2012/13 Assessment of ASX Clearing and Settlement Facilities B2.1 ASX Settlement

Standard 6: Liquidity Risk

A securities settlement facility should effectively measure, monitor and manage its liquidity risk. A securities settlement facility should maintain sufficient liquid resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under 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 generate the largest aggregate liquidity obligation for the securities settlement facility in extreme but plausible market conditions.

Rating: Observed

ASX Settlement conducts settlement on a DvP model 3 basis, and does not assume payment obligations in the settlement process. While participants face liquidity exposures arising from the possible reconstitution of the multilateral net batch in a default, ASX Settlement's back-out procedures are designed to avoid concentrated liquidity exposures for non-defaulting participants (SSF Standard 6.1). These procedures are disclosed to participants through ASX Settlement's Operating Rules and Procedures (SSF Standard 6.2). ASX Settlement does not assume liquidity risk as principal through its settlement process (SSF Standards 6.3, 6.4, 6.5, 6.6, 6.7, 6.8).

During the next Assessment period, the Bank will consider steps taken by ASX Settlement to inform participants of the potential liquidity impact of a settlement failure under proposed new arrangements for dealing with an ASX Clear participant default (SSF Standards 6.1, 6.2).

On the basis of this information, the Bank's assessment is that ASX Settlement has observed the requirements of SSF Standard 6 during the 2012/13 Assessment period.

6.1 A securities settlement facility should have a robust framework to manage its liquidity risks from its participants, commercial bank money settlement agents, nostro agents, custodians, liquidity providers and other entities.

ASX Settlement conducts its settlements on a DvP model 3 basis in a multilateral net batch (see SSF Standard 10). While ASX Settlement does not assume any payment obligations in the batch settlement process, and hence does not assume liquidity risk as principal, the nature of the multilateral net batch creates liquidity exposures between participants. The default of a participant with a payment obligation in the batch would typically require the reconstitution of the batch to remove sufficient transactions of the defaulting participant to bring its payment obligations down to zero. This reconstitution may create liquidity pressures for non-defaulting participants due to receive funds in respect of transactions that are removed. ASX Settlement seeks to minimise these liquidity pressures through the use of its back-out procedures (see SSF Standard 11.3). Under these procedures, transactions are removed from the batch in such a way as to ensure that non-defaulting participants' payment obligations do not increase. While non-defaulting participants due to receive a net payment of funds in the batch may be exposed to liquidity risk associated with a reduction in expected receipts, ASX Settlement's back-out algorithm is designed to ensure that an expected receipt does not become a payment obligation, and disperses this risk across a number of participants through a random allocation mechanism.

ASX consulted in July 2013 on a proposal to amend the way that it would deal with a shortfall of funds related to novated transactions. Under this proposal, ASX Clear would meet any payment obligations to allow securities delivery transactions to settle as intended, with participants providing the funds for settlement via separate repurchase transactions for the same stock to settle at a later date (see Appendix B1.1, CCP Standards 7.3 and 7.9 for further details). The net economic and operational effect of these transactions on non-defaulting participants would replicate the current back-out arrangements, but would explicitly recognise and formalise the role of participants in providing liquidity to ASX Clear to allow settlement to occur as scheduled.

6.2 A securities settlement facility should have effective operational and analytical tools to identify, measure and monitor its settlement and funding flows on an ongoing and timely basis, including its use of intraday liquidity.

As ASX Settlement does not assume liquidity risk as principal, it does not have payment obligations related to settlement.

ASX Settlement provides participants with information regarding their money and securities settlement obligations between trade date and settlement date. This information includes individual trade notifications, netted obligations, projected funds obligations and rescheduled settlements following delivery failures. Participants use this information to produce reports that enable them to monitor and manage their funding and delivery obligations and risks.

As ASX Settlement uses an algorithm to select transactions for rescheduling, it is not possible for ASX Settlement to provide detailed information to participants on how their settlement obligations might change in the event of a default. However, ASX Settlement's back-out arrangements are described in Rule 10.11 of the ASX Settlement Operating Rules, as well as in related Procedures available to participants. During the next Assessment period, the Bank will consider steps taken by ASX Settlement and ASX Clear to inform participants of the potential liquidity impact of a settlement failure under the proposed new arrangements for dealing with an ASX Clear participant default (see SSF Standard 6.1).

