2014/15 Assessment of ASX Clearing and Settlement Facilities Appendix A: Detailed Assessment of Clearing and Settlement Facilities against the Financial Stability Standards

Introduction

This Appendix sets out the Reserve Bank's assessment of how well ASX Clear Pty Limited (ASX Clear) and ASX Clear (Futures) Pty Limited (ASX Clear (Futures)) have complied with the Financial Stability Standards for Central Counterparties (CCP Standards), and how well ASX Settlement Pty Limited (ASX Settlement) and Austraclear Limited (Austraclear) have complied with the Financial Stability Standards for Securities Settlement Facilities (SSF Standards) during the year to 30 June 2015 (the 2014/15 Assessment period).[67] In setting out its assessment, the Bank has applied the rating system used in the Committee on Payments and Market Infrastructures' (CPMI) and the Technical Committee of the International Organization of Securities Commissions' (IOSCO) Principles for Financial Market Infrastructures: Disclosure framework and assessment methodology.[68] Under this framework, the Bank has assessed each of the ASX Group (ASX) clearing and settlement (CS) facilities' observance of the requirements of each of the applicable CCP Standards or SSF Standards (together the FSS) as being:

  • Observed – Any identified gaps and shortcomings are not issues of concern and are minor, manageable and of a nature that the facility could consider taking them up in the normal course of its business.
  • Broadly observed – The assessment has identified one or more issues of concern that the facility should address and follow up on in a defined timeline.
  • Partly observed – The assessment has identified one or more issues of concern that could become serious if not addressed promptly. The facility should accord a high priority to addressing these issues.
  • Not observed – The assessment has identified one or more serious issues of concern that warrant immediate action. Therefore, the facility should accord the highest priority to addressing these issues.
  • Not applicable – The standard does not apply to the type of facility being assessed because of the particular legal, institutional, structural or other characteristics of the facility.

Section 821A(aa) of the Corporations Act 2001 requires that a CS facility licensee, to the extent reasonably practicable to do so, comply with the FSS and do all other things necessary to reduce systemic risk. In assessing how well a CS facility complies with a CCP or SSF standard, the Bank has assessed how well the facility complies with the headline standard and each of the ‘sub’-standards listed under the headline standard. A single overall rating is applied to each CCP or SSF Standard, reflecting this assessment.

Where a facility has been assessed to observe a CCP or SSF Standard, the Bank nevertheless expects ASX to work towards continual strengthening of its observance of the standard. ASX recognises this and has governance arrangements in place to motivate and encourage continuous improvement. This Appendix includes some recommendations encouraging such improvement in some specific areas. These are not exhaustive, and ASX is encouraged to continue to seek further improvements to its observance of the FSS over the coming Assessment period. This is in accordance with the general obligation on CS facilities to do all things necessary to reduce systemic risk.

Where a facility has been assessed to broadly observe a CCP or SSF Standard, the Bank will have sought evidence that a plan is in place to address the identified issue of concern within a clear, defined and reasonable time frame, and that it would not be reasonably practicable for the facility to take such actions immediately in order to fully observe the standard. This Appendix includes recommendations that identify the steps required by ASX to address the relevant issues of concern and fully observe the applicable CCP or SSF Standard.

The Bank's ratings of each of the CS facilities against relevant FSS are supplemented by detailed information under each sub-standard that is relevant to the Bank's assessment. The Bank gathered this information through its regular liaison with ASX staff, the supply of regular data and reports by ASX, and a series of specific information requests and meetings with ASX during and immediately following the Assessment period to gather information relevant to assessing compliance with the FSS. Arrangements for regular liaison and the supply of data and reports by ASX are described in further detail under the detailed assessments of CCP Standard 21 and SSF Standard 19.

Supplementary interpretation of CCP Standards

In assessing how well ASX Clear and ASX Clear (Futures) have observed certain sub-standards of the CCP Standards, the Bank has applied the supplementary interpretation of these sub-standards issued by way of an exchange of letters with ASX in October 2014.[69] This supplementary interpretation supersedes the Bank's previous supplementary interpretation of the CCP Standards issued in August 2013 (see Section 3.6). The supplementary interpretation of the CCP Standards applies to any domestically licensed derivatives CCP that provides services to participants that are either established in the EU or subject to EU bank capital regulations, and affects CCP Standards 2.6, 4.2, 4.4, 6.3, 7.3, 13.2, 13.3, 15.4 and 21.

