2015/16 Assessment of ASX Clearing and Settlement Facilities A1.2 ASX Clear (Futures) Standard 7: Liquidity risk

A central counterparty should effectively measure, monitor and manage its liquidity risk. A central counterparty should maintain sufficient liquid resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate liquidity obligation for the central counterparty in extreme but plausible market conditions.

ASX Clear (Futures) maintains a framework for managing its liquidity risk (CCP Standard 7.1). Under this framework, ASX Clear (Futures) provides participants with information to assist them in managing their liquidity needs and risks, and employs an experienced Portfolio Risk Manager to monitor and manage ASX Clear (Futures)' own settlement and funding flows (CCP Standard 7.2). ASX Clear (Futures) aims to hold sufficient liquid resources to meet its payment obligations on time in the event that the two participants and their affilates with the largest aggregate payment obligation to the CCP were to default in the extreme but plausible scenarios envisaged in its stress tests (CCP Standards 7.3, 7.8). This level of cover reflects the Bank's supplementary interpretation of CCP Standard 7.3, including the Bank's view that ASX Clear (Futures) is systemically important in multiple jurisdictions. The liquid resources held to cover liquidity obligations under these stressed scenarios comprise a portfolio of high quality assets managed by ASXCC on ASX Clear (Futures)' behalf, supported by procedures to ensure timely and reliable access to liquidity from the portfolio as required (CCP Standards 7.4, 7.6). A validation of ASX Clear (Futures)' liquidity stress test models was completed using an external expert in June 2016. To enhance its management of liquidity risk, ASX Clear (Futures) has access, via ASXCC as an ESA holder, to AUD liquidity from the Reserve Bank against eligible collateral (CCP Standard 7.7). ASX Clear (Futures) implemented in October 2015 enhanced powers to comprehensively address uncovered liquidity shortfalls, as part of broader enhancements to its recovery arrangements (CCP Standard 7.9).

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

Sources of liquidity risk

The primary source of liquidity risk in ASX Clear (Futures) is the potential default of a participant with payment obligations to the CCP. To the extent that the CCP relies on such incoming payment flows to meet its obligations to other participants, it could face a liquidity shortfall. Payment obligations to and from participants typically take the form of initial and variation margin, although they may also relate to the cash settlement of contracts.

ASX Clear (Futures) also faces 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 (see CCP Standard 7.3). 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.

ASX Clear (Futures) does not rely on commercial bank money settlement agents, nostro agents, custodians or liquidity providers in meeting its AUD payment obligations.

Managing liquidity risk

ASX Clear (Futures) minimises the size of its liquidity obligations to participants through daily and intraday settlement of variation margin. This prevents the build-up of large liquidity (and credit) exposures. ASX Clear (Futures)' framework for managing its remaining liquidity risks involves the monitoring of liquidity exposures through daily stress testing (see CCP Standard 7.8) and the maintenance of sufficient liquid resources to be able to meet payment obligations arising from the default of two participants and their affiliates in extreme but plausible market conditions, and to meet day-to-day liquidity requirements (see CCP Standard 7.3).

ASX Clear (Futures) also provides participants with information to help them manage their liquidity needs and risks, which in turn protects the CCP. Participants are provided with sufficient information to understand their intraday margin call obligations, and replicate stress test outcomes. ASX publishes a daily SPAN margin parameter file that allows participants to estimate payment obligations associated with margin requirements for actual or hypothetical portfolios. ASX provides advance warnings and communications in respect of calls for additional margin, and margin rate changes. For example, participants are notified if their stress test results approach their STELs. Additionally, ASX liaises closely with participants ahead of implementing any new obligations that could affect their liquidity needs.

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

Daily cash flows and investment of funds across the ASX CCPs are monitored and managed by a Portfolio Risk Manager. In addition, the CRPM department reviews a daily report of key risk indicators related to liquidity demands. Any issues are escalated to the CRO. Funding arrangements, such as settlement flows and foreign currency lodgements, are also monitored in real time by the CRPM and Treasury functions.

Portfolio Risk Management uses reports provided by CRPM to monitor SPAN-calculated margin flows originating from ASX Clear (Futures)' Collateral Management System, which feed into ASX's Treasury Management System. Portfolio Risk Management enters trades required to manage daily cash flows into ASX's Treasury Management System. Post Trade Operations uses daily settlement reports produced by the Treasury Management System to generate settlement instructions in Austraclear. Resulting cash flow movements are monitored in RITS. Margin payments from participants must be matched in Austraclear by 10.30 am and settled by 11.00 am, while outward payments to participants are manually managed in the RITS queue and are only released once all incoming margin obligations have been settled (generally by 12.00 pm).

