2014/15 Assessment of ASX Clearing and Settlement Facilities 5. Special Topic – Stress Testing

A CCP relies on its financial resources to absorb potential losses stemming from participant default, and thereby support its core counterparty risk management function. A CCP conducts regular stress tests to verify the sufficiency of its financial resources in extreme (but plausible) market conditions.

The importance of stress testing to the resilience of CCPs has received increasing attention internationally among both regulators and CCP participants. Domestically, the Bank recommended a full external expert validation of ASX's capital and liquidity stress test models as part of its 2013/14 Assessment of the ASX CCPs. The resulting validation reports have contributed to changes in ASX's stress-testing approach. Further enhancements are expected, including in response to international policy developments in this area.

This section describes ASX's stress-testing framework, and assesses it in light of existing requirements under the FSS and the anticipated direction of the international work. ASX is found to have observed all relevant requirements of the FSS. The Bank has nevertheless identified a number of areas in which ASX could usefully enhance its stress-testing approach in the spirit of continuous improvement, consistent with ASX plans to implement further refinements in future phases of its stress-testing enhancement programme.

5.1 FSS Requirements

The FSS requirements that relate to stress testing are contained within CCP Standard 4 for credit risk (set out in Table 13). These requirements cover four main areas:

• Governance and process. Governance arrangements should define the objectives of stress testing and clarify the allocation of responsibilities for stress testing. The ASX CCPs are required to use stress testing to ensure that their prefunded financial resources are sufficient to cover obligations that could arise in the event of the joint default of any two participants and their affiliates (Cover 2) in ‘extreme but plausible’ market conditions (CCP Standard 4.4).^[38] Stress tests must be carried out daily.
• Modelling extreme but plausible scenarios. Stress testing should employ a wide range of scenarios that take into account material sources of risk in a variety of extreme but plausible market conditions. These should include historically observed peak market movements as well as forward-looking scenarios, and take into account changes in market conditions, such as correlations between products, market liquidity and concentration, as well as interdependencies in the default management process (CCP Standard 4.6).
• Use of stress-test outcomes. CCPs should have an effective means of increasing financial resources where stress-test losses indicate a shortfall. This could involve an increase in margin or pooled financial resources, depending on the frequency and dispersion of such projected stress-test losses (CCP Standard 4.7).
• Review and validation. CCPs should review stress-test scenarios and assumptions each month to ensure that they remain appropriate given changing market conditions (CCP Standard 4.5). CCPs should also carry out ‘reverse’ stress testing to identify extreme scenarios in which total financial resources would not be sufficient to cover tail risk (CCP Standard 4.6). In addition, a CCP should carry out a full annual validation of its stress-test model (CCP Standard 4.5).

5.2 CPMI-IOSCO Work

Enhancements to ASX's stress-testing approach are being undertaken in the context of wider international efforts to improve the transparency and consistency of stress-testing approaches across CCPs (see Section 3.5.1, Box A). Some large international clearing participants, as well as some regulators, have expressed concerns that stress-testing frameworks of many CCPs globally are not sufficiently transparent and that differing approaches across CCPs inhibit comparisons of resilience. There is also a concern that the relatively high-level requirements set out in the PFMIs may not provide sufficient guidance to promote a consistent approach to stress testing.

In response, CPMI and IOSCO have commenced work to evaluate current stress-testing practices of CCPs, and consider the case for additional guidance to promote consistency and comparability. The first phase of the CPMI-IOSCO work involves a stocktake of current stress-testing practices across CCPs based in a wide variety of jurisdictions. The case for developing standardised supervisory stress tests will be considered as part of the CPMI-IOSCO process.