Table 16: Supplementary Interpretation of the CCP Standards
CCP Standard Additional Interpretation
Governance

CCP Standard 2.6. The board should establish a clear, documented risk management framework that includes the central counterparty's risk tolerance policy, assigns responsibilities and accountability for risk decisions, and addresses decision-making in crises and emergencies. Governance arrangements should ensure that risk management and internal control functions have sufficient authority, independence, resources and access to the board, including through the maintenance of a separate and independent internal audit function.		 The guidance to this CCP Standard, in 2.6.3, states that ‘…a central counterparty should have a risk committee responsible for advising the board on the central counterparty's overall current and future risk tolerance and strategy, or equivalent…’

It is the Bank's judgement that, in accordance with the guidance, establishment of an independent risk committee is the most appropriate way to help the board discharge its risk-related responsibilities. The risk committee should comprise representatives of participants, and depending on the scale and nature of client clearing activity, also indirect participants. The Bank will interpret CCP Standard 2.6 accordingly in the case of ASX Clear (Futures) and ASX Clear.
Credit Risk

CCP Standard 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.

CCP Standard 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. In additional 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…		 The guidance in 4.2.4 discusses the role of prefunded financial resources in managing losses caused by participant defaults. The guidance recognises that the default waterfall may include ‘…a defaulter's initial margin, the defaulter's contribution to a prefunded default arrangement, a specified portion of the central counterparty's own funds, and other participants’ contributions to a prefunded default arrangement.' The guidance does not prescribe a particular composition of prefunded financial resources, nor does it prescribe the order in which such funds should be drawn.

Nevertheless, the Bank would expect that a material proportion of pooled financial resources comprised a central counterparty's own resources, and further, that a sufficient proportion of such resources would be drawn first in the event that a defaulting participant's margin and other contributions were exhausted, so as to ensure that the central counterparty faced appropriate incentives to set robust risk management standards. The Bank will interpret CCP Standard 4.2 accordingly in the case of ASX Clear (Futures) and ASX Clear.

Separately, the guidance in 4.4.2, states that ‘…determinations of whether a central counterparty is systemically important in multiple jurisdictions should include consideration of, among other factors: the location of the central counterparty's participants; the aggregate volume and value of transactions that originate in each jurisdiction in which it operates; the proportion of its total volume and value of transactions that originate in each jurisdiction in which it operates; the range of currencies in which the instruments it clears are cleared or settled; any links it has with FMIs located in other jurisdictions; and the extent to which it clears instruments that are subject to mandatory clearing obligations in multiple jurisdictions…’

In forming a judgement on systemic importance with reference to these factors, the Bank will take into account the (implicit or explicit) views of the relevant overseas regulatory authorities. The need to obtain recognition under EMIR – in order either to continue to provide services to clearing members established in the EU, or to be considered a ‘qualifying CCP’ under EU bank capital regulations – may be regarded as evidence that the EU authorities consider an Australian domestic central counterparty to be a possible vehicle for the transmission of risks to the EU. This may therefore be evidence of systemic importance in multiple jurisdictions.

If a systemically important domestic central counterparty in Australia not only required recognition in the EU, but also had material participation of clearing members established in the EU and cleared a range of products, including derivatives with different characteristics (including levels of liquidity), the Bank would expect to conclude that such a central counterparty was systemically important in multiple jurisdictions.

