2015/16 Assessment of ASX Clearing and Settlement Facilities 3. Assessment of Clearing and Settlement Facilities against the Financial Stability Standards

3.1 Introduction to the ASX Clearing and Settlement Facilities

The ASX Group operates four CS facilities: two CCPs and two SSFs. Each of these facilities holds a CS facility licence, and each is required under the Corporations Act to comply with applicable FSS determined by the Bank and to do all other things necessary to reduce systemic risk.

3.1.1 Central counterparties

A CCP acts as the buyer to every seller, and the seller to every buyer in a market. It does so by interposing itself as the legal counterparty to all purchases and sales via a process known as novation. These arrangements provide substantial benefits to participants in terms of counterparty risk management as well as greater opportunities for netting of obligations. At the same time, however, they result in a significant concentration of risk in the CCP. This risk can crystallise if a participant defaults on its obligations to the CCP, since the CCP must continue to meet its obligations to all of the non-defaulting participants. Accordingly, it is critical that the CCP identifies and properly controls risks arising from its operations and conducts its affairs in accordance with the CCP Standards. Primary responsibility for the design and operation of a CCP in accordance with the CCP Standards lies with a CCP's board and senior management.

The ASX Group includes two CCPs that are required to observe the CCP Standards:

• ASX Clear provides CCP services for ASX-quoted cash equities, debt products and warrants traded on the ASX and Chi-X Australia Pty Ltd (Chi-X) markets, and equity-related derivatives traded on the ASX market.
• ASX Clear (Futures) provides CCP services for futures and options on interest rate, equity, energy and commodity products traded on the ASX 24 market, as well as Australian dollar-denominated (AUD-denominated) OTC IRD.

3.1.2 Securities settlement facilities

An SSF provides for the final settlement of securities transactions. Settlement involves transfer of the title to the security, as well as the transfer of cash. These functions are linked via appropriate delivery-versus-payment (DvP) arrangements incorporated within the settlement process. SSFs are systemically important FMIs that are essential to the smooth functioning of the financial system. Accordingly, it is critical that each SSF identifies and properly controls risks arising from its operations and conducts its affairs in accordance with the SSF Standards. Primary responsibility for the design and operation of an SSF in accordance with the SSF Standards lies with a CS facility licensee's board and senior management.

The ASX Group includes two SSFs that are required to observe the SSF Standards:

• ASX Settlement provides SSF services for ASX-listed cash equities, debt products and warrants traded on the ASX and Chi-X markets; ASX Settlement also provides SSF services for non-ASX listed securities quoted on the National Stock Exchange of Australia (NSX), SIM Venture Securities Exchange Limited (SIM) and the Sydney Stock Exchange Limited (SSX).
• Austraclear provides SSF services for trades in debt securities, including government bonds and repurchase agreements.

3.2 Activity in the ASX Clearing and Settlement Facilities

As in the previous year, the average volume of trading in cash equities cleared by ASX Clear grew strongly, while the volume of trades in equity options declined significantly in 2015/16. Both the average daily volume of futures contracts and the notional value of OTC IRD cleared by ASX Clear (Futures) increased in the Assessment period. The daily average value of debt securities settled in Austraclear also increased compared with the previous year. Average price volatility in the equities market increased compared with the previous year to be above the 10-year average. Volatility in the interest rate futures market, however, edged down during the Assessment period.

3.2.1 Cash equities

The daily average value and volume of cash equity trades increased by 8 per cent and 24 per cent, respectively, in 2015/16 (Graph 1, top panel). As a result, the average transaction size decreased by 13 per cent in 2015/16, consistent with the long-term trend prior to 2014/15, which has been partly driven by growth in algorithmic trading (Graph 1, bottom panel).

The daily average value of cash equity settlements in ASX Settlement increased by 6 per cent in 2015/16 to $9 billion. This increase was consistent with the growth in trading activity, albeit trends in net settlement values can deviate from trends in gross trading values, since the latter do not include non-market transactions and netting efficiency can change over time.

The average volatility in equity prices, as measured by the average of absolute daily percentage changes in the S&P ASX All Ordinaries Index, increased by 0.3 percentage points in 2015/16, to be above the 10-year average of 0.8 per cent (Graph 2, top panel). This primarily reflected three periods of heighted volatility: in August to September 2015; January to February 2016; and late June 2016. High volatility in the first two periods was caused by a combination of falls in commodity prices and concerns about China's economy, while high volatility in the last period was driven by the United Kingdom (UK) referendum on European Union (EU) membership. Volatility also continued to move closely with trends in major international equity markets (Graph 2, bottom panel)

3.2.2 Derivatives

The average daily trading volume on the ASX 24 market increased by 8 per cent in 2015/16, to around 530,000 trades per day (Graph 3). This was driven by strong growth in the average turnover of 10-year Treasury bond futures, which increased by 22 per cent. Increases in the average turnover of SPI 200 equity index futures and 90-day bank bill futures of 17 per cent and 3 per cent, respectively, also contributed to overall growth. Trading volumes in the most actively traded New Zealand dollar-denominated (NZD-denominated) contract (90-day bank bill futures) continued to increase in 2015/16, by 37 per cent. However, overall volumes in NZD futures, together with agricultural and energy contracts, represented less than 2 per cent of all contracts traded on the ASX 24 market in 2015/16.

The average daily number of equity options contracts traded on the ASX market declined significantly in 2015/16, by 16 per cent. The decrease is consistent with the longer term trend, although the magnitude of the decreases in previous years was smaller. In response to these declining volumes, ASX has continued to broaden the range of exchange-traded options (ETOs) products, in consultation with an advisory panel comprising participants and end users (see Section 3.5.6).

Average volatility in the prices of interest rate derivatives contracts edged down in 2015/16 compared with the period before (Graph 4). Volatility remained around or below the 10-year average for most of the period, except for spikes in early July 2015, which were associated with the developments in Greece and the Chinese equity market. Evidently, volatility in equity derivatives contracts broadly reflected activities in the underlying equity market (see Section 3.2.1).

3.2.3 Debt securities

In 2015/16, the average daily value of debt securities settled in Austraclear increased by 7 per cent, to $43 billion. This includes the value of securities settled under repurchase agreements (other than intraday repurchase agreements with the Bank). There has been no material migration of settlement activity in Australian Government securities from Austraclear to ASX Settlement since the 2013 launch of a service that allows retail investors to directly trade, clear and settle interest in these securities.

3.3 Risk Management in the ASX Central Counterparties

CCPs are exposed to both credit and liquidity risks, primarily following the default of one or more participants. Credit risk is the risk that one or more counterparties will not fulfil their obligations to the CCP, resulting in a financial loss, while liquidity risk arises where the CCP is unable to meet its payments obligations at the time that they are due, even if it has the ability to do so in the future. ASX Clear and ASX Clear (Futures) manage the risks arising from a potential default in a number of ways, including through participation requirements, margin collection, the maintenance of prefunded pooled financial resources, recovery tools, and risk monitoring and compliance activities.

3.3.1 Participation requirements

Participants in each CCP must meet minimum capital requirements. While capital is only a proxy for the overall financial standing of a participant, minimum capital requirements offer comfort that a participant has adequate resources to withstand an unexpected shock, perhaps arising from operational or risk-control failings.

• ASX Clear requires direct participants that clear cash equities or derivatives to maintain at least $5 million in capital. ‘General participants’, which are able to clear on behalf of third-party participants, are subject to tiered capital requirements. A general participant must maintain $5 million in capital to support its own clearing activity and $5 million to support each third-party clearing relationship, up to a maximum of $20 million. In June 2016, ASX proposed changes to capital requirements to better recognise the complexity and breadth of participants' business models (see Section 3.5.8).
• ASX Clear (Futures) requires participants that clear futures only to hold at least $5 million in net tangible assets (NTA). Participants using the OTC derivatives clearing service must meet a higher minimum NTA (or Tier 1 Capital) requirement of $50 million.

3.3.2 Margin collection

The CCPs cover their credit and liquidity exposures to their participants by collecting several types of margin.

• Variation margin. Variation (or ‘mark-to-market’) margin is collected at least daily from participants with mark-to-market losses and, in the case of futures and OTC derivatives, paid out to the participants with mark-to-market gains.
• Initial margin. Both CCPs routinely collect initial margin from participants to mitigate credit risk arising from potential changes in the market value of a defaulting participant's open positions between the last settlement of variation margin and the close out of these positions by the CCP.
• Intraday margin. Both CCPs monitor participants' portfolios intraday, to take account of changes in both prices and positions. Intraday margin calculations are carried out routinely in ASX Clear (Futures), and in response to large price changes at both CCPs. Intraday margin calls may be made where there is significant erosion in the margin cover provided by individual participants for derivatives positions. Both CCPs may also make margin calls on an ad hoc basis.
• Additional initial margin (AIM). The CCPs may also make calls for AIM when exceptionally large or concentrated exposures are identified through stress tests, or when predefined limits on the ratio of positions to capital are exceeded.

ASX requires that margin be posted in the form of cash or securities that ASX would be able to rapidly and reliably liquidate in the event of the participant's default. ASX applies haircuts to non-cash and foreign currency collateral to cover market risk on the liquidation of those assets. Much of the margin posted across the two CCPs in 2015/16 took the form of cash; an average of 53 per cent of margin requirements in ASX Clear and 95 per cent of AUD-denominated margin requirements in ASX Clear (Futures) were met in cash during the Assessment period. Clients of participants in ASX Clear commonly post non-cash collateral in excess of margin requirements for equity derivatives. In 2015/16, on average 82 per cent of the value of non-cash collateral posted against derivatives positions in ASX Clear was in excess of margin obligations.

The CCPs conduct regular and ad hoc margin reviews to ensure that margin rates are set at levels appropriate to the prevailing risk environment. Margin rates in the cash equities market and applied to equity-related derivatives (including the SPI 200 equity index futures contract) were generally higher during the Assessment period than 2014/15, reflecting higher average volatility. Despite lower volatility in the interest rate futures market, average margin rates in these contracts were slightly higher during 2015/16. This was primarily driven by elevated margin rates in the second half of 2015, which in turn reflected high volatility in the prices of the contracts in June and July 2015 (Graph 5). However, margin rates were lowered for most of the first half of 2016, reflecting that fact that volatility in these contracts subsided.

