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

Standard 12: General Business Risk

A securities settlement facility should identify, monitor and manage its general business risk and hold, or demonstrate that it has legally certain access to, sufficient liquid net assets funded by equity to cover potential general business losses so that it can continue operations and services as a going concern if those losses materialise. Further, liquid net assets should at all times be sufficient to ensure a recovery or orderly wind-down of critical operations and services.

Rating: Broadly observed

ASX Settlement identifies, monitors and manages its general business risks in the context of its overall Enterprise Risk Management Policy (SSF Standard 12.1). It has access to sufficient funds held at group level, and invested in high-quality and sufficiently liquid assets to continue operations as a going concern if it incurs general business losses, and plans to enhance the legal basis of such access through a new clause in the ASX Group Support Agreement (SSF Standards 12.2, 12.4). ASX maintains viable arrangements to raise additional equity for its CS facilities, as required. This was demonstrated by ASX's $533 million capital raising during the Assessment period (SSF Standard 12.5).

The Bank notes the following steps that ASX Settlement should take in order to fully observe SSF Standard 12:

In order to meet the requirements of SSF Standard 12.2, implement plans to enhance intragroup legal agreements to explicitly reflect the allocation and availability of business risk capital to ASX Settlement.
In order to meet the requirements of SSF Standard 12.3, which comes into effect on 31 March 2014, ASX Settlement should develop and maintain a viable recovery plan and ensure that the capital it holds under SSF Standard 12.2 is sufficient to fund this plan. The plan should be consistent with forthcoming CPSS-IOSCO guidance on recovery planning. As ASX Settlement develops its recovery plan, it should also review and integrate the recapitalisation processes described under SSF Standard 12.5 with its broader recovery planning arrangements.

Based on this information, and noting that SSF Standard 12.3 is not yet in force, the Bank's assessment is that ASX Settlement has broadly observed the requirements of SSF Standard 12 during the 2012/13 Assessment period. ASX Settlement's management of general business risk is described in further detail under the following sub-standards.

12.1 A securities settlement facility should have robust management and control systems to identify, monitor and manage general business risks, including losses from poor execution of business strategy, negative cash flows or unexpected and excessively large operating expenses.

ASX's approach to business risk is consistent with its overall Enterprise Risk Management Policy and Framework (see SSF Standard 3). Under the framework, formal policies are in place for individual risk categories such as accounting, authorisations, business continuity, technology, fraud control and procurement.

ASX monitors a variety of financial business risks, including market risk, credit risk, liquidity risk and capital risk.

Group funds (as distinct from collateral lodged by participants) may be exposed to market risk due to changes in market variables such as interest rates, foreign currency rates and equity prices. Mitigants for market risk include hedging of foreign exchange risk and monitoring of equity price risk, with appropriate capital allocation.
Credit risk for general business activities arises in the collection of receivables, which principally comprises fees from market participants, issuers, users of market data and other customers. Mitigants include active collection procedures on trade receivables and ‘ageing’ of receivable amounts.
Liquidity risk is mitigated by prudent liquidity management, with forward planning and forecasting of liquidity requirements.
ASX manages its capital at a group level, in accordance with an objective of maintaining a prudent level of surplus net tangible equity. Ongoing monitoring of cash flows and capital adequacy is conducted via quarterly meetings of CALCO.

ASX undertakes periodic strategic risk assessments in the context of its overall business plans, through which the ASX strategic risk environment is analysed. This analysis is used to identify new strategic business initiatives, such as the projects that delivered clearing and settlement of retail CGS, and the ASX Collateral and over-the-counter (OTC) derivatives clearing services. New projects identified through this process are subject to financial analysis, which includes high, low and base case revenue assumptions and forecasts. Impacts on capital are also determined and analysed.

ASX undertakes risk assessments when undertaking an expansion of its activities or in the event of material changes to its business. Risk assessments are built into ASX's project management framework (see SSF Standard 14.4). Under this framework an initial high-level risk indication is defined at the project concept stage. This is followed by a formal project risk assessment covering both project delivery risks and impacts to business activities. ASX will typically conduct a series of workshops involving project staff to discuss risks associated with the planned service. Prior to the project being approved for launch/production, ASX prepares an operational readiness summary and conducts a final workshop to discuss risks that may be associated with initial launch. This includes consideration of potential failure scenarios and workarounds, procedures for escalation of issues, and help desk and key staff availability.

Following launch, the risks of a new activity are captured in business unit risk profiles that are prepared by business unit management every six months. CALCO also monitors actual and forecast capital and liquidity requirements on a quarterly basis, including the impact of new projects.

12.2 A securities settlement facility should hold, or demonstrate that it has legally certain access to, liquid net assets funded by equity (such as common stock, disclosed reserves or other retained earnings) so that it can continue operations and services as a going concern if it incurs general business losses. The amount of liquid net assets funded by equity a securities settlement facility should hold, or have access to, should be determined by its general business risk profile and the length of time required to achieve a recovery or orderly wind-down, as appropriate, of its critical operations and services if such action is taken.