The Bank will interpret CCP Standard 4.4 accordingly in the case of ASX Clear (Futures) and ASX Clear and hold these central counterparties to the higher standard that they should maintain additional financial resources to cover the default of the largest two participants and their affiliates (by credit exposure).
Margin

CCP Standard 6.3. …Initial margin should meet an established single-tailed confidence interval of at least 99 per cent with respect to the estimated distribution 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 product cleared by the central counterparty…		 The guidance to this CCP Standard elaborates further. In particular, the guidance in paragraphs 6.3.1 – 6.3.3 requires that:

  • ‘…the method selected by the central counterparty to estimate its potential future exposure should be capable of measuring and incorporating the effects of price volatility and other relevant product factors and portfolio effects over a close out period that reflects the market size and dynamics for each product cleared by the central counterparty…’
  • ‘…close out periods should be set on a product-specific basis because less liquid products might require significantly longer close out periods…’
  • ‘…a central counterparty should select an appropriate sample period for its margin model to calculate required margin for each product that it clears…’
  • ‘…selection of the period should be carefully examined based on the theoretical properties of the margin model and empirical tests on these properties using historical data…’
In interpreting CCP Standard 6.3 with reference to the guidance summarised above, a domestically licensed central counterparty that clears a range of products with varying degrees of liquidity and provides services to systemically important financial institutions headquartered in multiple jurisdictions would typically be expected to:

  • apply a higher confidence interval, of at least 99.5 per cent, in relation to less liquid products, such as OTC derivatives, to reflect increased uncertainty around potential future exposure for products with such characteristics
  • use a close out assumption of at least five days for less liquid products, such as OTC derivatives, and the higher of a one or two day close out period for more liquid exchange-traded products
  • consider a range of sample periods to inform the calibration of margin requirements.
Liquidity Risk

CCP Standard 7.3. A central counterparty should maintain sufficient liquid resources in all relevant currencies to settle securities-related payments, make required variation margin payments and meet other payment obligations on time with a high degree of confidence under a wide range of potential stress scenarios… 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 consider maintaining additional liquidity resources to cover a wider range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions.		 Consistent with the equivalent requirement in relation to credit risk, the Bank will, in determining whether a central counterparty is systemically important in multiple jurisdictions, take into account the (implicit or explicit) views of the relevant overseas regulatory authorities. The need to obtain recognition under EMIR – in order either to continue to provide services to clearing members established in the EU, or to be considered a ‘qualifying CCP’ under EU bank capital regulations – may be regarded as evidence that the EU authorities consider an Australian domestic central counterparty to be a possible vehicle for the transmission of risks to the EU. This may therefore be evidence of systemic importance in multiple jurisdictions. If a systemically important domestic central counterparty in Australia not only required recognition in the EU, but also had material participation of clearing members established in the EU and cleared a range of products, including derivatives with different characteristics (including levels of liquidity), the Bank would expect to conclude that such a central counterparty was systemically important in multiple jurisdictions.

The Bank will interpret CCP Standard 7.3 accordingly in the case of ASX Clear (Futures) and ASX Clear, and hold these central counterparties to the higher standard that they should maintain additional liquid resources to cover liquidity needs in the event of the default of the two participants and their affiliates that would generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions.
Segregation and Portability

CCP Standard 13.2. A central counterparty should employ an account structure that enables it readily to identify positions of a participant's customers and to segregate related collateral. A central counterparty should maintain customer positions and collateral in individual customer accounts or in omnibus customer accounts, or equivalent.

CCP Standard 13.3. To the extent reasonably practicable under prevailing law, a central counterparty should structure its portability arrangements in a way that makes it highly likely that the positions and collateral of a defaulting participant's customers will be transferred to one or more other participants.		 CCP Standards 13.2 and 13.3 do not explicitly require that a central counterparty offer the choice between individual and omnibus account structures. However, associated guidance (particularly 13.2.2-13.2.9) draws out the relevant considerations for a central counterparty in determining appropriate account structures. The guidance in 13.3.1 observes that ‘in order to achieve a high likelihood of portability, a central counterparty will need to: have the ability to identify positions that belong to customers; identify and assert rights to related collateral held by or through the central counterparty; transfer positions and related collateral to one or more other participants…’.

Where a central counterparty clears derivatives products for a variety of participant and underlying customer types, the Bank will interpret CCP Standards 13.2 and 13.3 as requiring that the central counterparty employ an account structure that enables its participants to offer their customers individual segregation.