On 24 June, the day of the UK referendum on EU membership, ASX increased the price scanning ranges (the key parameter that drives initial margin requirements) on the SPI 200 equity index futures and the 10-year Treasury bond futures contracts. The decision to increase margin rates reflected the observation that by early afternoon, a ‘Leave’ vote seemed to be likely – ASX considered it prudent to increase collateral held to cover forward-looking volatility ahead of the European and United States (US) trading days. In light of the outcome of the vote, the higher initial margin requirements were retained by the ASX CCPs, as a precaution, in the week following the vote. Since 30 June, ASX has reviewed the CCPs' margin rates, in light of the uncertainty caused by the UK referendum. As a result of this review, ASX has increased the margin rates on most of the CCPs' derivatives contracts, but has pared earlier increases to the SPI 200 and 10-year Treasury bond futures contracts (see below).

To validate their margin rate settings, the CCPs perform regular backtesting and sensitivity analysis of their margin models. Backtesting uses observed historical data to assess the performance of a model over a given time period. Daily backtesting against actual dynamic portfolios compares the initial margin calculated on the portfolio of a participant or client to the variation margin calculated on that portfolio (representing the change in its value over the assumed holding period). ASX also uses backtesting based on static portfolios which abstract from changes in portfolio composition. Under both types of backtesting, when variation margin exceeds initial margin coverage, an exception is recorded.

ASX undertakes further analysis when an exception is recorded, both to investigate model performance and to determine whether any follow-up actions are required. In addition, ASX performs more comprehensive periodic backtesting reviews to examine the model in more detail; this provides a basis for recommending changes to the model or further analysis. Results from the periodic backtesting of ASX's margin models based on static portfolios during the Assessment period indicated that the observed number of exceptions were within expected levels (Table 5).

ASX also carries out monthly sensitivity analysis to test the performance of its margin models beyond the boundaries of existing assumptions. ASX varies three main assumptions when conducting sensitivity analysis: the confidence interval; holding period; and look-back period.

As measured by margin requirements, the CCPs' total credit exposure increased in 2015/16, compared with the previous year.

• Average daily margin held by ASX Clear against equity derivatives was 11 per cent higher in 2015/16. This increase was due to higher margin rates, but was partly offset by lower open interest. By contrast, average daily initial margin held by ASX Clear against unsettled cash equity transactions in 2015/16 was little changed from the previous year despite the increase in trading activity and higher volatility (Graph 6, top panel). This is partly explained by the transition to a shorter settlement cycle in March 2016 (see Section 3.5.7); the average daily initial margin held after the transition was 4 per cent lower than in 2014/15.
• Average daily initial margin held by ASX Clear (Futures) rose by 17 per cent in 2015/16 (Graph 6, bottom panel). This reflects increases in average margin rates across three of the four major futures contracts, as well as an increase in participants' open positions in the same contracts.

The CCPs call margin on an intraday basis when exposures due to changes in market value and the opening of new positions exceed predefined limits. Intraday margin calls for both CCPs would equal the total shortfall in initial and variation margin if triggered.

• ASX Clear calculates intraday margin requirements when there is a significant market movement. Margin is called from participants if the calculated call amount represents an erosion of initial margin of 40 per cent or greater and the call amount exceeds $100,000.

• ASX Clear (Futures) calculates intraday margin at 8.05 am, 11.10 am and 1.30 pm, and at other times if there are significant movements in the prices of individual contracts. The afternoon intraday margin run was introduced by ASX Clear (Futures) in August 2015. Intraday margin is called if a participant's margin balance is eroded by more than a predefined percentage threshold or by more than a predefined dollar value threshold, and the call amount exceeds $1 million. The percentage erosion threshold is 25 per cent for participants that clear exchange-traded products only, 10 per cent for participants that clear OTC derivatives products only and 20 per cent for participants clearing both OTC and exchange-traded products. The dollar value threshold varies depending on the ASX's Internal Credit Rating (ICR) of the participant; it also varies across a participants' house and client positions. It is currently set at $15 million for the house accounts of A- and B-rated participants, and $35 million for the client accounts of these participants. For C-rated participants, this threshold is set at $6 million for house accounts and $14 million for client accounts.

  As part of the changes to intraday margin processes implemented in August 2015, ASX Clear (Futures) returns collateral that has been collected as part of an earlier intraday call, if the positions to which the earlier call was related had since decreased. In addition to the three routine intraday margin runs, ASX Clear (Futures) also performs ‘for-information’ margin calculations on an hourly basis to inform its intraday risk management policy.

During the Assessment period, there were 261 intraday margin calls at ASX Clear totalling $662 million, and 1,829 AUD-denominated calls at ASX Clear (Futures) totalling $27 billion. A large number of intraday calls at ASX Clear (Futures) across the period reflected margin calls on house accounts due to client trades that had not yet been allocated to client accounts at the time of the margin run.^[8] During the Assessment period, there were 307 intraday margin returns at ASX Clear (Futures) totalling $1.4 billion.

Intraday margin calls reflect not only intraday changes in prices, but also intraday changes in participants' positions. Particularly large and frequent intraday margin calls could nevertheless indicate that initial margin did not adequately cover intraday exposures. ASX has investigated the size and frequency of intraday margin calls on ASX Clear (Futures) and has concluded that it does not indicate inadequate margin cover. Indeed, the average daily amount of intraday margin called for ASX Clear and ASX Clear (Futures) was around $3 million and $105 million, respectively, or less than 1 per cent of average daily initial margin called at ASX Clear and around 3 per cent at ASX Clear (Futures). This view is also supported by the results of backtesting (see above).

The largest intraday margin call over the period was in response to the result of the UK referendum. On 24 June, the ASX CCPs called more than $900 million intraday margin, driven primarily by large price changes in the 10-year Treasury bond futures contract. The ASX CCPs also made AIM calls that afternoon from participants with particularly large positions, and, as discussed above, increased the margin rates for two of its most actively traded derivative products.

3.3.3 The maintenance of prefunded pooled financial resources

The margin and other collateral posted by a participant would be drawn on first in the event of that participant's default.^[9] Should this prove insufficient to meet the CCP's obligations, the CCP may draw on a fixed quantity of prefunded pooled financial resources (from now referred to as the CCP's ‘default fund’).

• During the Assessment period, ASX Clear's default fund totalled $250 million (Graph 7). This comprised $103.5 million of own equity, $71.5 million paid into a restricted capital reserve from the National Guarantee Fund in 2005, and fully drawn-down subordinated loans totalling $75 million provided by ASX Clearing Corporation Limited (ASXCC), the CCPs' parent company. On 30 June 2016, the subordinated loans from ASXCC were converted to ASX Clear's own equity.
• During the Assessment period, ASX Clear (Futures)' default fund totalled $650 million (Graph 8). This included $360 million of ASX capital, $200 million of contributions from participants and a $90 million subordinated loan from ASXCC. On 30 June 2016, the subordinated loan from ASXCC was converted to ASX Clear (Futures)' own equity.

3.3.4 Credit risk management

In order to assess the adequacy of its financial resources to cover its current and potential future credit exposures, the CCPs perform daily credit stress tests.^[10] These tests compare each CCP's available prefunded resources against the largest potential loss in the event of the joint default of two participants and their affiliates under a range of extreme but plausible scenarios (Cover 2 target). The requirement to meet the Cover 2 target reflects the Bank's supplementary interpretation of the FSS, under which both CCPs are deemed to be systemically important in multiple jurisdictions; one relevant factor in this regard being that they have been granted regulatory recognition in the EU.

• ASX Clear's maximum projected stress test losses exceeded the total default fund for four days in 2015/16 (Graph 9). These excesses were primarily driven by large cash and derivatives positions held by two participants. To cover this exposure, ASX called AIM from these participants (see below). Since the stress test excesses were largely isolated to individual participants and were covered by AIM, an increase in the default fund was not considered necessary.
• ASX Clear (Futures)' maximum projected stress test losses remained well below the default fund during 2015/16 (Graph 10).

The CCPs call AIM when credit stress test results are in excess of stress test exposure limits (STELs), ensuring that any excess is fully covered. These limits are based on ASX's ICRs of participants. AIM can be called even when stress test exposures do not exceed total resources: A-rated participants have STELs that are half of the total default fund of each CCP, and lower rated participants have lower STELs.

During the Assessment period, ASX Clear made STEL AIM calls on 48 days against six participants, with the largest totalling $68.4 million. ASX Clear (Futures) made no STEL AIM calls.

3.3.5 Liquidity risk management

Credit exposures faced by the CCPs from a participant default would also create liquidity exposures. The CCPs may also face default liquidity exposures in excess of their credit exposures, even in the absence of a participant default. These additional exposures may be particularly large for ASX Clear, given that it novates equity trades with delivery obligations. If a participant with net equity delivery obligations were to default, ASX Clear's liquidity exposure would include the cost of purchasing the securities to meet the delivery obligations of the defaulted participant. By contrast, ASX Clear's credit exposure would be limited to the change in price in the securities between the defaulting participant's last variation margin payment and the time the CCP executes an offsetting securities trade. ASX Clear also faces liquidity exposures from its acceptance of equity collateral against derivative positions. Specifically, if ASX Clear were to liquidate its equity collateral, it would likely have to wait two days to receive the proceeds of the sale.

The ASX CCPs perform daily liquidity stress tests to assess the adequacy of the CCPs' prefunded financial resources to cover the largest potential liquidity exposure arising from the joint default of two participants and their affiliates under a range of extreme but plausible scenarios (Cover 2 liquidity target). ASX Clear's liquidity stress test framework is based on the price movements from its credit stress test scenarios, but recognises several liquidity-specific risks faced by the CCP. Separate models are used for the cash equities and derivatives market to recognise the distinct liquidity risks that arise in each of those markets. To assess the adequacy of its financial resources, ASX Clear compares the results of its liquidity stress tests in excess of the margin posted by the two participants' generating the Cover 2 liquidity target against its Available Financial Resources (AFR). ASX Clear's AFR is comprised of its pooled prefunded resources, as well as a $150 million committed liquidity facility secured from ASX Limited.^[11] However, a stress test result in excess of the AFR is considered a breach only where the excess is solely due to derivatives transactions. This reflects the CCP's ability to use offsetting transaction arrangements (OTAs) to mitigate the liquidity obligations arising from cash market transactions. During the Assessment period, liquidity stress test results at ASX Clear exceeded the AFR for 152 days. However, since none of these were the result of derivatives transactions, no breaches were recorded.

