible.

Collateral management system

ASX Clear manages the calculation and execution of margin calls through its Derivatives Clearing System (DCS) and CMM System, and is able to accurately monitor initial and variation margin levels and flows on an intraday basis (although intraday margin is not calculated or called for cash equities). The timely deposit, withdrawal and substitution of non-cash collateral are facilitated by CHESS. ASX intends to extend its collateral management service, currently available for debt securities held in Austraclear, to securities in CHESS. This would increase the ease of collateral substitution for ASX Clear participants.

Re-use of collateral

ASX Clear does not re-use non-cash collateral posted by participants and the re-use of such collateral is not supported under its Operating Rules.

Footnote

Premium margin is used to cover the amount that would be required to close out short positions in exchange-traded options positions (see CCP Standard 6.1). [1]