6.3 A securities settlement facility should maintain sufficient liquid resources in all relevant currencies to effect same-day settlement and, where appropriate, intraday or multiday settlement of payment obligations with a high degree of confidence under 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 generate the largest aggregate payment obligation in extreme but plausible market conditions.

As ASX Settlement does not assume liquidity risk as principal, it does not need to maintain liquid resources to cover payment obligations.

6.4 For the purpose of meeting its minimum liquid resource requirement, a securities settlement facility's qualifying liquid resources in each currency include cash at the central bank of issue and at creditworthy commercial banks, committed lines of credit, committed foreign exchange swaps and committed repos, as well as highly marketable collateral held in custody and investments that are readily available and convertible into cash with prearranged and highly reliable funding arrangements, even in extreme but plausible market conditions. If a securities settlement facility has access to routine credit at the central bank of issue, the securities settlement facility may count such access as part of the minimum requirement to the extent it has collateral that is eligible for pledging to (or for conducting other appropriate forms of transactions with) the relevant central bank. All such resources should be available when needed.

As ASX Settlement does not assume liquidity risk as principal, it does not maintain liquid resources to cover payment obligations in stressed scenarios (see SSF Standard 6.3).

6.5 A securities settlement facility may supplement its qualifying liquid resources with other forms of liquid resources. If the securities settlement facility does so, these liquid resources should be in the form of assets that are likely to be saleable or acceptable as collateral for lines of credit, swaps or repos on an ad hoc basis following a default, even if this cannot be reliably prearranged or guaranteed in extreme market conditions. Even if a securities settlement facility does not have access to routine central bank credit, it should still take account of what collateral is typically accepted by the relevant central bank, as such assets may be more likely to be liquid in stressed circumstances. A securities settlement facility should not assume the availability of emergency central bank credit as part of its liquidity plan.

As ASX Settlement does not assume liquidity risk as principal, it does not maintain liquid resources to cover payment obligations in stressed scenarios (see SSF Standard 6.3).

6.6 A securities settlement facility should obtain a high degree of confidence, through rigorous due diligence, that each provider of its minimum required qualifying liquid resources, whether a participant of the securities settlement facility or an external party, has sufficient information to understand and to manage its associated liquidity risks, and that it has the capacity to perform as required under its commitment. Where relevant to assessing a liquidity provider's performance reliability with respect to a particular currency, a liquidity provider's potential access to credit from the central bank of issue may be taken into account. A securities settlement facility should regularly test its procedures for accessing its liquid resources at a liquidity provider.

As ASX Settlement does not assume liquidity risk as principal, it does not maintain liquid resources to cover payment obligations in stressed scenarios (see SSF Standard 6.3).

6.7 A securities settlement facility with access to central bank accounts, payment services or securities services should use these services, where practical, to enhance its management of liquidity risk.

ASX Settlement does not assume liquidity risk as principal.

6.8 A securities settlement facility should determine the amount and regularly test the sufficiency of its liquid resources through rigorous stress testing. A securities settlement facility should have clear procedures to report the results of its stress tests to appropriate decision-makers at the securities settlement facility and to use these results to evaluate the adequacy of, and adjust, its liquidity risk management framework. In conducting stress testing, a securities settlement facility should consider a wide range of relevant scenarios. 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. Scenarios should also take into account the design and operation of the securities settlement facility, include all entities that might pose material liquidity risks to the securities settlement facility (such as commercial bank money settlement agents, nostro agents, custodians, liquidity providers and linked FMIs) and, where appropriate, cover a multiday period. In all cases, a securities settlement facility should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount and form of total liquid resources it maintains.

As ASX Settlement does not assume liquidity risk as principal, it does not maintain liquid resources to cover payment obligations in stressed scenarios (see SSF Standard 6.3).

6.9 A securities settlement facility should establish explicit rules and procedures that enable the securities settlement facility to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations on time following any individual or combined default among its participants. These rules and procedures should address unforeseen and potentially uncovered liquidity shortfalls and should aim to avoid unwinding, revoking or delaying the same-day settlement of payment obligations. These rules and procedures should also indicate the securities settlement facility's process to replenish any liquidity resources it may employ during a stress event, so that it can continue to operate in a safe and sound manner.

As ASX Settlement does not assume liquidity risk as principal, it does not need rules and procedures to address a liquidity shortfall.