ASX Clear (Futures)' liquidity stress test framework is also based on its credit stress test scenarios. Since the CCP does not accept equity collateral or guarantee delivery, it does not recognise these risks in the liquidity stress test framework.^[12] ASX Clear (Futures) recorded no breaches of its prefunded liquid resources during the Assessment period.

Both ASX Clear and ASX Clear (Futures) also face liquidity risk from the reinvestment of pooled prefunded resources and the portion of margin posted by participants in the form of cash. These assets are reinvested and held by ASXCC, the holding company for the two CCPs, according to a defined treasury investment policy and investment mandate. Liquidity risk arises since ASXCC would have to convert its assets into cash to meet any obligations arising from a participant default or for day-to-day liquidity requirements, such as the return of cash margin to participants. To manage this risk, ASXCC's investment mandate requires that it maintains liquid assets readily available to meet the Cover 2 liquidity target as well as meet day-to-day liquidity requirements, across both CCPs.^[13]

In July 2016, ASX initiated enhancements to its liquidity stress test framework (see Section 3.5.1).

3.3.6 Recovery tools

In a highly unlikely scenario that involves more than two large participant defaults or market conditions that are beyond ‘extreme but plausible’, it is possible that prefunded pooled or other liquid financial resources could be insufficient to fully absorb default-related losses or meet payment obligations. In such circumstances, the CCP may be left with an uncovered credit loss or liquidity shortfall. In October 2015, ASX implemented enhanced recovery arrangements to address such a threat to its ongoing viability. Under the new arrangements, each CCP's approach for allocating an uncovered credit loss or liquidity shortfall following a participant default relies on a number of tools (see 2014/15 Assessment).

• Recovery Assessments. The power to call for additional cash contributions from participants to meet uncovered losses and fund payment obligations, in proportion to the risk associated with positions held by the CCP's participants prior to the default. Recovery Assessments are capped at $300 million in ASX Clear and $600 million in ASX Clear (Futures) (or $200 million for a single default).
• Payment haircutting. A tool, available to ASX Clear (Futures) only, allowing the CCP to reduce (haircut) outgoing payments to participants in order to allocate losses or a liquidity shortfall arising from a defaulting participant's portfolio. There is no cap on the use of this tool.
• Complete termination. A reserve power that could be used to allocate losses or a liquidity shortfall if the above tools were insufficient. Complete termination would involve tearing up all open contracts at the CCP and settling them at their current market value. Any residual losses or liquidity obligations of the CCP could be allocated by haircutting settlement payments to participants. Use of this tool would have a highly disruptive effect on the markets served by the CCP, so would be considered only as a last resort.

In addition, ASX Clear can address a liquidity shortfall relating to the settlement of securities transactions via the use of OTAs with participants due to receive funds in the settlement batch.^[14] Both CCPs also have the powers to restore a matched book via partial or complete termination of contracts if normal close-out processes cannot be carried out.

In June 2016, the ASX CCPs implemented further enhancements to their replenishment arrangements, in order to allow the CCPs to promptly return to full financial cover following a participant default while mitigating the potential for procyclicality (see Section 3.5.1 and Box A).

3.3.7 Risk monitoring and compliance

The two CCPs actively monitor their exposure to financial risk. This includes monitoring of day-to-day developments regarding, among other things, participants' financial requirements, risk profiles, open positions and settlement obligations to the CCPs. The CCPs carry out a range of participant monitoring spot checks and other examinations designed to validate the accuracy of the information that participants are required to submit to the CCPs. The CCPs also determine and review participants' ICRs, drawing in part on information provided by participants in their regular capital returns to ASX, and maintain a ‘watch list’ of participants deemed to warrant more intensive monitoring.

Monitoring of key risk indicators focuses on the participant's capital-based position limit (CBPL, which places an upper bound on participant exposures relative to capital), STEL (see Section 3.3.3), and measures of concentration risk in particular products. Each of these metrics is used, respectively, by ASX to ensure that a large position established by a participant or its clients does not lead to an unacceptable increase in the probability of a default, the potential loss given default, or the degree of difficulty in closing out a concentrated position in a default. While concentration triggers were not breached in 2015/16, ASX has initiated work to better take into account concentration and liquidity risks in its margin and stress test models (see Sections 3.5.1).

The CCPs also have wide-ranging powers to sanction participants in order to preserve their financial and operational integrity. For example, the CCPs may suspend or terminate a participant's authority to clear some or all market transactions in the event of a default, or in the event of a breach of the CCP's Operating Rules and Procedures that could have an adverse impact on the CCP. The action taken in the event of a breach will depend on a number of factors, including the participant's history of compliance and whether the breach implies negligence, incompetence or dishonesty. Where a breach has been identified and the participant has taken appropriate steps to rectify it, the CCPs will typically continue to monitor the participant closely for a period of time. These powers were used during the Assessment period.

3.4 Operational Performance of the ASX CS Facilities

ASX manages its operational risks in the context of its group-wide Enterprise Risk Management Framework, applying consistent operational risk controls across all of its CS facilities. Key operational objectives are minimum availability of 99.8 per cent (99.9 per cent for Austraclear) and peak capacity utilisation of 50 per cent. These objectives were met during the Assessment period (Table 6). System availability was equal to or above 99.9 per cent for all systems, while peak usage was below the target of 50 per cent for all systems.

3.4.1 Incidents

The four ASX CS facilities experienced several operational incidents during 2015/16. A high-level description of these incidents is summarised in Table 7.

3.4.2 EXIGO insourcing

EXIGO is the core system used by Austraclear. In November 2015, Austraclear completed an insourcing project to take over EXIGO's third-level operational and software support (requiring expert knowledge of the core system), which had previously been provided by a service provider. Insourcing third-level support has reduced operational risk by giving ASX control over future development of the system, both in terms of the nature and the timing of system enhancements. The insourcing project has also significantly simplified the system architecture through the removal of legacy components, which was expected to improve operational and recovery procedures.

The EXIGO insourcing project, which commenced during 2011/12, required ASX to manage the transition process and adequately resource third-level support for Austraclear. ASX recruited dedicated developers for this project, with a senior developer from the service provider seconded to Sydney during the development phase. In addition, ASX staff spent time at the vendor's offices to acquire the specialist knowledge required to provide advanced support for EXIGO. While carrying out the insourcing project, ASX retained the option to extend third-level support arrangements for as long as required. This option was utilised to accommodate delays without compromising support for EXIGO, including delays created by the resource requirements of other projects and to provide additional time for clients to update their systems. ASX also retained third-level support from the service provider for a further two months following the completion of the project.

3.4.3 Participation in the ASX CS facilities

Table 8 provides summary information on participation levels in the ASX CS facilities. These were little changed during the Assessment period. Changes to participation requirements and the effect of participation structures on operational risk management are discussed in Section 3.5.8.

3.5 Material Developments and Recommendations

The ASX CS facilities have implemented a number of enhancements over the course of the Assessment period in response to recommendations and other regulatory priorities set out in the 2014/15 Assessment. In addition, the ASX CS facilities have made commercially driven improvements to existing processes and implemented changes related to the launch of new products and services.

3.5.1 CCP risk management

Risk management has again been an important focus for the ASX CCPs over the period, and for the Bank in its Assessment. The Bank made several recommendations in its 2014/15 Assessment related to stress testing, margin models, and recovery planning. CCP risk management has also continued to be a key focus of recent international policy work.

Independent model validation

The FSS require the ASX CCPs to conduct independent validations of their risk management models on an annual basis. ASX's internal Model Validation Standard further requires that for models that are critical to ASX (as measured against a series of risk factors), model validations should be reviewed by an external expert.

The first validation of ASX's cash market margining (CMM) model was completed in March 2016 by an external party. This validation considered ASX's processes for daily margin calculation and the quarterly calibration of margin parameters, including the accuracy and level of detail provided in relevant documentation. ASX's CMM model was benchmarked on a number of metrics against peer exchanges as part of this validation. Four low-risk issues were identified as part of the validation, primarily related to the documentation of the model.

Independent validations of ASX's credit and liquidity stress test models and the Standard Portfolio Analysis of Risk (SPAN) margin model were also completed in 2015/16 using an external party. These models were subject to detailed validations during the 2014/15 Assessment period also using an external party; accordingly, the 2015/16 validations considered whether the models remained fit for purpose in light of changes to ASX's product scope, economic trends and risk management developments at other financial institutions. The reviews noted that many of the recommendations from the 2014/15 reviews had been appropriately actioned by ASX.

A common theme in ASX's recent independent risk model validation exercises has been that there is scope for improvement in ASX's documentation of its risk models. This is consistent with the Bank's own observations. In its recommendations, the Bank encourages ASX to continue enhancing the documentation of the key elements of its financial risk management framework. This will better support the governance of decision-making and reduce key-person risk. It will also provide a sound basis for ASX's disclosures to both participants and regulators. Indeed, as part of this, ASX is encouraged to ensure that it clearly articulates to participants and regulators (and, where appropriate, the public) the analytical basis and rationale for the choice and calibration of key model parameters and assumptions.

Enhancements to stress testing

ASX implemented a number of enhancements to its credit and liquidity stress test models during the Assessment period, several of which are consistent with recommendations from ASX's external model validations and the Bank's 2014/15 Assessment.