5.3 Stress Testing in the ASX Risk Management Framework

ASX Clear and ASX Clear (Futures) use stress testing to determine the appropriate size of their respective default funds and to calculate requirements for AIM, which is typically called to cover large, concentrated exposures to individual participants. In this way, stress testing builds on initial margin requirements placed on participants, which are modelled according to estimates of the CCPs' potential future exposure to participants under normal market volatility.^[39]

The focus of this section is on ASX's capital stress tests, which seek to estimate on a Cover 2 basis the maximum credit exposure that the ASX CCPs could face. The capital stress tests operate by applying a range of extreme but plausible price and volatility shocks to underlying risk factors, which in turn affect the value of positions held by participants each day. These shocks are reflected in a set of scenarios that are applied to portfolios for each participant, generating potential Cover 2 losses in excess of initial margin for each CCP.^[40] The ASX CCPs conduct daily capital stress tests in order to ensure that prefunded financial resources are sufficient to meet Cover 2 requirements. These prefunded resources include margin posted by participants and pooled financial resources held in each CCP's default fund.^[41] ASX Clear currently holds $250 million of pooled prefunded financial resources, while ASX Clear (Futures) holds $650 million.^[42]

Where stress tests indicated persistent and widespread breaches of financial cover on a Cover 2 basis, ASX would consider an increase in pooled financial resources. Similarly, stress tests that indicated exposures were persistently below the current level of financial resources could be used to support a reduction in the size of the default fund. The ASX CCPs typically maintain a buffer of pooled financial resources in excess of stressed exposures to minimise the need for frequent adjustments. In late 2013 and early 2014, however, ASX Clear (Futures) significantly increased its level of pooled financial resources in line with stress-testing outcomes when transitioning from Cover 1 to Cover 2 (Graph 11). This increase in resources was also in anticipation of higher exposures from the launch of its OTC derivatives clearing service.

Individual participants with potential stress losses that exceed a predetermined STEL are required to post AIM. Participants' STELs are largely determined by ASX's ICRs assigned to each participant, with the highest-rated participants' assigned limits equal to half of the CCP's prefunded resources.^[43] This incentivises participants to manage the risk they bring to the CCP, since those with very large stressed exposures are required to cover these exposures on a ‘defaulter pays’ basis via AIM. Graph 11 illustrates the use of AIM by ASX Clear (Futures) to manage stress-testing results in excess of prefunded financial cover by individual participants; the adjusted Cover 1 and Cover 2 data take into account the additional cover provided by AIM, which is particularly prominent in the first half of 2015.

While the sizing of the default fund and AIM calls are based on stress tests utilising a wide range of scenarios, ASX also maintains a range of ‘for-information’ scenarios that are not directly used for these purposes. For-information scenarios are used by ASX management to support broader analysis of the sufficiency of the CCPs' financial cover. These scenarios may include some that are considered ‘beyond plausible’, or that are focused on potential future, or emerging, risks. As market conditions evolve, some of these for-information scenarios may be rotated into the set of scenarios used for AIM and default fund sizing.

Both CCPs also perform daily liquidity stress tests to ensure the adequacy of their liquidity arrangements. These liquidity stress tests determine the maximum level of liquid funds that each CCP would need to access in order to meet its obligations on time in the event of the default of the two largest participants and their affiliates. While the liquidity stress tests are closely related to the capital stress tests, there are some differences arising from the expected timing of payments. These are of particular significance in the settlement of securities transactions cleared by ASX Clear. ASX's liquidity stress-testing framework underwent an independent external validation in early 2015 (see Section 3.5.1).

5.3.1 Review and validation

In order to ensure that stress tests remain appropriate, ASX has begun reviewing its set of stress scenarios on a monthly basis by using forward-looking and current market indicators. Recommendations for change are submitted to the CCP Boards for approval as required or as part of a comprehensive annual review of the stress tests at Board level. In addition, ASX performs monthly reverse stress tests to provide management with further information and to test model assumptions. These reverse stress tests examine the effect of varying the magnitude and direction of both shocks and participant positions, as well as the number of participant defaults assumed. The aim is to identify scenarios in which the CCPs' financial resources would be exhausted. The scenarios identified as a result of this process assist management in determining whether existing stress-test scenarios adequately capture the range of extreme but plausible risks to the CCPs' financial resources.

The internal review of stress tests is supplemented by an annual external validation, the first of which was carried out by an external independent expert in late 2014. The findings of this first validation and enhancements to ASX's stress-testing approach in response are the primary focus of Section 5.4.