Accordingly, in relation to their clearing of derivatives products, ASX Clear (Futures) and ASX Clear will each be expected to make available to its participants an account structure that enables its participants to offer their customers an option that allows for separate identification and protection of individual customers' gross positions and collateral (or collateral value). To further protect derivatives customers, ASX Clear (Futures) and ASX Clear will each be expected to make available an account structure that enables excess customer collateral to be held directly with the central counterparty.
Custody and Investment Risks

CCP Standard 15.4. A central counterparty's investment strategy should be consistent with its overall risk management strategy and fully disclosed to its participants, and investments should be secured by, or be claims on, high-quality obligors. These investments should allow for quick liquidation with little, if any, adverse price effect.		 Although not explicitly stated in CCP Standard 15.4 or associated guidance (15.4.1), the Bank will interpret this requirement as applying in all market conditions, including in periods of market stress. Furthermore, since CCP Standard 15.4 also requires that a central counterparty's investment strategy should be ‘consistent with its overall risk management strategy’ and that ‘investments should be secured by, or be claims on, high-quality obligors’, and since the guidance (15.4.1) notes that investments should be subject to appropriate controls for wrong-way risk, the Bank would not consider investments in a central counterparty's own, or an affiliated entity's, securities, to be consistent with these requirements.

The Bank will interpret CCP Standard 15.4 accordingly in the case of ASX Clear (Futures) and ASX Clear.
Regulatory Reporting

CCP Standard 21. A central counterparty should inform the Reserve Bank in a timely manner of any events or changes to its operations or circumstances that may materially impact its management of risks or ability to continue operations. A central counterparty should also regularly provide information to the Reserve Bank regarding its financial position and risk		 CCP Standard 21 sets out a range of reporting requirements for central counterparties. The Bank is currently reviewing its regular information requirements and will inform ASX Clear (Futures) and ASX Clear accordingly.

In the meantime, the Bank would like to clarify that in accordance with CCP Standard 21.1(i), which requires notification to the Bank if ‘…any internal audits or independent external reviews are undertaken of its operations, risk management processes or internal control mechanisms, including providing the conclusions of such audits or reviews’, domestically licensed central counterparties such as ASX Clear (Futures) and ASX Clear will be expected to provide the Bank with copies of any reviews of their margin methodologies.

ASX Group Structure

All four CS facilities are part of the ASX Group. In the ASX corporate structure, the two central counterparties (CCPs) – ASX Clear and ASX Clear (Futures) – are subsidiaries of ASX Clearing Corporation Limited (ASXCC), while the two securities settlement facilities (SSFs) – ASX Settlement and Austraclear – are subsidiaries of ASX Settlement Corporation Limited (Figure 1). ASXCC and ASX Settlement Corporation Limited are in turn subsidiaries of the ASX Group's parent entity, ASX Limited. ASX Limited is the licensed operator of the ASX market, while another subsidiary, Australian Securities Exchange Limited, is the licensed operator of the ASX 24 market. The ASX market provides a trading platform for ASX listed securities and equity derivatives, while ASX 24 is an exchange for futures products. ASX Clear and ASX Settlement provide clearing and settlement services for the ASX market, and ASX Clear (Futures) provides clearing services for the ASX 24 market.[70]

Figure 1
Figure 1: ASX Group Structure - explained in the paragraph below.

ASX Limited is a listed company. The ASX Limited Board is responsible for overseeing the processes for identifying significant risks to ASX and ensuring that appropriate policies, as well as adequate control, monitoring and reporting mechanisms, are in place. In addition, ASX Limited's Board assigns certain responsibilities to subsidiaries within the group, including the boards of the four CS facilities (the CS Boards). The CS Boards are responsible for managing the particular clearing and settlement risks faced by each respective CS facility, including through compliance with the FSS. The CS Boards are subject to common governance arrangements with high-level objectives set out in the CS Boards' Charter. A majority of the directors on the CS Boards are common to the boards of all four CS facilities; however, one of the directors on the ASX Clear and ASX Settlement Boards does not sit on the ASX Clear (Futures) and Austraclear Boards, and two of the directors on the ASX Clear (Futures) and Austraclear Boards do not sit on the ASX Clear and ASX Settlement Boards.

ASXCC is a wholly owned subsidiary of ASX Limited. ASXCC is the holding company for, and manages the financial resources of, the two CCPs. It invests these resources according to a treasury investment policy and investment mandate approved by the CS Boards.