• Intraday price movements. Effective February 2016, ASX's historical stress test scenarios incorporate intraday movements. Previously, historical stress test scenarios were calibrated using the most extreme change in closing prices. These scenarios are now based on the most extreme close-to-high or close-to-low price observed over the relevant holding period.
• Additional credit stress test scenarios. ASX implemented four additional forward-looking for-information stress test scenarios during the Assessment period, including scenarios which assume up to four simultaneous participant defaults. In August 2016, ASX Clear (Futures) also introduced a set of new scenarios for exchange-traded derivatives, and modified its existing scenarios for OTC derivatives and portfolio-margined futures, to incorporate absolute (i.e. basis point) shocks to yields. Prior to this change, ASX's stress-test scenarios applied only relative (i.e. percentage) shocks to yields; this approach could have understated the magnitude of potential shocks to yields in a low interest rate environment.
• Enhanced sensitivity analysis. ASX has extended the scope of its stress test sensitivity analysis to include stresses to the assumed shape of the yield curve. This analysis considered the effect of stressing the correlation between points on the yield curve from an 80 per cent to a zero per cent correlation. The analysis concluded that stress test losses were less extreme under a zero correlation assumption than under the current regime, which considers particular combinations of co-movements of yields at different maturities.^[15]
• Extended risk factor coverage. 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. As mentioned in the 2014/2015 Assessment, ASX Clear (Futures) has extended its coverage of risk factors to include the 30-day interbank cash futures contract, as well as electricity contracts. ASX further extended its coverage of risk factors during the 2015/16 Assessment period to include 20-year Treasury bond futures.

ASX has not implemented recommendations to make active in ASX Clear certain ‘forward-looking’ hypothetical scenarios and introduce a framework for collectively shocking individual sectors simultaneously with broader market-wide shocks. These recommendations will be implemented through enhancements to ASX's risk management systems (see below). In the meantime, ASX has put in place interim measures to ensure that the daily stress test results from ASX Clear's forward-looking scenarios and scenarios involving shocks to individual sectors are reviewed on a monthly basis. These monthly reviews may trigger ad hoc calls for AIM.

Liquidity risk management

ASX Clear (Futures) was one of 10 derivatives CCPs recently assessed as part of the CPMI-IOSCO Level 3 Implementation Monitoring Assessment, which considered the outcomes arising from CCPs' implementation of the Principles in the PFMI related to financial risk management and recovery (see Box B). Overall, the assessment found that CCPs had made important and meaningful progress in implementing arrangements consistent with the Principles. The assessment, however, also identified some gaps and shortcomings. Most relevant to the ASX CCPs, the report identified a number of shortcomings in relation to liquidity stress testing, including that some CCPs did not include sufficient liquidity-specific scenarios in their stress test scenarios.

Consistent with this finding, and also reflecting the Bank's own analysis and observations arising from ASX's independent validation of its liquidity stress tests, the Bank has discussed with ASX how its liquidity stress test approach may be enhanced to better reflect liquidity-specific risks. In light of these discussions, ASX has recently commenced work on a set of enhancements to its liquidity stress test and risk management framework.

• Stresses to liquid resources. From August 2016, ASX will apply haircuts to value its liquid resources when assessing the adequacy of those resources. These haircuts will incorporate extreme but plausible (once-in-20-year) movements in the prices of the underlying securities, as well as the relevant haircut that would apply if these securities were used to collateralise a repurchase agreement at the Bank. ASX assesses the adequacy of its liquid assets for each CCP and across both CCPs on a daily basis.
• Liquidity-specific stress test scenarios. ASX has developed four new liquidity-specific stress test scenarios. These scenarios consider stresses to cash margin outflows arising from various sources: a market contraction resulting from a market stress event; a market contraction resulting from the default of a major non-ASX CCP; a market contraction resulting from the default of two clearing participants; or a change in participants' use of cash versus non-cash collateral. Notwithstanding that these scenarios will undergo further refinement and validation during the coming Assessment period, initial stress test results indicate that ASX's total liquid assets were sufficient to cover the liquidity exposures arising from these scenarios. Once refined, ASX will integrate these scenarios into each CCP's liquidity stress test framework.
• Cash market liquidity buffer. ASX has also indicated its intention to refine elements of ASX Clear's liquidity stress test framework to better align the framework with its strategy for managing liquidity obligations in a default scenario. This would involve maintaining resources to cover a pre-specified value of stressed liquidity exposures arising from cash market transactions, while continuing to maintain sufficient liquid resources to cover the stressed liquidity exposures arising from derivatives transactions. ASX has already implemented processes for monitoring liquidity exposures against this buffer, and will make formal changes to its documentation and governance processes to implement this change during the 2016/17 Assessment period.

This work addresses the material concerns identified in the CPMI-IOSCO implementation monitoring report. ASX, nevertheless, plans to expand and refine the liquidity-specific stress test scenarios developed to date and formally integrate these scenarios into the CCPs' liquidity stress test framework. To support these enhancements, ASX should also clarify and document its processes for responding to breaches of target liquidity coverage, and enhance its sensitivity analysis on the effect of varying liquidity-specific assumptions in ASX Clear's liquidity stress test framework. The Bank also recommends ASX undertake several enhancements to its broader approach to liquidity risk management, including its processes for conducting due diligence on its liquidity providers and its arrangements for testing its procedures for accessing the CCPs' liquid resources.

Review of liquidity, concentration and spread risks

ASX is enhancing its approach to addressing risks arising from illiquid or highly concentrated participant portfolios. Under ASX's current approach, these risks are measured against selected metrics; if pre-specified triggers are hit, ASX reviews the materiality of the risks associated with the relevant portfolio and may call for AIM on a discretionary basis. This approach relies on a single trigger for each metric. For example, a portfolio is reviewed if a participant's position in an individual product is greater than 25 per cent of:

• the participant's total portfolio, either by value or the number of contracts held
• the product's total open interest or more than two times the average daily turnover in that product.

ASX is proposing an approach which will apply risk-based initial margin add-ons to address concentration and liquidity risks. These risks will be measured using similar metrics, but add-ons will be triggered at a lower threshold and on an automatic basis. The ‘single trigger’ approach will also be replaced by a more granular approach that scales the size of margin add-ons with the level of risk associated with a portfolio. Where add-ons are triggered, ASX will also apply risk-based multipliers to the price and volatility shocks used in credit stress testing for the relevant portfolio.

Alongside these changes, ASX will be introducing margin parameter add-ons and credit-stress test multipliers to address the risk that bid-offer spreads could widen in a close-out scenario. ASX currently uses mid prices in calibrating its margin and stress test models and parameters, with no adjustment for such ‘spread risk’.

ASX expects to implement these changes in 2016/17.

Collateral haircuts

In June 2016, ASX revised its definition of ‘stressed market conditions’ for the purposes of setting haircuts on posted non-cash collateral for ASX Clear (Futures). The anticipated date for implementation of this change for ASX Clear is September 2016. Under the revised approach, haircuts on non-cash collateral are set to cover a fall in the value of the collateral over a three-day period at a 99.9 per cent confidence level, based on 20 years of price history (where available).^[16] This coverage is equivalent to the fifth-worst price move over the 20-year look-back period. ASX had previously calibrated haircuts to cover the largest price fall over the 20-year look-back period, consistent with the methodology used to calculate price changes in credit stress test scenarios. Alongside these changes, ASX has increased the frequency of its reviews of collateral haircuts from annually to at least semiannually.

ASX Clear additionally already stresses posted collateral beyond the collateral haircut to cover a once-in-20-year event in its credit stress test framework. By contrast, ASX Clear (Futures)' credit stress test framework will require enhancement in order to similarly additionally stress posted collateral beyond the haircut. ASX is planning to implement this change as part of planned enhancements to its risk management system (discussed below). While this leaves a gap currently, the magnitude of this uncovered risk is small, since non-cash collateral comprised less than 4 per cent of posted collateral at ASX Clear (Futures) in 2015/16.

Recovery planning

In October 2015, ASX implemented more detailed and comprehensive recovery arrangements. These include tools to address uncovered credit losses and liquidity shortfalls for the two CCPs, as well as measures to address non-default losses across all four CS facilities (see Section 3.3.6). In its 2014/15 Assessment, the Bank judged that ASX's new arrangements observed all of the minimum requirements in the FSS related to recovery planning, with the exception of certain requirements related to replenishment.

Accordingly, the 2014/15 Assessment recommended that ASX carry out further work to enhance its arrangements for the replenishment of the CCP's financial resources in the event that these were drawn down following a participant default. The objective was to allow for a more timely return to full financial cover while minimising any negative procyclical impact on the financial system. As part of this work, ASX was required to validate the credibility of its arrangements to fund the CCPs' own replenishment contributions in stressed circumstances. The Bank also encouraged ASX to complete the documentation of its enhanced recovery plans, and to integrate testing and review of the recovery plans into its broader framework for testing and review of risk management and default management policies and processes.

These recommendations were addressed during the Assessment period. Following a consultation in December 2015, and extensive engagement with the Bank, ASX implemented enhancements to its replenishment arrangements in June 2016 (see Box A for details).

ASX also reviewed its capacity to meet its own contribution to replenishment, as well as to replenish business risk capital in stressed market conditions. As part of this, ASX presented its recapitalisation plans to the Bank in late 2015. Under these plans, ASX Limited would use existing cash reserves and raise additional capital through equity issuance to meet its replenishment obligations, making these available to the ASX CCPs under a Replenishment Deed. ASX is encouraged to continue to review the credibility of these arrangements on an ongoing basis.

Also during the Assessment period, ASX updated its Recovery Plan to reflect the expanded set of recovery tools. The Plan identifies scenarios that could threaten the ASX CS facilities' ongoing provision of critical clearing services, describes the trigger events that would need to occur in each scenario for the Recovery Plan to be activated, and sets out how ASX would respond to such scenarios on the basis of its recovery powers. The Plan also covers the governance arrangements for the recovery framework; this includes responsibilities for the testing and maintenance of the associated documents and procedures, which has been integrated into ASX's broader framework for testing and review of its risk and default management processes. The first test of ASX's enhanced recovery arrangements took place in June 2016, in the context of ASX's default management fire drill for exchange-traded products (see Section 4).

The Bank has identified a number of aspects of the Plan that could usefully be elaborated to better support its practical application in a stressed scenario. These are refinements that ASX is encouraged to take up in the normal course of its business. The Bank will continue to monitor the development of the Plan over the coming Assessment period.