5.4 Enhanced ASX Stress-testing Framework

ASX is currently implementing a number of enhancements to its capital stress-testing approach, partly motivated by recommendations from the external validation of the capital stress-testing models. As part of this validation, ASX's stress-testing processes and assumptions were benchmarked against those of a range of prominent CCPs based in Asia, Europe and the United States.

ASX's approach was found to be broadly comparable to that of its peers, but a number of enhancements were recommended to bring ASX closer into line with international best practice as identified by the benchmarking study. The recommendations focus on ASX's approach to constructing its stress-testing scenarios, given the key role these play in driving estimates of stressed exposures. Table 10 summarises ASX's responses to these recommendations. These are discussed in more detail in the remainder of this Section.

ASX is implementing its proposed enhancements in two phases, the first of which came into effect in July 2015. The second phase of enhancements will be partly dependent on the outcomes of the CPMI-IOSCO work on stress testing as well as enhancements to ASX's statistical models and risk systems. While the timing for completion of this second phase is uncertain, work on implementation is currently underway.

5.4.1 Selection of risk factors

Stress-test scenarios may be designed to apply shocks to the full range of risk factors that could influence losses by a CCP in the event of a default, or they may apply shocks to only a subset of risk factors based on materiality considerations.

ASX Clear (Futures) previously applied shocks to risk factors underlying the four main futures contracts (equity index futures, 3- and 10-year government bond futures and 90-day bank bill futures), together with exposures on OTC IRD referencing the BBSW and Australian overnight index average (AONIA), covering around 90 per cent of open positions at the CCP. ASX is extending coverage to the next largest (and only other AUD) interest rate futures contract (the 30-day interbank cash futures contract) as well as electricity contracts, taking stress-test coverage in ASX Clear (Futures) to around 98 per cent of open positions. ASX has concluded that other risk factors in ASX Clear (Futures) (such as those related to agricultural futures, or New Zealand dollar-denominated contracts) do not presently give rise to material exposures.

ASX has also extended its coverage of sector-specific equity shocks in ASX Clear; these now cover all 10 industry sectors in addition to market-wide risk factors.^[44] ASX Clear's stress tests also include scenarios individually covering the 25 largest stocks by open derivatives positions.

5.4.2 House and client positions

In considering its total exposure to a defaulting participant, a CCP must consider the effects of the potential transfer of the accounts of that participant's clients to a non-defaulting participant. ASX makes the conservative assumption that client positions commingled in omnibus client accounts could not be transferred in a timely manner to another clearing participant in the event of a default, acknowledging that this would be extremely challenging to arrange in a short time frame. ASX therefore includes all stressed losses on omnibus client accounts in its stress-test outcomes.

For individually segregated client accounts on ASX Clear, ASX assumes that client accounts with sufficient margin to cover losses would be transferred (or closed out with profits that cannot be offset against other losses), along with the 50 per cent of remaining loss-making client accounts with the smallest losses. In practice, this means that almost the entire value (approximately 98 per cent) of any losses in excess of margin in segregated client accounts is assumed to be realised by the CCP.^[45]

In calculating the stressed losses at the level of each participant, ASX sums all stressed losses in excess of margin posted on client accounts that are assumed to be realised, and adds these to stressed losses on the participant's own proprietary (‘house’) positions. In doing so, ASX excludes any remaining margin in excess of estimated stressed losses on client accounts, since ASX would be required to return such margin to clients (via the external administrator of the defaulted participant) after completion of the close-out process. However, if there is an excess of margin over estimated stressed losses on house positions, ASX applies this to any net loss on client positions. The external validation of ASX's stress-testing models did not identify the need for any changes to ASX's treatment of house and client positions and collateral.

5.4.3 Confidence level and holding period

The calibration of stress-test scenarios depends on two key settings: the desired confidence level for financial resource cover; and the assumed period over which a CCP is exposed to losses (‘holding period’). Previously, ASX calibrated its stress tests to a once-in-30 year event (covering 99.987 per cent of the estimated distribution of price movements), extending to once-in-100 years (or 99.996 per cent of price movements) for multi-asset scenarios in ASX Clear (Futures). A single-day holding period was applied for exchange-traded products, implicitly assuming that positions in these products inherited from a defaulting participant could be closed out in a single day, even in stressed market conditions.^[46] In benchmarking, ASX was found to be generally more conservative than its international peers in setting the confidence level for stress tests, but found to apply a less conservative assumption in setting its holding period for exchange-traded products.