7.3 A central counterparty should maintain sufficient liquid resources in all relevant currencies to settle securities-related payments, make required variation margin payments and meet other payment obligations on time with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions. In addition, a central counterparty that is involved in activities with a more complex risk profile or that is systemically important in multiple jurisdictions should consider maintaining additional liquidity resources sufficient to cover a wider range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions.

Reflecting the Bank's supplementary interpretation of the FSS, the Bank has concluded that ASX Clear (Futures) is systemically important in multiple jurisdictions and therefore subject to the higher financial resource requirement that it should maintain additional liquid resources to cover liquidity needs in the event of the default of the two participants and their affiliates that would generate the largest aggregate payment obligation to the CCP in extreme but plausible market conditions.

Consistent with this requirement, the objective of the ASX Liquidity Risk Policy is for ASX Clear (Futures) to maintain, with a high degree of confidence, sufficient liquidity to conduct day-today activities and manage the default of two participants and their affiliates. In practice, the CCP aims to hold sufficient liquid sufficient to cover the sum of:

• The DLR across the ASX CCPs. The DLR for ASX Clear (Futures) is the amount required to cover the estimated payment obligations for the CCP in the event of the joint default of the two largest participants (as measured by payment obligations to the CCP) and their affiliates under the stressed market conditions envisaged in the CCP's liquidity stress test (see CCP Standard 7.8). The DLR is estimated by summing:

  - the aggregate margin requirement of the two largest participants and their affiliates, used to cover payment obligations associated with variation margin or the close-out of positions in normal market conditions

  - additional payment obligations that would be required to meet variation margin or cash flows on the close-out of positions in extreme but plausible market conditions

  - an adjustment for the variation margin payable by, or due to, those participants (see CCP Standard 7.8).

  The calculation of ASX Clear (Futures)' DLR is described in Appendix A1.1, CCP Standard 7.3.

• An ‘ordinary liquidity requirement’. This is intended to cover day-to-day liquidity requirements, such as the return of margin to participants, and is specified as a percentage of the ASXCC investment portfolio. This portfolio comprises both CCPs' default funds as well as the cash margins posted at both CCPs. This is calibrated to the maximum margin outflow in normal market conditions in the ASXCC cash collateral portfolio (as a percentage of portfolio value) over the previous 12 months and is reviewed annually.

While ASX Clear (Futures)' pooled prefunded resources, as well as over 93 percent of margin posted by participants, are in the form of cash, these funds are reinvested by ASXCC (of which ASX Clear (Futures) is a subsidiary; see ‘ASX Group Structure’ in Appendix A). Accordingly, to support the ASX Liquidity Risk Policy, ASXCC's treasury investment policy requires that a portion of ASXCC investments must be invested in liquid assets, such that ASXCC holds sufficient liquid assets to meet the minimum liquidity resource requirement across both ASX CCPs (CCP Standard 7.4). ASXCC's Investment Mandate establishes a clear definition of liquid assets: 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 Reserve Bank.

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

ASXCC holds an ESA at the Bank to facilitate money settlements on behalf of ASX Clear (Futures) and ASX Clear (see CCP Standard 7.7). As an ESA holder, ASXCC is eligible for access to AUD liquidity under the Bank's overnight and intraday liquidity facilities (against eligible collateral specified by the Bank that is held within its investment portfolio), including in times of market stress.

The ASXCC Investment Mandate requires the Portfolio Risk Manager to maintain high-quality liquid assets to meet ASX Clear (Futures)' minimum liquid resource requirements, consistent with the definition of qualifying liquid assets under this standard (see CCP Standard 7.3). Liquid assets must be cash at creditworthy commercial banks that is available for use within two hours or held in a restricted set of highly liquid securities eligible for repurchase transactions with the Bank. Securities that could be used to meet the minimum liquid resource requirement include: certain fixed bonds, discount bonds and floating rate notes that have been issued in Australia and are eligible for repurchase transactions with the Bank; and bank bills and negotiable certificates of deposit eligible for repurchase transactions with the Bank. Eligible investment counterparties are discussed under CCP Standard 15.

ASXCC has made amendments to its investment mandate to clarify how ASX's portfolio will change over 2016/17 to meet the Bank's expectations for the credit and liquidity risk profile of ASX treasury investments (see CCP Standard 15.4). These changes will introduce a distinction between ASX's ‘Core’ liquidity (held to meet the Ordinary and Default Liquidity Requirements across the ASX CCPs) and ‘Additional’ liquidity (held to meet uncovered liquidity shortfalls across the CCPs). By 30 June 2017, assets eligible for Core liquidity will be restricted to cash held in accounts at central banks or creditworthy commercial banks and securities issued by the Australian or State Governments (held outright or via repo).