Disclosures on participants' exposure to recovery tools

Following the introduction of its enhanced recovery arrangements in October 2015, ASX developed additional disclosures to assist participants in understanding and managing their contingent exposure to the use of the CCPs' tools for allocating uncovered credit losses and liquidity shortfalls (see Section 3.3.6).

• In June 2016, ASX Clear began to disseminate monthly disclosures to individual participants on their contingent liquidity exposures to the use of OTAs. These disclosures show each participant's ‘worst-case’ liquidity exposure arising from the default of the largest two clearing participants and their affiliates on each day in the preceding month.
• In August 2015, ASX Clear introduced monthly disclosures on participants' individual maximum exposures to the use of Recovery Assessments. ASX Clear (Futures) will also begin to disseminate disclosures on participants' aggregate contingent exposures to payment haircutting under a range of extreme scenarios by the end of 2016.

The disclosures will be disseminated to participants using ASX's new Customer Portal. This new portal improves the design and functionality of ASX's website and provides support for the dissemination of non-public information to participants. The new Customer Portal went live in June 2016.

Resolution

In February 2015, the government, on the advice of the Council of Financial Regulators (CFR), released a consultation paper on proposals to establish a special resolution regime for FMIs. The key proposals set out in the consultation paper were that: the regime would extend to all domestically incorporated and licensed CS facilities; the Bank would be the resolution authority for CS facilities, with an overarching objective to maintain overall stability in the financial system and an additional key objective to maintain the continuity of critical FMI services; and the powers of the resolution authority and safeguards under the regime would be aligned with the Financial Stability Board's (FSB) Key Attributes of Effective Resolution Regimes for Financial Institutions.

Eight responses to the consultation were received, including two confidential submissions. Stakeholders universally supported the principle of establishing an FMI resolution regime, with the consultation responses also providing feedback on a number of specific areas related to the design and scope of the regime. In November 2015, the CFR published a response to consultation, setting out the CFR's views on how this feedback should be addressed in developing draft legislation. During 2016, the CFR has continued to advise the government on the development of draft legislation consistent with the proposals in the February 2015 consultation and the response to the consultation. The CFR has also been developing operational arrangements that will support the regime once implemented.

Each ASX CS facility will be required to ensure that its operational arrangements are able to support resolution actions under the proposed Australian FMI resolution regime once operative. The CS facilities have therefore already introduced standard clauses into their agreements with critical service providers requiring that they give notice to the Bank of any intention to terminate the agreement as a consequence of the facility's insolvency or failure to meet its obligations. This is intended to give the Bank an opportunity to take action to remedy the breach or otherwise ensure continued service provision under the proposed FMI resolution regime. Once legislation to establish a special resolution regime for FMIs has been introduced, ASX should review its operational arrangements more broadly to ensure that they are consistent with the form of the regime.

Renewal of risk systems

As part of its group-wide technology transformation project (see Section 3.5.7), ASX is enhancing its risk management systems. The first phase of this project, which focused on the default management of OTC derivatives and portfolio-margined futures products, was implemented in October 2015. This part of the system is able to generate hedging recommendations for the defaulter's OTC derivatives portfolio (including any portfolio-margined futures) prior to the portfolio being auctioned to non-defaulting participants. This system was used to support ASX's OTC derivatives default management fire drill in July 2016.

Implementation of the second phase has provided ASX Clear (Futures) participants with the functionality to automatically optimise their margin requirements for OTC and portfolio-margined futures positions by selecting the most optimal set of futures positions to be allocated to their cleared OTC portfolio.^[20] The margin optimiser was launched in January 2016, initially accepting four eligible futures products for portfolio-margining on OTC participants' house accounts. In July 2016, ASX broadened the scope of eligible futures contracts and extended the margin optimisation functionality to individual client accounts.

The third phase of the project is expected to deliver improved stress test and margining capabilities, including the ability to calculate exposures and margin requirements in close to real time. ASX is implementing this phase in stages, with the system functionality for ASX Clear (Futures) being developed first. ASX has finalised the design study and initial business requirements for the ASX Clear (Futures) part of the system, and has commenced work on some of the detailed functional requirements. The third phase is expected to take one to two years to implement. As ASX progressively develops its capabilities, it will consider how to integrate more frequent margin and stress test calculations into a ‘real-time risk management’ approach that removes the potential for delay in covering intraday changes to exposures.

Once these changes are implemented, the project will move on to enhancing and automating the CCPs' default management capabilities for exchange-traded products, creating a global view of all ASX exposures, and harmonising pre- and post-trade risk management capabilities.

The Bank is receiving regular updates on this project, and will continue to engage with ASX on the design, specifications and implementation of the system throughout the project. ASX is encouraged to continue to progress enhancements to the CCPs risk management systems, including the ability to calculate margin and stress test exposures on a near real-time basis.

International CCP workplan

In light of the increasing systemic importance of CCPs, the FSB has been taking a deeper interest in CCP resilience. Since this interest cuts across the existing mandates of CPMI, IOSCO and the Basel Committee on Banking Supervision, the chairs of these standard-setting bodies have developed a joint CCP workplan to further enhance the effectiveness of CCP resilience, recovery and resolution. As part of this workplan, in August, CPMI-IOSCO published a report setting out an assessment of consistency in the outcomes of CCPs' implementation of the Principles with respect to their financial risk management and recovery practices (see Box B).^[21] The assessment covered 10 CCPs internationally that provide clearing services for derivatives, including ASX Clear (Futures).

Overall, the assessment found that CCPs had made important and meaningful progress in implementing arrangements consistent with the Principles. The assessment, however, also identified some gaps and shortcomings. Most relevant to ASX, the report identified a number of shortcomings in relation to liquidity stress testing, including that some CCPs did not include sufficient liquidity-specific scenarios in their stress test scenarios (see ‘Liquidity risk management’ above).

In August, CPMI-IOSCO also published further draft guidance on the Principles in the area of resilience and recovery for CCPs for public comment. The draft guidance is intended to provide more detailed interpretation of the requirements in the Principles in key aspects of CCPs' financial risk management frameworks (see Box B).^[22] The proposed additional guidance will inform the Bank's dialogue with ASX on these matters in the coming period.

3.5.2 Legal basis

In May 2016, Parliament passed the Financial Legislation Amendment (Resilience and Collateral Protection) Act (2016) (Resilience Act) to amend the Payment Systems and Netting Act (1998) (PSNA). The amendments enhance the legal basis of ASX's CS facilities in the following areas.

• Non-terminal external administration. The amendments provide additional certainty to the settlement of payments in real-time gross settlement (RTGS) systems, such as Austraclear and the Reserve Bank Information and Transfer System (RITS), and netting arrangements, such as ASX Settlement, that have been approved under the PSNA. In particular, the amendments facilitate the ongoing participation by institutions in ‘non-terminal’ external administration (e.g. statutory management) by clarifying that the protections under the PSNA continue to apply.
• Extension of netting protections. The amendments also extend the PSNA protections given to netting arrangements to cover any transfer of property for the purposes of discharging a net obligation in such arrangements that are governed by the rules of a CS facility. This enhances the finality protections given to the settlement of transactions in ASX Settlement that were entered into by a participant prior to its entry into any form of external administration.
• Protection of recovery powers. The Resilience Act enhances the protections afforded to the CCPs as ‘netting markets’, as defined in the PSNA. In particular, the changes protect the exercise of recovery powers and protect default fund contributions by participants should participants subsequently enter administration. The Resilience Act clarifies that the netting market protections in the PSNA apply to the rules governing the operation of a netting market (e.g. the operating rules of a CCP), which codify ASX's recovery powers and the replenishment obligations of participant. The Resilience Act also broadens the types of transaction that are protected to any payment or transfer of property (whether absolutely or by way of security) by a party to meet any obligation (previously, this protection was limited to payments and transfers to meet deposit or margin call obligations).

3.5.3 Governance

A number of changes to the governance of the ASX CS facilities' activities were implemented during and shortly after the Assessment period. These changes address regulatory developments during 2015/16 and respond to broader changes in the governance arrangements of the ASX Group.

Change in ASX CEO

On 21 March, ASX announced that its Managing Director and CEO, Elmer Funke Kupper, had resigned. ASX announced in August that a new Managing Director and CEO, Dominic Stevens, had been appointed. During the interim period, the ASX Chairman, Rick Holliday-Smith provided oversight and board-level input to the Deputy CEO and Group General Counsel, who together had assumed the day-to-day running of the company. Under these interim arrangements, the Chairman did not have day-to-day responsibilities within ASX, but served as a point of contact for senior external stakeholders, including regulators. Before the new CEO was appointed, the Bank discussed the effectiveness of the interim governance arrangements with the Chairman, including to understand how conflicts of interest are managed.

Competition in Clearing Review

On 30 March, the government endorsed the recommendations of the review of competition in clearing Australian cash equities carried out by the CFR and the Australian Competition and Consumer Commission – together, the Agencies – in the first half of 2015.^[23] The Agencies had identified three core conclusions from their consultation and supporting analysis:

• The policy approach should be one of openness to competition. This would recognise the potential benefits of competitive discipline and be consistent with prevailing legislative settings. To prohibit competition would be unprecedented internationally.
• Competition, even if permitted, may not emerge for some time, if at all. There remain strong forces in favour of a single provider of clearing services, so a competing CCP may never emerge.
• The regulators should have powers to deal with an ongoing monopoly. Regulatory mechanisms may be necessary to discipline ASX's conduct as a monopoly provider.

Reflecting these views, the Agencies developed a number of recommendations. These included recommendations that the government confirm a policy stance of openness to competition, and implement legislative reforms giving the relevant regulators rule-making and arbitration powers that would enable them to enforce, as necessary:

• a set of Minimum Conditions that support competition in the clearing of cash equities, while also ensuring the safety and efficiency of the market
• a set of Regulatory Expectations for ASX's conduct in operating its cash equity clearing and settlement services until such time as a competitor emerged.

In its announcement, the government committed to develop and consult on legislative changes in accordance with these recommendations. The government also committed to developing legislative proposals to bring ownership restrictions on ASX into line with similar limits on other important financial sector entities.