In response to these findings, ASX has extended its holding period for exchange-traded products to a minimum of three days, while reducing the targeted confidence level to a once-in-20-year event (or 99.980 per cent of the estimated distribution of price movements).^[47] In order to assess the impact of these changes on stress-test outcomes, ASX has carried out backtests of the revised settings against positions held by its participants over the previous 12 months. This backtesting revealed little impact from the changes on the aggregate stress-test exposure in either CCP, measured on a Cover 2 basis, although there was some impact observed at the individual participant level in some cases. This is because, over the past 20 years, equity prices are observed to adjust more quickly to extreme shocks than interest rate futures prices,^[48] and therefore each type of shock is relatively more sensitive to the changes in either confidence level (for equity price shocks) or holding period (for yield shocks). Table 11 presents a selection of the revised stress-test scenarios for exchange-traded products.

In order to retain information to assist management in understanding the impact of more extreme scenarios, ASX intends to develop once-in-30- and once-in-40-year scenarios, as well as longer holding periods as part of the second phase of its stress-test enhancements. These scenarios will not directly feed into the sizing of financial resources or the calling of AIMs, but will be used by management in broader analysis of the sufficiency of the CCPs' financial cover.

5.4.4 Selection of scenarios and methodology

Historical scenarios

ASX applies a range of scenarios based on 20 years of historical data in its stress-testing approach. These historically based scenarios are drawn from an actual or simulated distribution based on the targeted once-in-20-year confidence level.

The methodology applied by ASX to construct historically based scenarios varies by scenario type. For scenarios that involve shocks to a single risk factor, ASX uses the most extreme observed movement in the previous 20 years. For scenarios that involve shocks to multiple risk factors, a simulated joint distribution is constructed based on 20 years of price history, using a student t distribution and Monte Carlo simulation to generate additional data points.^[49] ASX has to assume a structure for the scenarios that it draws from this joint distribution so as to be able to draw a combination of price shocks that meet the desired confidence level. For interest rate contracts, ASX bases its scenarios on one of ten particular combinations of co-movements of yields at different maturities.^[50]

• Parallel shifts shock yields up or down across all points on the yield curve.
• Tilts involve changes to the gradient of the yield curve. The tilt scenarios involve fixing yields at either the short or long end of the curve, and shocking yields at the opposite end of the curve either up or down. The middle of the curve moves in the same direction as this shock, but by a smaller magnitude.
• Twists, like tilts, involve a change to the gradient of the yield curve, but instead fix yields in the middle of the curve while adjusting short and long end yields up or down in opposite directions.
• Bends apply shocks to the middle of the yield curve, either up or down, that are opposite in direction to shocks applied to the short and long ends.

These yield curve shocks are combined with either an increase or decrease in equity prices. Within the structures of these yield and equity price co-movements, simulated scenarios are chosen according to the desired confidence level. Assumptions regarding the correlation between different risk factors (between equity and yield moves, and between yields of different maturities) play a key role in determining the relative sizes of shocks within each of these structures. In addition, ASX considers various forms of basis risk in its exchange-traded and OTC products (which may be cross-margined). These scenarios allow for a breakdown in the established correlations between futures and swap contracts, the spread between the BBSW and AONIA rates, and spreads across various swap rate tenors.

ASX Clear (Futures) has extended its approach to shocking correlations between equity price and interest rate movements at historical maximum boundaries. These changes have introduced assumed correlations that approximately span the range of historical observations, rather than relying on average correlations observed in the previous 12 months or correlations observed only in the context of certain events.^[51] In addition, as part of a second phase of enhancements to stress testing, ASX is proposing further sensitivity analysis of its approach to modelling shocks that affect the shape of the yield curve. ASX will be examining the effects of relaxing the assumed correlations between the different points on the yield curve in order to investigate the impact of stresses that arise from other plausible combinations of yield co-movements and whether they generate greater losses than the current twists, bends and tilts.