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

ASX Clear (Futures) does not supplement its qualifying liquid resources with other forms of liquid resources.

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

ASX Clear (Futures) does not rely on private liquidity providers in determining the size of its qualifying liquid resources. Nonetheless, consistent with the guidance to the Financial Stability Standards for CCPs, ASX has internal procedures for using its liquidity resources to complete settlement during a liquidity shortfall. The Portfolio Risk Manager, in consultation with the CRO, is responsible for the provision of timely liquidity to fund margin and settlement obligations to non-defaulting participants. The Default Management Standard (see CCP Standard 12.1) provides a high-level summary of the factors to be considered in the liquidation of participant non-cash collateral, as well as the liquidation of treasury investments representing participant cash collateral and other prefunded financial resources. While the order of use of particular collateral types will depend on the particular circumstances, a typical order of use may be AUD cash first, followed by non-cash and foreign currency collateral. The order of liquidation of non-cash and foreign currency collateral to meet funding requirements will depend on factors such as prevailing market conditions, liquidity needs and the amount of funds required relative to the size of each collateral lodgement. Procedures for dealing with liquid assets in the treasury investment portfolio are documented, and are available for Portfolio Risk Management staff at both primary and backup sites. Non-cash collateral is limited to highly liquid government securities (see CCP Standard 5.1).

7.7 A central counterparty with access to central bank accounts, payment services or securities services should use these services, where practical, to enhance its management of liquidity risk. A central counterparty that the Reserve Bank determines to be systemically important in Australia and has obligations in Australian dollars should operate its own Exchange Settlement Account, in its own name or that of a related body corporate acceptable to the Reserve Bank, to enhance its management of Australian dollar liquidity risk.

ASXCC holds an ESA. Accordingly, ASX Clear (Futures) may, via ASXCC, access AUD liquidity under the Bank's overnight and intraday liquidity facilities (against eligible collateral specified by the Bank). ASXCC's Investment Mandate clarifies its ability to make use of these services, by specifying the list of securities (from the Bank's approved list) available for repurchase, including the securities of the Commonwealth, certain states and major banks (CCP Standard 15).

ASX Clear (Futures) uses ASXCC's ESA to settle its AUD margin and cash settlement obligations in RITS (see also CCP Standard 9).

7.8 A central counterparty should determine the amount and regularly test the sufficiency of its liquid resources through rigorous stress testing. A central counterparty should have clear procedures to report the results of its stress tests to appropriate decision-makers at the central counterparty and to use these results to evaluate the adequacy of, and adjust, its liquidity risk management framework. In conducting stress testing, a central counterparty should consider a wide range of relevant scenarios. Scenarios should include relevant peak historic price volatilities, shifts in other market factors such as price determinants and yield curves, multiple defaults over various time horizons, simultaneous pressures in funding and asset markets, and a spectrum of forward-looking stress scenarios in a variety of extreme but plausible market conditions. Scenarios should also take into account the design and operation of the central counterparty, include all entities that might pose material liquidity risks to the central counterparty (such as commercial bank money settlement agents, nostro agents, custodians, liquidity providers and linked FMIs) and, where appropriate, cover a multiday period. In all cases, a central counterparty should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount and form of total liquid resources it maintains.

ASX Clear (Futures) uses a daily liquidity stress test model to assess the adequacy of its liquidity arrangements. This model, which is based on ASX Clear (Futures)' credit stress tests (described under CCP Standard 4), tests the sufficiency of liquid resources against the joint default of the two participants, and their affiliates (including affiliations between participants involved in OTC and futures clearing) that would create the largest liquidity exposure for the CCP. The liquidity stress tests assume that a default occurs just prior to receipt of the previous day's variation margin payments, if owed by the defaulter, or just after any variation margin payments have been paid, if owed to the defaulter. The stress tests thereby make a worst-case assumption with respect to the timing of AUD variation margin flows under each stress test scenario.

All stress test scenarios are based on historical moves and have been set so that they replicate extreme market moves that have a probability of occurrence of once in 20 years (see CCP Standard 4.6). Scenarios cover single-asset price moves, as well as movements in price and volatility occurring jointly across the equity index futures, AUD interest rate futures, and electricity futures contracts. In addition, scenarios also cover movements in the AONIA and BBSW rates that are used as the reference rates for OTC IRS. Additional scenarios account for various forms of basis risk between futures and OTC prices, and the AONIA and BBSW curves at various tenors. Scenarios also cover a range of hypothetical macroeconomic and market events, such as a commodity collapse, or sovereign default. In February 2016, ASX Clear (Futures) modified its stress test scenarios to reflect intraday (rather than close-to-close) price movements. Price changes are now based on the most extreme close-to-high or close-to-low price movements observed over the relevant holding period.