In 2012/13, ASX revised its approach to business risk capital to take into account the requirements of this standard and requirements arising from its own strategic projects; in particular, the introduction of the OTC derivatives clearing service. A capital raising in June 2013 contributed to an increase in ASX's total capital allocations for operational and business risk from $50 million to $225 million across the ASX Group. ASX Group has also historically held surplus capital of $200 to $250 million, and a little over half of the increase in capital allocated to operational and business risk represents a specific allocation from that surplus. This formalises ASX's previous approach to business risk capital, under which business losses would be met by the surplus capital held. Capital allocations for general business risk across the group, including for each CS facility, are published twice a year by ASX.

Of the $225 million allocation, $140 million has been attributed specifically to operational and business risks across both Austraclear and ASX Settlement. Since ASX has identified constraints to making business risk capital bankruptcy remote within the SSFs, this capital is held at the ASX Group level to ensure that it cannot be applied to meet losses caused by a participant default. A group-wide capital buffer provides protection to allocated business risk capital against potential losses sustained elsewhere in the group. While ASX considers that its existing framework provides a sufficient legal basis for the use of funds allocated to ASX Settlement at the group level to cover a business risk loss, ASX will further enhance the legal basis for this arrangement through a new clause in the ASX Group Support Agreement. This clause will clarify the allocation and availability of business risk capital to the CS facilities to support their obligations under the FSS.

In determining the sufficiency of the $140 million in operational and business risk capital set aside for ASX Settlement and Austraclear, ASX first calculated risk amounts for the individual SSFs. This was based on a methodology in use at other settlement facilities, fund managers and custodians that applies a capital charge for operational and business risk to the value of securities held in the facility. The correlation is modelled on a percentage basis, with the percentage of required risk resources declining as the level of assets increases – recognising that a significant part of the risk resources required will represent a fixed cost. ASX's application of this methodology results in a 0.79 basis points charge on around $1.3 trillion of securities held in each SSF, giving a required value of risk resources of around $100 million for each of ASX Settlement and Austraclear. ASX assumes that the two facilities will not both require their full risk funds at the same time, using a ‘square root of the sum of squares’ formula to arrive at the figure of $140 million to cover the operational and business risk exposure of both settlement facilities. This reflects that the custodial and operational risks that this capital is calibrated to cover are unlikely to result in simultaneous peak losses in both SSFs. The business risk capital held in respect of the SSFs is sufficient to ensure that, even if one SSF were to utilise its full capital allocation of $100 million, sufficient funds would be available to fund the other SSF's recovery plan and meet the single largest uninsured business loss event for that facility. In addition, ASX's general capital buffer is sufficient to ensure that it would remain able to provide $100 million to second SSF in the event that this was required. The proposed enhancements to the ASX Group Support Agreement will clarify ASX's obligations to provide these funds in accordance with the SSF's obligations under the SSF Standards.

12.3 A securities settlement facility should maintain a viable recovery or orderly wind-down plan and should hold, or have legally certain access to, sufficient liquid net assets funded by equity to implement this plan. At a minimum, a securities settlement facility should hold, or have legally certain access to, liquid net assets funded by equity equal to at least six months of current operating expenses. These assets are in addition to resources held to cover participant defaults or other risks covered under SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk. However, equity held under international risk-based capital standards can be included where relevant and appropriate to avoid duplicate capital requirements.

SSF Standard 12.3 comes into effect on 31 March 2014.

ASX Settlement intends to articulate its recovery plans following the release of finalised CPSS-IOSCO guidance on recovery planning, expected in late 2013. The capital that ASX Settlement would use to fund operations during implementation of a recovery plan is described under SSF Standard 12.2.

12.4 Assets held to cover general business risk should be of high quality and sufficiently liquid in order to allow the securities settlement facility to meet its current and projected operating expenses under a range of scenarios, including in adverse market conditions.

The risk capital for ASX's CS facilities is invested in accordance with the ASX Limited and ASX Operations Pty Limited Investment Mandate. The Investment Mandate specifies investment objectives, responsibilities, approved products and counterparties, and audit and maintenance of the mandate. Approved products are generally highly rated and liquid products such as: cash deposits; bank bills, negotiable certificates of deposit and floating rate notes issued by APRA-approved ADIs; foreign exchange in specified currencies; CGS; and selected semi-government securities. Limits are applied against counterparty, liquidity and market risks. Liquidity limits are specified for maximum instrument maturity and weighted average maturity.

12.5 A securities settlement facility should maintain a viable plan for raising additional equity should its equity fall close to or below the amount needed. This plan should be approved by the board of directors and updated regularly.

As noted, ASX Limited manages its operational and business risk capital at the group level. The ASX Limited Board monitors the ongoing capital adequacy of the ASX Group as part of its regular capital planning activities. The Board determines the most appropriate means of raising additional capital when needed, giving due consideration to prevailing market conditions and available alternative financing mechanisms. For example, in June 2013, ASX Limited conducted a capital raising in the form of a $553 million share entitlement offer, with the bulk of the funds being used to increase the risk capital and financial resources of the CS facilities. Recapitalisation processes should be reviewed and integrated with broader recovery planning arrangements following the forthcoming release of CPSS-IOSCO guidance referenced in SSF Standard 12.3.