ASX has also reviewed its approach to stressing correlations between equity prices in different sectors in ASX Clear. Currently, the stress-testing approach for ASX Clear applies sector-specific shocks in isolation, assuming that prices remain stable in all other sectors and the market as a whole. Particularly for the larger sectors, an isolated shock of this nature seems implausible. In addition, only if a participant had a very highly skewed portfolio would such a shock be more severe than the broader market-wide shock scenario. In order to provide a more meaningful estimate of stressed exposures arising from shocks that fall primarily on a particular sector, ASX is planning to add scenarios that apply sector-specific shocks in the context of a broader market-wide price movement. These will come into effect in ASX's second phase of stress-test enhancements.^[52]

ASX's approach to constructing historically based scenarios ensures that single risk factor scenarios take into consideration the peak historical price movements observed over the previous 20 years. However, in the case of scenarios that involve multiple risk factors, the simulation approach does not guarantee that the combination of risk factor moves will fully capture (or be at least as severe as) those actually observed in extreme ‘stress’ events. This is because only a representative sample of combinations of price movements can be captured in the finite set of scenarios used in stress testing; in some cases a historical event may generate an unusual combination of risk factor movements that affects some portfolios more heavily than would a combination of multifactor movements generated from a simulated distribution. Similarly, historical events that fall outside the 20-year look-back period are not covered. This includes the stock market crash of 1987.^[53]

In order to better understand the impact of severe historical events, ASX includes additional ‘for information’ scenarios based on historical events both within and outside the 20-year look-back period, including the 1987 stock market crash. Further ‘additional information only’ scenarios are intended to be added as part of the second phase of stress-testing enhancements.

Forward-looking scenarios

ASX has previously relied largely on the use of historically based scenarios in constructing its stress tests. By contrast, ASX's international benchmarking suggested that CCPs typically use a wide range of hypothetical scenarios for both fund sizing and management information. In response, ASX has introduced a series of forward-looking hypothetical scenarios motivated by external ‘macro’ events, such as shocks stemming from natural disasters, collapses in commodity prices or offshore sovereign defaults (Table 12). In discussions with ASX, the Bank has sought to ensure that the macro events selected could feasibly generate significant shocks to relevant risk factors over the three-day holding period.

These forward-looking scenarios have been constructed with reference to domestic or overseas events of a similar nature, with judgement applied to ensure that the resultant shocks are plausible in the current Australian context. Consideration is given to the likely sensitivity of different risk factors to each scenario. For example, a corporate or sovereign default is likely to have a significant impact on short-term interbank rates, with a relatively smaller impact on longer-term interest rates.

ASX intends to expand the suite of its forward-looking scenarios over time, applying the most relevant of these at any point in time in its calibration of the default fund and AIMs calls, while using the remainder of such scenarios for management information. The initial set of macro event-based scenarios is active for AIM purposes in ASX Clear (Futures). The equivalent set of scenarios in ASX Clear is being monitored closely for management information, but is not initially active for AIM purposes. ASX plans to make these scenarios active in ASX Clear alongside planned enhancements to its risk management system (see Section 3.5.6).

In a second phase of enhancements to its stress-testing approach, ASX proposes to introduce a series of additional forward-looking for-information scenarios that address situations in which one or more defaults (either by participants in the CCP or in related markets) introduces stress to key risk factors. This stress could be transmitted by information effects, disruption to markets or interference with normal default-management processes. More generally, ASX intends to significantly expand the range of ‘for information’ scenarios that it maintains in order to inform management understanding of emerging risks. These could include scenarios that are thought to be ‘beyond plausible’.

Other methodological enhancements

Along with enhancements flowing from the major recommendations of the external validation report, ASX is implementing a number of other methodological enhancements to its stress-testing framework. These enhancements include a scaling up of shocks for contracts with highly concentrated positions, to take into account reduced liquidity in these contracts following a default. Participants with gross or net market positions that account for more than 25 per cent of total exposure will be subject to an increase in the price shock applied to the relevant contract(s).