The results of the liquidity stress tests generate the DLR, which is compared with ASX Clear (Futures)' AFR (set to $650 million; see CCP Standard 4.4). A stress test result above the AFR is considered a breach of the AFR and triggers a detailed investigation into the breach. When assessing the materiality of a liquidity stress test breach, the CCPs consider contributing and mitigating factors, such as changes in the ICR of the participant, atypical trading activity, and any AIM that is being held. Given that liquidity resources are maintained on an aggregate basis (in ASXCC), in order to test the sufficiency of ASX's overall liquid resources the results of liquidity stress testing for each CCP are aggregated to calculate the total DLR.

The results of liquidity stress testing are regularly reported to ASX senior management, the Clearing Boards and the Bank. All liquidity stress test breaches are reported to: the CRO; the Senior Manager, CRPM; the General Manager, Finance; and the Portfolio Risk Manager. A sustained or widely distributed breach may lead to a review of the adequacy of the AFR.Over the Assessment period, there were no liquidity stress test breaches.

Consistent with the findings of a CPMI-IOSCO report monitoring the implementation of the Principles, and also reflecting the Bank's own analysis and observations arising from ASX's independent validation of its liquidity stress tests, during the Assessment period, 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 (see Section 3.5.1).

Review and validation

Since stress scenarios are common across both the credit and liquidity stress tests for ASX Clear (Futures), the same reverse stress testing approach is used in sensitivity analysis of both models (see CCP Standard 4.6).

ASX's Model Validation Standard requires that all models that are critical to ASX (as measured against a series of risk factors) undergo a full annual validation (see CCP Standard 2.6). Under this framework the liquidity stress test model must be validated every two years using an external expert. A validation of ASX Clear (Futures)' liquidity stress test model was completed using an external expert in June 2016.

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

ASX Clear (Futures) has developed arrangements designed to to comprehensively address a liquidity shortfall as part of its broader package of recovery measures that came into effect in October 2015 (see CCP Standard 3.5). Under these arrangements, prefunded liquid resources are supplemented by three additional tools.

• A remaining liquidity shortfall resulting from a participant default would initially be addressed, where possible, via Recovery Assessments called in cash from surviving participants (see CCP Standard 4.8). These would be capped at the level of participants' default fund contributions (a maximum of $200 million in aggregate), if assessments were called in relation to a single default; or at three times the level of participants' default fund contributions (a maximum of $600 million in aggregate), if assessments were called in relation to multiple participants defaulting within a defined default period.^[15] ASX Clear (Futures) would have the flexibility to call for assessments where it anticipates a liquidity shortfall resulting from a participant default, increasing the likelihood that these funds will be available to meet liquidity needs on a timely basis.
• ASX Clear (Futures) would also have the power to reduce (haircut) outgoing payments to participants. For example, a haircut could be applied to variation margin payments due to participants with net in-the-money positions in the event of mark-to-market loss on the defaulter's portfolio. Payment haircuts could be applied to a broad range of ASX Clear (Futures)' payment obligations, excluding the return of initial margin. There is no cap on the use of payment haircutting to address a liquidity shortfall, although ASX Clear (Futures) would consult with the Risk Consultative Committee in determining whether to continue payment haircutting if losses allocated via this tool exceed $650 million.
• Any residual liquidity shortfall that could not be addressed via Recovery Assessments or payment haircutting would be addressed via a power to completely terminate all open contracts. Complete termination would be reserved as a last resort tool if there was no other means of addressing a liquidity shortfall (including via intervention of the Reserve Bank as resolution authority if current proposals for a special resolution regime for FMIs are implemented). Under complete termination all open contracts at the CCP would be settled with participants at their current market value, with any residual liquidity shortfall of the CCP addressed by haircutting settlement payments to participants. Reliance on complete termination is extremely unlikely, since payment haircutting provides an uncapped mechanism to address liquidity obligations associated with the majority of payment flows.

Footnote

The cap on assessments for multiple defaults remains in place until the expiry of a ‘default period’ that commences with the default of the first participant and concludes 22 business days after completion of the default management process for the final defaulting participant, where each default is separated from completion of the default management process for the preceding default by 22 business days or less. [15]