3.5.4 Participant default rules and procedures

The ASX DMF is intended to assist in the management of a participant default; the documentation covers each stage of a default, from its identification through to its conclusion. In the 2015/16 Assessment period, ASX carried out a comprehensive review of the DMF, in part to take into account enhancements to ASX's recovery arrangements (see Section 3.3.6) and experience gained from the default of BBY in May 2015.

A more detailed description and assessment of ASX's default management arrangements, including recommendations for further enhancements, is set out in Section 4.

Experience gained from the default of BBY Limited

In May 2015, ASX employed its default management procedures to deal with the appointment of a voluntary administrator to BBY, a participant of ASX Clear, ASX Settlement and Austraclear. Overall, the incident was managed successfully, with no evident market impact and all close-out losses sufficiently covered by margin held. The event nevertheless highlighted several matters related to ASX's risk management and default management arrangements that were worthy of further consideration.

In line with the Bank's 2014/15 recommendations, ASX completed a detailed review of the experiences gained from the default of BBY in May 2015. Based on the review, ASX set out a plan for implementing a number of enhancements to its risk and default management arrangements. This plan includes:

• changes to ASX Clear participants' core capital and liquidity risk management requirements
• a review of how the CCPs' margin and stress test models could better take into account liquidity, spread and concentration risks
• changes to improve portability arrangements and the close-out process
• education and communication initiatives, including updates to participant disclosures on ASX's default management arrangements.

ASX intends to implement the elements of the plan during 2016/17.

Segregation and portability

The FSS require the ASX CCPs to offer account structures that support the segregation of client positions and collateral from those of their clearing participant. Under the Bank's supplementary interpretation of the FSS, each CCP must also allow clients to hold excess collateral directly with the CCP. During the Assessment period, ASX Clear and ASX Clear (Futures) implemented arrangements that bring their client account structures into line with these requirements and fully address recommendations contained in the Bank's previous Assessments.

ASX Clear (Futures)

Since July 2014, ASX Clear (Futures) has offered both OTC and exchange-traded derivatives clients the choice of holding their positions in either an individually segregated account or a client omnibus account. Under both account types, client positions and collateral are separated from the clearing agent's proprietary positions. This protects client collateral from being used to meet a shortfall in a participant's proprietary account in the event of that participant's default. Under the omnibus account structure, however, if another client in the account were to subsequently default, any collateral in the client account could be used to cover losses arising from the client default. By using the standard individually segregated client account structure, client collateral is also protected against fellow customer risk by legally segregating positions and assuring (non-defaulting) clients the value of the collateral they posted.

In September 2015, ASX extended the standard segregated account structure to allow for the individual segregation of cash and securities lodged as excess collateral. For clients that choose to hold their margin under these new arrangements, ASX Clear (Futures) guarantees the transfer or return of the total value of collateral attributed to an individual client account (net of any close-out costs). Previously, excess client collateral could not be attributed to individual clients, which meant that ASX could only guarantee the value of a client's initial margin requirement. For a client that holds an individual account under the new arrangements, ASX Clear (Futures) would transfer or return equivalent securities to those that had been attributed to the client if its clearing participant were to default. This is because all client collateral continues to be operationally managed in a single commingled account. These arrangements are consistent with the supplementary interpretation of the FSS and address the recommendations set out in the Bank's 2013/14 Assessment.

While use of individually segregated account structures in ASX Clear (Futures) remains low at present, future growth in the use of individual client accounts would provide ASX Clear (Futures) the added benefit of more direct information on the risks associated with participants clearing large or concentrated positions on behalf of clients. The Bank will continue to discuss ASX's approach to addressing concentration risks associated with tiered participation.

ASX Clear

In November 2015, ASX Clear implemented arrangements that allow excess client cash collateral posted against derivatives positions to be held directly with ASX Clear and attributed to an individual client account.^[24] Under these arrangements, ASX Clear would transfer or return to a defaulted participant's client trust account any excess collateral that had been attributed to an individual client account (net of any close-out costs). These arrangements are consistent with the supplementary interpretation of the FSS and address the Bank's 2014/15 recommendations.

3.5.5 Business and investment risks

Investment policy

In accordance with the treasury investment policy endorsed annually by the CS Boards, ASXCC invests cash margin posted by participants, as well as prefunded pooled financial risk resources, in highly rated short-dated assets. The policy establishes counterparty eligibility criteria and sets investment limits to control investment counterparty risk. For a number of years, the Bank has expressed concerns in its Assessments that, notwithstanding limits on both the absolute level and share of exposure to each of the four large domestic banks, the policy still allowed relatively large and concentrated credit exposures to these banks. In response to the Bank's concerns and ASX's own review of its treasury investment policy in 2012/13, it has since gradually lowered the concentration of investments in the major banks and placed greater reliance on government securities and secured investments.

Following continued dialogue with ASX on its treasury investment policy, in the 2014/15 Assessment, the Bank clarified its expectation for the credit and liquidity risk profile of ASX's treasury investments, with an implementation date of end June 2017. In particular, ASX should:

• limit its credit exposures to individual non-government investment counterparties/issuers to the level of capital set aside for non-default or general business risk losses
• ensure that other investments are with government-related obligors or secured by assets issued by government-related or other highly creditworthy obligors, subject to prudent concentration limits
• ensure that the CCPs' minimum liquid resource requirement (under CCP Standard 7.3) is invested in, or secured by, government/semi-government securities or cash, with other investments able to address effectively any additional liquidity shortfalls (e.g. be investments in, or secured by, securities eligible for repo with the Bank).

The timeframe for implementation reflected the time required for an orderly transition to the desired investment profile, including time to develop secured investment arrangements with a broad range of counterparties. In response, ASX has endorsed revisions to its treasury investment policy. The most recent revision, approved by the CS Boards in May 2016, clarifies how ASX intends to meet the Bank's expectations for the credit and liquidity risk profile of its treasury investments.

Under these changes, by end June 2017, over half of the CCPs' investment portfolio will be invested in government or semi-government bonds, or reverse repurchase agreements secured by such bonds. The remainder of the portfolio will be primarily invested in securities issued by authorised deposit-taking institutions (ADIs), or held in deposits with ADIs. Individual unsecured exposures to non-government-related issuers or counterparties will be limited to the level of business risk capital held across the two CCPs (currently $75 million). In the highly unlikely event that investment losses were incurred that exceeded this amount, ASX's enhanced recovery arrangements provide for the allocation of these losses to participants. In April 2016, ASX published guidance for participants on how to calculate their contingent exposure to the allocation of investment losses in excess of the CCPs' business risk capital.

Financial results

The continued profitability of the ASX Group provides an important mitigant against general business risk for the ASX CS facilities. ASX Limited's statutory profit after tax for the 2015/16 financial year was $426 million, up 5.7 per cent from the previous year. Total operating revenue grew 6.5 per cent to $746 million over the year, reflecting broad-based revenue growth across ASX's four main business lines. Trading and clearing services across both the cash and derivatives markets accounted for approximately half of revenue growth, driven by higher trading activity across most cash market and derivative products. Operating expenses also increased by 6.5 per cent, primarily due to higher staff costs, equipment and administration costs resulting from the launch of new services, and costs associated with the CEO transition (see Section 3.5.3). Capital expenditure was 13.1 per cent higher at $50.2 million, primarily due to increased investment associated with ASX's technology transformation project (see Section 3.5.7).

Business strategy

ASX manages its strategic business risks at a group-wide level, communicating its business strategy to investors, participants and other stakeholders in accordance with its continuous disclosure obligations as a listed company. The key elements of the ASX strategy are to:

• continue development of new products and services in Australian and New Zealand dollar financial markets and expand the range of products and services to intermediaries and end-investors (see Section 3.5.6)
• provide globally connected financial infrastructure through investment in its technology platforms (see Section 3.5.7)
• deliver an outstanding customer experience.

3.5.6 New products and services

ASX launched, or further developed, several new products and services during the 2015/16 Assessment period.