ASX also intends to investigate a number of other technical changes to its methodological approach as part of its second phase of enhancements. These include the introduction of an absolute floor on shocks to yields (i.e. a basis point shock) on interest rate products, or a shock applied directly to contract prices, since existing scenarios based on a relative (percentage) shock to yields may understate risks should Australia move into a sufficiently low rate environment. Indicators of such an environment are currently monitored monthly as part of capital stress test forward-looking and market indicators.

5.4.5 Reverse stress testing

While outside the scope of the external validation report that has motivated many of the preceding changes to ASX's stress-testing framework, ASX has made further enhancements to its reverse stress-testing approach, including in response to recommendations in the Bank's 2013/14 Assessment. ASX carries out reverse stress testing on a monthly basis, to identify scenarios that would result in the exhaustion of available prefunded financial resources, but that are more extreme than those considered in the capital stress tests. ASX considers the extreme shocks that would exhaust financial resources under a Cover 2 assumption based on participants' current portfolios.

In addition to its routine monthly reverse stress testing, ASX has developed a flexible framework for reverse stress testing that allows it to define particular combinations of assumptions that can be varied for the purposes of ad hoc analysis. These include increases in the size, or changes in the direction, of participants' positions and the magnitude of shocks applied to these positions, as well as changes to the number of participants that are assumed to default.

One area of enhancement to reverse stress testing that was recommended in the Bank's 2013/14 Assessment was to take better account of potential extreme sector-specific equity shocks in ASX Clear. As noted above, ASX is planning changes to its stress-testing approach to take better account of such risks in its routine stress-testing scenarios for ASX Clear, and has implemented a similar approach involving sector-specific shocks as part of its June 2015 monthly reverse stress-testing process.

5.5 Conclusions and Recommendations

ASX has made significant enhancements to its stress-testing framework, in part motivated by findings of the external validation that was carried out towards the end of the 2013/14 Assessment period. The Bank's assessment is that ASX has observed all the relevant minimum requirements in the FSS. The Bank has nevertheless identified a number of areas in which ASX could usefully enhance its observance of the relevant standards in the spirit of continuous improvement, consistent with ASX plans to further refine its stress-testing approach over the coming period.

ASX has already undertaken to carry out work in many of the areas covered by the recommendations as part of a second phase of its stress-testing framework improvements. The Bank therefore expects ASX's stress-testing approach to continue to evolve over the coming period, both to incorporate planned refinements as part of the second phase of its enhancements, and to take into account developments in the international policy work on stress testing. On the basis of changes already implemented under phase 1, the Bank has drawn a number of key conclusions:

• Selection of risk factors. An extension of the coverage of risk factors at ASX Clear (Futures) is appropriate, and ASX should continue to review coverage as participants' positions evolve over time, to ensure that all material risks remain subject to stress testing.

• Confidence level and holding period. ASX's settings for confidence level and holding period meet the requirement to calibrate stress scenarios to ‘extreme but plausible’ market conditions. ASX should nevertheless continue to review this interpretation in light of evolving international best practice, including outcomes of the CPMI-IOSCO work.

  – It is reasonable to expect that it would take longer to close out positions in stressed market conditions, and therefore an extension of the holding period to three days for exchange-traded products is appropriate.

  – The reduction in ASX's targeted confidence level from once-in-30 to once-in-20 years still provides for a sufficient level of prefunded financial resources. However, the planned introduction of additional for-information scenarios based on higher confidence levels (once-in-30 and once-in-40 years) should provide valuable information regarding the resilience of the CCPs to more extreme events.

• Scenario selection and methodology. Refinements to ASX's scenario selection and stress-testing methodology improve the sensitivity of the stress-test models to a wider range of shocks.

  – The introduction of forward-looking hypothetical scenarios is an important complement to historically based scenarios; ASX is, however, encouraged to implement planned enhancements to incorporate a broader range of market disruptions or default-related events, and to make active existing forward-looking scenarios in ASX Clear.

  – The incorporation of additional for-information scenarios based directly on historical events will usefully complement existing scenarios drawn from a historically based distribution.

  – Planned refinements to the methodology used to stress assumed correlations between risk factors in both CCPs are beneficial (including planned sensitivity analysis on the assumed shape of the yield curve in ASX Clear (Futures)).