The CS facilities rely in the delivery of their services on group-wide operational and compliance resources that reside in ASX Operations Pty Limited (ASX Operations), which is a wholly owned subsidiary of ASX Limited.

  • ASX Operations provides most operational resources required by the CS facilities, including services to enable ASX Compliance Pty Limited (ASX Compliance) to perform its services.
  • ASX Compliance provides compliance services to the licensed entities of the ASX Group, including monitoring and enforcing participants' compliance with the Operating Rules of the CS facilities.

ASX has adopted a group-wide organisational structure to manage the business operations of its various entities, including the CS facilities. Its business units are organised into nine main divisions:

  • Office of the Chief Executive Officer (CEO)
  • Risk
  • Operations
  • Technology
  • Business Development
  • ASX Compliance
  • Office of General Counsel and Company Secretariat, Regulatory Policy and Regulatory Assurance
  • Chief Financial Officer (CFO) Office
  • Human Resources.

Risk contains a number of departments that play key roles in the management of risks faced by the CS facilities:

  • Clearing Risk Policy – develops and maintains policies and standards related to CCP clearing risk management.
  • Clearing Risk Quantification (CRQ) – maintains and validates CCP risk and pricing models.
  • Clearing Risk Management (CRM) – implements CCP risk management policies and standards, and maintains effective procedures for carrying out those policies and standards.
  • Risk Systems Development – responsible for the development of enhanced risk management systems.
  • Enterprise Risk – responsible for enterprise-wide risk management, including general business risk.
  • Portfolio Risk Management – responsible for managing investment and liquidity risks associated with ASXCC's investment portfolio.
  • Internal Audit – conducts risk-based reviews of internal controls and procedures across ASX. Internal Audit reports to the Chief Risk Officer (CRO) for administrative purposes only.

ASX's Clearing Risk Policy Framework also sets out roles for a number of internal committees that bring together decision makers and experts from departments across the group:

  • Clearing Risk Policy Committee (CRPC) – reviews policies and standards prior to CS Board submission.
  • Capital and Liquidity Committee (CALCO) – advises on changes to clearing risk policies and standards related to capital, liquidity and balance sheet management.
  • CCP Risk, Operations and Compliance Committee (CROCC) – discusses and shares information across relevant operational, compliance and risk management departments.
  • Enterprise Risk Management Committee (ERMC) – reviews and approves enterprise risk management policy and related reporting prior to Board submission.
  • Risk Quantification Group (RQG) – responsible for quantitative risk management matters, including review and approval of margin and stress-test model backtesting results and proposed model parameter changes.
  • Participant Incident Response Committee (PIRC) – responsible for monitoring and managing material participant incidents and, in the case of a clearing participant, escalation of potential default events to the ASX Default Management Committee.
  • Default Management Committee (DMC) – coordinates ASX's response to a clearing participant default, and conducts the review and testing of the CCPs' default management approach.

ASX's Settlement Risk Policy Framework sets out roles for a number of additional internal committees:

  • Settlement Risk Policy Committee (SRPC) – reviews policies and standards prior to CS Board submission.
  • SSF Risk, Operations and Compliance Committee (SROCC) – discusses and shares information across relevant operational, compliance and risk management departments.
  • Enterprise Risk Management Committee (ERMC) – reviews and approves enterprise risk management policy and related reporting prior to Board submission.
  • Participant Incident Response Committee (PIRC) – responsible for monitoring and managing material participant incidents, including any non-compliance with capital obligations, settlement default, operational failure or an event which might result in the participant becoming an externally-administered body corporate or an insolvent under administration, and, in the case of a clearing participant, escalation of potential default events to the DMC.

Footnotes

The full text of the detailed assessments of each of these CS facilities is available at <http://www.rba.gov.au/payments-system/clearing-settlement/assessments/2014-2015/>. [67]

Available at <http://www.bis.org/cpmi/publ/d106.htm>. [68]

The Bank's letter to ASX is available at <http://www.rba.gov.au/payments-system/clearing-settlement/pdf/supplementary-guidance-domestic-derivatives-ccps.pdf>. [69]

ASX Clear and ASX Settlement also provide clearing and settlement services for markets other than ASX; these are noted in Section 3.1. [70]