• OTC derivatives clearing. Activity in ASX Clear (Futures)' OTC IRD clearing service continued to grow during 2015/16. At the end of the Assessment period, the notional value of cleared OTC derivatives trades outstanding was $1 600 billion, compared with $441 billion at the end of June 2015.^[25] The OTC service currently offers clearing of AUD-denominated interest rate swaps (IRS) referencing either the bank bill swap rate (BBSW) or the overnight indexed swap rate. ASX is planning, by end 2016, to extend its OTC product scope to include basis swaps referencing the BBSW and the Australian overnight index average rate (AONIA), and introduce longer maturities of BBSW-referenced IRS. ASX also intends to run its first multilateral OTC trade compression run by in early 2017. Although client clearing is available within the OTC service, activity currently remains focused on the inter-dealer market.
• Deliverable Swap Futures (DSFs). ASX Clear (Futures) introduced clearing of DSFs in November 2015. DSFs are futures contracts that result in the delivery of an at-the-money OTC IRS at expiry. These contracts allow users to gain exposure to the underlying swap rate, generally with lower collateral and initial margin requirements compared with a standard OTC swap. The futures products transition to OTC products at the point of expiry; participants must therefore either have OTC clearing arrangements established, or close out their positions at least five days prior to expiry. There has not been any activity in these products during the Assessment period.
• 20-year Treasury bond futures. ASX Clear (Futures) launched a 20-year Australian Treasury bond futures contract in September 2016. Similar to the 3- and 10-year contracts, this contract is cash settled by reference to the average price of a basket of representative bonds, with settlement months in March, June, September and December. Since its launch, activity in this product has grown significantly to 1 600 trades on average each day in the June quarter, but still represents a relatively small proportion of total futures activity.
• Mini SPI 200 index futures. ASX introduced mini SPI 200 index futures contracts in October 2015. These contracts provide exposure to the same underlying index as the standard SPI 200 futures contract, but with a smaller notional value ($5 per index point, rather than $25). During the June quarter, activity in this product was around 100 trades on average each day.
• New wheat contracts. Also in October, ASX introduced Eastern Australia wheat futures and options contracts. These are essentially identical to the existing NSW wheat futures and options contracts (which will no longer be available to trade beyond a March 2017 futures expiry), but allow delivery to a broader range of ports on the east coast of Australia.
• Total Return Single Stock (TORESS) Options. ASX launched exchange-traded TORESS options in November 2015. TORESS options are designed to offer exposures that directly mirror returns on the underlying stock, with a lower upfront investment. In contrast to ordinary ETOs, TORESS options are cash settled upon exercise, and any ordinary dividends on the underlying are adjusted for by a cash transfer between the seller and the buyer of the option. The cash settlement of the dividend amount is intended to simplify the pricing of the options by eliminating dividend pricing risk. Margin requirements are calculated by ASX Clear using the SPAN methodology, allowing for margin offsets between TORESS options and standard ETOs. ASX currently only offers TORESS low exercise price options (LEPOs) on selected ETO classes, although it is also considering introducing TORESS low strike ETOs at a later stage.^[26]
• Austraclear. In August 2016, ASX introduced the capability to issue, settle and hold securities denominated in Chinese renminbi (RMB) in Austraclear. The RMB payments leg arising from settlement of these products will be facilitated by Austraclear's Foreign Currency Settlement Service.
• ASX Collateral. Use of ASX's centralised collateral management service continued to grow during 2015/16. Around $4.8 billion of collateral was under the management of the ASX Collateral service at the end of the Assessment period. This service automates the optimisation and allocation of collateral, with title remaining and settlement continuing to take place in Austraclear. ASX's focus currently remains on growing use of the service for Austraclear securities. As part of this, ASX has committed to expanding the ASX Collateral service for fixed income securities to provide for a tri-party securities lending service; this extension is expected to be implemented in the coming Assessment period. Once this is implemented, ASX will consider extending the service to allow for the lodgement of equity securities in ASX Settlement and establishing links to global collateral pools.
• mFund Settlement Service. Use of the mFund Settlement Service increased over the Assessment period. The service was launched in May 2014 as a means of facilitating payments for managed fund units through multilateral net settlement within the CHESS batch. At the end of June 2016, around 159 funds, with 48 fund managers and 8 brokers, were using the service. The Bank has continued to monitor the composition of the daily CHESS batch to assess any potential for settlement disruption arising from services that expand the use of the batch beyond settlement of novated transactions (and transactions to prime the settlement of novated trades). The Bank has judged that the mFund service does not currently pose significant risks to the batch process, as settlement values from the service remain relatively low; around $120.9 million was settled through the mFund service during 2015/16.
• Services for unaffiliated market operators. ASX offers a Trade Acceptance Service (TAS), which allows trades executed on approved market operator (AMO) platforms to be submitted to ASX Clear and ASX Settlement. The TAS had initially only been limited to ASX-listed securities traded on AMO exchanges, including Chi-X. During the Assessment period, the TAS was extended to facilitate the clearing and settlement of non-ASX-listed products. ASX began to clear and settle warrants listed on the Chi-X market in November 2015.

3.5.7 Operations

During the Assessment period, ASX progressed significant changes to a number of its key systems and operational arrangements. The Bank also discussed with ASX its arrangements for managing risks arising from critical service providers and continued its dialogue on ASX's cyber resilience approach.

Technology transformation

ASX is progressing its technology transformation project, which will upgrade all of its major trading and post-trading systems over the next two to four years. The project is intended to rationalise ASX's core technology onto a single services platform, removing interdependencies that currently exist between unrelated systems.

As part of this project, ASX is upgrading its trading, risk management and market monitoring systems. ASX is planning to launch a new derivatives trading platform in February 2017. The upgrade of ASX's risk management system, which is of particular interest to the Bank, is discussed in more detail in Section 3.5.1. The project will also involve a renewal of ASX's clearing and settlement platforms. As part of this renewal, ASX plans on consolidating its derivatives clearing systems across the two CCPs onto a common platform. ASX has begun the design study for this new system.

Given the significance of the technology transformation project for ASX's critical trading, clearing, settlement and risk management systems, the ASX Limited Board and CS Boards will continue to receive regular status updates throughout the life of the project. ASX's Audit and Risk Committee, together with the executive-level Enterprise Risk Management Committee, oversees the management of operational and strategic risks associated with execution of the project, with internal and external audit carrying out reviews of key elements. ASX's Enterprise Portfolio Steering Committee provides executive-level oversight of project management; this includes determining the prioritisation of resourcing for key project elements.

During the Assessment period, the Bank has received regular detailed updates on the progress of the technology transformation project. These updates have provided an opportunity for the Bank to examine ASX's prioritisation decisions, resourcing challenges, interdependencies with day-to-day business-as-usual processes, and potential change-management issues.

Distributed ledger technology

Another important component of the technology transformation project is the replacement of the CHESS clearing and settlement system. This replacement is an important element of ensuring that ASX's core clearing and settlement infrastructure for cash equities meets international best practice, and that its performance, resilience, security and functionality continue to meet the needs of its users. ASX announced in January 2016 that it had selected a vendor, DAH, to develop a potential CHESS replacement based on a permissioned, private DLT system. As part of the partnership, ASX initially acquired a 5 per cent equity interest in DAH, increasing this to 8.5 per cent in June 2016.

Working with DAH, ASX has developed a working prototype of the DLT system. This prototype will be developed further over the coming 12–18 months, in consultation with stakeholders. ASX intends to make a final decision on whether to implement the replacement system towards the end of 2017. The Bank encourages ASX to continue to invest in the ongoing maintenance and smooth functioning of the CHESS system in the transition to its replacement system, ensuring that it continues to meet the needs of users and that it continues to support stability in the financial system. ASX is also encouraged to invest in appropriate contingency arrangements, to ensure the timely implementation of an alternative CHESS replacement system should the decision be taken not to proceed with the DLT solution.

The governance arrangements that apply to ASX's broader technology transformation project also apply to the DLT project. The Bank has received monthly updates on the DLT project through dedicated ‘regulator workshops’ involving ASX, DAH and other relevant regulators. These workshops provide an opportunity for the Bank to identify, at an early stage, any regulatory or supervisory issues that might need to be addressed.

Cyber resilience

In light of the growing threat of cyber attacks, the Bank has made cyber resilience a key priority in its supervision of ASX's CS facilities, as well as other FMIs. Consistent with recommendations in its 2014/15 Assessment, the Bank has continued a dialogue with ASX on cyber resilience matters during the Assessment period, in collaboration with ASIC.

Separately, CPMI and IOSCO published guidance on cyber resilience for FMIs in late June (see Box C).^[27] Subsequently, the Bank formally adopted this guidance to support its assessments against relevant requirements in the FSS. While most aspects of the guidance apply with immediate effect, the guidance recognises that it may take time for FMIs to meet the expectation that they be able to recover critical operations within two hours following an extreme cyber attack. Consistent with the guidance, the Assessment recommends that ASX develop concrete plans to improve its capabilities to meet this requirement by end June 2017.

An important theme in the guidance is that cyber resilience cannot be achieved by an FMI alone; it is a collective endeavour of the whole ‘ecosystem’. This has recently been highlighted by the prominent cyber attacks on members of the Society for Worldwide Interbank Financial Telecommunication's (SWIFT) key messaging network. The guidance requires that an FMI's participation requirements should be designed to ensure that they adequately support its cyber resilience framework. For instance, SWIFT has announced a Customer Security Programme, which includes work to enhance the cyber resilience of its users. In light of these developments, the Assessment recommends that ASX consider developing participant requirements in the area of cyber resilience, liaising as appropriate with the Bank and other relevant authorities.

Shorter settlement cycle for cash equities

On 7 March 2016, ASX successfully transitioned from a three-day to a two-day settlement cycle (T+2) for cash equities. This was identified as a key priority by the Business Committee in 2013/14, and mirrors similar moves underway in a number of jurisdictions internationally.

As part of the changes, ASX has extended the cut-off time for submitting instructions to the daily settlement batch from 10.30 am to 11.30 am. This is intended to mitigate the potential impact of a shortened cycle on participant arrangements to process and pre-position securities for settlement. The extension, however, has reduced the time available to complete payment authorisations and address any problems or delays to settlement. Specifically, the time available to ASX to address any implications for batch settlement arising from a participant payment default has been reduced to 90 minutes (from two hours). The Bank has gained comfort that ASX has implemented sufficient measures to mitigate any adverse impact from this reduction. There have not been any material operational issues since the transition, and the settlement fail rate has decreased below historical observations.

ASX kept market participants engaged throughout the transition to the shorter settlement cycle, ensuring that the industry would be ready for the change. As part of this, ASX established a Market Implementation Group to facilitate the exchange of information on implementation progress and issues, which was open to all market participants, system vendors and other interested parties. ASX also hosted a number of workshops with industry bodies (including the Australian Custodial Services Association, the Australian Securities Lending Association, and the Stockbrokers Association of Australia), participants and their system vendors to discuss the relevant business and technical requirements.

Alongside the changes in the cash equities market, the Australian Financial Markets Authority endorsed the transition of settlement conventions for wholesale debt securities to T+2 (including for Australian Government bonds that are also traded on ASX). The New Zealand Stock Exchange also moved to a T+2 settlement cycle for cash equities. Both these transitions took effect on 7 March 2016.

Payment providers

In 2014/15, ASX Clear and ASX Settlement, in cooperation with the Australian Payments Clearing Association (APCA), established a forum for engaging Payment Providers. The APCA standing sub-committee comprises representatives of the Payment Providers, with ASX acting as an ‘observer’. The role of the committee is: to consider and provide feedback on proposed amendments to the agreement that governs arrangements with Payment Providers; to facilitate consultation with Payment Providers; and to ensure that Payment Providers are notified of any upcoming developments. The committee met twice during the Assessment period. The issues discussed included the transition to a shorter settlement cycle in the cash equities market and changes to align the ASX Settlement business days with RITS's operating days.

Oversight of critical service providers

Consistent with the 2015/16 regulatory priorities, the Bank met with ASX to discuss how it applied the oversight expectations for critical service providers (CSPs) set out in Annex F of the PFMI and the Bank's guidance to CCP Standard 16.9 and SSF Standard 14.9. To complement Annex F, CPMI and IOSCO released an Assessment Methodology, which provides a framework for considering how to apply Annex F.