  – There is merit in considering the introduction of an absolute floor on shocks to yields on interest rate products should Australia move to a sufficiently low rate environment.

• Reverse stress testing. The introduction of sector-specific shocks into reverse stress testing for ASX Clear will usefully complement the existing analysis of sensitivity to market-wide movements.

Table 13 summarises the Bank's assessment of the ASX CCPs against the specific sub-standards of the FSS that address matters related to capital stress testing, applying the rating system described in Section 2.2. Table 13 includes the Bank's recommendations and identifies areas in which the Bank will continue to monitor developments during the 2015/16 Assessment period.

Footnotes

The Bank has issued a supplementary interpretation of CCP Standard 4.4, which confirms that the ASX CCPs are considered to be ‘systemically important in multiple jurisdictions’ and therefore required to size their financial resources to a Cover 2 standard (see Section 3.6). [38]

ASX models initial margin requirements to cover 99.7 per cent of the distribution of potential future exposure to participants (see Appendices A1.1 and A1.2, CCP Standards 6.1 and 6.3 for more detail on initial margin requirements in the ASX CCPs). [39]

Further detail on the construction of stress-test scenarios is provided in the discussion of enhancements to ASX's stress-testing framework below (see also Appendices A1.1 and A1.2, CCP Standards 4.4–4.7). [40]

Historically, both CCPs calculated their prefunded financial resources on a Cover 1 basis (i.e. assuming a single default only), but moved to doing so on a Cover 2 basis in light of the Bank's supplementary interpretation of the FSS. This supplementary interpretation was issued in the context of the CCPs' applications for recognition in the EU (see Section 3.6). In the case of ASX Clear (Futures), the transition to Cover 2 took place in September 2013. ASX Clear, by contrast, decided more recently to seek recognition in the EU and began conducting its stress tests on a Cover 2 basis only from 31 March 2015. This has not required an increase in ASX Clear's prefunded financial resources. [41]

Pooled financial resources are invested at the parent entity level by ASX Clearing Corporation Ltd. [42]

For more information on ASX's ICRs and AIM, see Appendices A1.1 and A1.2, CCP Standards 4.2 and 4.7. [43]

ASX Clear's capital stress test previously included sector-specific scenarios for consumer staples, energy, financials, health care, industrials, materials and telecom services; new scenarios have been added for the consumer discretionary, utilities and information technology sectors. [44]

There is currently limited use of individually segregated client accounts on ASX Clear (Futures). ASX Clear (Futures)' estimate of stressed losses currently includes the two largest losses in excess of margin on individual client accounts at each of its participants; in practice this means that losses on all client accounts are assumed to be realised by the CCP. [45]

ASX applies a five-day holding period for OTC derivatives products, in line with its international peers, reflecting the longer default management and auction process required to close out positions in these less liquid products. [46]

Scenarios involving shocks to the shape of the yield curve in ASX Clear (Futures) have not been updated as part of the first phase of ASX's stress-testing enhancements, since ASX plans to investigate changes to the way in which these shocks are applied as part of its second phase of enhancements (see Section 5.4.4). [47]

In theory, absolute returns – and therefore the severity of price shock scenarios – should rise in line with the square root of the holding period, although if returns are positively autocorrelated they will rise by more than this. While autocorrelated returns cannot persist in an efficient, liquid market, it is possible that such returns could be observed over a run of days in a stressed market. [48]

The use of a student t distribution allows ASX to model fatter tails than would result from a normal distribution. [49]

The relevant maturities are currently at 90 days (short end), three years (middle) and 10 years (long end). [50]

ASX uses pair-wise average annual correlations between equity prices and yields on its three largest interest rate futures contracts to estimate this range. [51]

These sector ‘de-correlation’ shocks have been included in reverse stress tests since June 2015. [52]

The All Ordinaries Index experienced a three-day price fall of 28 per cent in October 1987, nearly twice the 14.3 per cent price fall in ASX's revised stress-test scenarios. The fall was even greater for the Share Price Index futures contract, which experienced a single-day price fall of 34.2 per cent. This in part reflected that the contract was relatively new and liquidity was low. [53]