ASX has documented its approach to managing risks arising from CSPs. ASX's procedures prescribe that service levels be set for CSPs relating to the operations, resilience and security, and that these service levels must be codified in contractual agreements. ASX's approach includes a process for the regular collection of information from the CSP and evaluation of this information against the agreed service levels. To gather information from CSPs, ASX uses the Annex F Assessment Methodology as a source of questions.

Primary responsibility for managing risks arising from a CSP is assigned to the business area dependent on the provision of the relevant CSP's services. The ASX Limited Board and senior management, nevertheless, have ultimate responsibility for the management of risks arising from CSPs. The review of CSP risks is carried out on a periodic basis, and escalated where appropriate to the Enterprise Risk Management Committee and Audit and Risk Committee.

3.5.8 Participation and access

There were a number of developments during the Assessment period in relation to participation requirements and access.

Enhancements to ASX Clear participant requirements

• Liquidity risk management requirements. In light of experiences gained from the BBY default in 2016, ASX Clear consulted on new requirements in respect of participants' liquidity risk management frameworks during the Assessment period. The enhancements, which would be set out in a Guidance Note, would require that participants establish a formal liquidity risk management framework and prepare an annual liquidity plan. Participants would also be required to allocate overall liquidity risk management responsibility to a named individual and maintain robust liquidity-related operational and management reporting processes. The requirements are expected to be implemented in the Q3 2016.
  

  Participants that are ADIs regulated by Australian Prudential Regulation Authority (APRA) or non-bank subsidiaries of ADIs (subject to ASX's approval) would be exempt from the enhanced requirements if their arrangements are deemed to be adequately covered by an equivalent prudential supervisory framework. All other participants would be expected to carry out a ‘gap analysis’ that compares their current arrangements with the new requirements. Participants would be expected to comply with the new requirements within six months following the release of the Guidance Note.

• Minimum core capital requirements. To better recognise the complexity and breadth of participants' business models, in June 2016, ASX Clear launched a consultation on proposals to enhance the approach to determining minimum core capital requirements.^[28] The proposed enhancements would impose add-ons to a participant's existing base capital requirement that reflect its activities in own-account trading, non-ASX business, and short options trading by clients. ASX would apply an additional capital requirement of $2.5 million or $5 million for each of these activities, depending on the level of materiality. Under the new requirements, the minimum amount of core capital required would range from $5 million to $35 million, up from the current range of $5 million to $20 million.

Participants would be granted an initial transitional period of up to 12 months to meet any increased capital requirements. Subsequently, ASX would expect to review the capital requirements on at least an annual basis, and allow a transitional period of up to six months for participants to meet any subsequent increases.

Wholly remote clearing

In April 2015, ASX Clear (Futures) commenced a pilot scheme for the admission of participants that are incorporated and base their operations offshore. To date, the pilot scheme has been limited to one futures-only participant based in the UK. ASX Clear (Futures) will consider whether to extend the scheme more broadly at the conclusion of the pilot program. Any extension would be limited to a narrow range of jurisdictions with regulatory and legal frameworks that are deemed to be comparable with those in Australia. Participants clearing from offshore would be required to demonstrate that no conflicts of law would arise as a result of their participation.

Facilitated membership

During the Assessment period, ASX began to examine ways of streamlining the process for establishing ‘facilitated membership’ arrangements for clients. Under a facilitated membership arrangement, a client is able to become a direct member of an ASX CCP while continuing to outsource operational and administrative tasks to another clearing participant. Such an arrangement would allow a client to realise the benefits of direct membership, while avoiding some of the costs of establishing its own operational arrangements. As a direct member, the client would be responsible for its own funding obligations, including margin and default fund contributions. Such arrangements are permitted under ASX's existing rulebook, but have traditionally been implemented on a case-by-case basis. ASX is developing standardised documentation to assist prospective or existing participants wishing to wholly outsource operational and administrative tasks.

3.5.9 Disclosure

In accordance with the Disclosure Framework set out in the CPMI-IOSCO Principles for Financial Market Infrastructures: Disclosure framework and assessment methodology, ASX is required to provide comprehensive and detailed disclosures demonstrating how its CS facilities' governance, operations and risk management frameworks meet the requirements of the Principles. ASX published a revised disclosure document in October 2015, in part to reflect the introduction of ASX's enhanced recovery arrangements (see Section 3.5.1).^[29] ASX plans to continue updating this document periodically (at least annually) and to further enhance its disclosures as necessary.

ASX is also required to disclose certain quantitative risk and activity data in accordance with the CPMI-IOSCO Public quantitative disclosure standards for central counterparties, published in February 2015.^[30] In December 2015, consistent with the timeline set by CPMI and IOSCO, ASX began publishing an expanded set of quantitative disclosures for each CCP, consistent with minimum expectations under the framework.^[31] These data will be updated on a quarterly basis. The quantitative disclosures span a range of topics related to each CCP's implementation of the Principles. The disclosures are intended to enable participants and other stakeholders to more easily compare CCPs' risk controls, better understand the risks associated with direct or indirect participation in a CCP and with central clearing more broadly, and assess a CCP's systemic importance in relevant jurisdictions. The Bank will continue to monitor steps by ASX to refine and enhance its disclosures.

Footnotes

This would most commonly occur where the clearing and allocation of an executed trade was in progress during an intraday margin run. In general, some orders cannot be fully allocated or cleared until the order is filled, which may take place progressively through a trading session. For these yet-to-be-allocated trades, the call is on the house account. [8]

For ASX Clear (Futures) the other collateral would include the defaulted participant's contributions to the CCP's prefunded pooled financial resources. [9]

For more detail on the CCPs' credit stress test framework see Chapter 5 in the 2014/15 Assessment of ASX CS Facilities. [10]

$100 million of this facility is backed by a commercial bank liquidity facility secured by ASX Limited. [11]

While ASX Clear (Futures) novates derivatives with associated delivery obligations, it does not guarantee settlement of those obligations. If a participant were to default, the CCP's exposure would only be the replacement cost risk arising from the defaulted participant's obligations. [12]

In ASXCC's Investment Mandate, liquid assets comprise: cash available for use within two hours; and securities traded in a liquid market which can be sold for same day value with settlement proceeds available within two hours, and which are eligible for repurchase with the Bank. [13]

Under the first leg of the OTA, ASX Clear would, in effect, re-deliver the stock to the relevant non-defaulting participant in return for a payment equal to the amount of the payment obligation of ASX Clear to that participant. Under these arrangements, ASX Clear would agree to repurchase the stock the next business day under the second and final leg of the transaction. If this transaction was unable to be settled on the next business day, OTAs would be entered into on a daily basis until the settlement of on-market close-out trades had taken place. [14]

These include ‘twists’, ‘tilts’, ‘bends’ and parallel shifts of the yield curve. For more information, see Section 5.4.4 of the 2014/15 ASX Assessment. [15]

ASX Clear (Futures) also applies haircuts using the same methodology to cash collateral lodged to meet margin requirements for products denominated in a currency different to that of the collateral. [16]

The cooling-off period concludes 22 business days after the conclusion of the final default management process initiated during the period. [17]

If a subsequent default during the cooling-off period depleted the default fund below the Minimum Fund Size, participants could be required to make the contribution as soon as reasonably practicable following completion of that DMP, and potentially as soon as the next day. [18]

The CPMI-IOSCO report provides supplementary guidance on how FMIs can observe the relevant recovery-related requirements in the Principles (and FSS) that they have effective recovery plans. The guidance outlines a range of potential recovery tools with reference to a set of desired characteristics. See CPMI-IOSCO (2014), Recovery of Financial Market Infrastructures, Bank for International Settlements, Basel, available at <http://www.bis.org/cpmi/publ/d121.htm>. [19]

ASX Clear (Futures) allows OTC participants to cross-margin specific interest rate futures positions by allocating these positions to their OTC derivatives portfolio. This allows offsetting OTC and futures positions to be accounted for in the calculation of the participant's margin requirements. [20]

CPMI-IOSCO (2016), Implementation monitoring of PFMI: Level 3 assessment - Report on the financial risk management and recovery practices of 10 derivatives CCPs, Bank for International Settlements, Basel, available at <http://www.bis.org/cpmi/publ/d148.htm>. [21]

CPMI-IOSCO (2016), Resilience and recovery of central counterparties (CCPs): Further guidance on the PFMI – consultative report, Bank for International Settlements, Basel, available at <http://www.bis.org/cpmi/publ/d149.htm>. [22]

The Conclusions and the Government's response are available at <http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Review-of-competition-in-clearing-Australian-cash-equities>. [23]

Previous arrangements already enabled non-cash collateral (including excess collateral) lodged with ASX Clear in respect of derivatives transactions to remain under the beneficial ownership of clients. These arrangements satisfied the Bank's supplementary interpretation of the FSS in respect of non-cash collateral. [24]

These figures represent the notional value of all outstanding novated OTC IRD trades (i.e. the two novated contracts created by the clearing of a bilaterally agreed trade are counted separately). [25]

A LEPO is a European-style call option (exercisable only on the expiry date) with a strike price of one cent. [26]

CPMI-IOSCO (2016), Guidance on Cyber Resilience for FMIs is available at <https://www.bis.org/cpmi/publ/d146.pdf>. [27]

‘Core capital’ is defined by ASX to be the sum of: all paid-up ordinary share capital; all non-cumulative preference shares; all reserves, excluding revaluation reserves; and opening retained profits/losses, adjusted for current year movements. [28]

Available at <http://www.asx.com.au/documents/asx-compliance/pfmi-disclosure-framework.pdf>. [29]

Available at <http://www.bis.org/cpmi/publ/d125.pdf>. [30]

The quantitative disclosures for ASX Clear are available at <http://www.asx.com.au/regulation/regulatory-compliance/asx-clear.htm>, and for ASX Clear (Futures) at <http://www.asx.com.au/regulation/regulatory-compliance/asx-clear-futures.htm>. [31]