2015/16 Assessment of ASX Clearing and Settlement Facilities A1.2 ASX Clear (Futures) Standard 13: Segregation and portability

A central counterparty should have rules and procedures that enable the segregation of positions of a participant's customers and the collateral provided to the central counterparty with respect to those positions.

ASX Clear (Futures) offers individual and omnibus segregation to customers (or ‘clients’) of its exchange-traded derivatives and OTC clearing participants (CCP Standard 13.2). Individual segregation provides protection to clients not only in the event of the default of their clearing participant, but also the concurrent default of a fellow client (CCP Standard 13.1). The availability of individually segregated client accounts, margined on a gross basis at the clearing participant level, also increases the likelihood that client positions could be transferred in the event of a participant default (CCP Standard 13.3). During the Assessment period, ASX Clear (Futures) introduced arrangements that support the posting of excess client collateral, consistent with the Bank's supplementary interpretation of CCP Standards 13.2 and 13.3. ASX Clear (Futures) has produced a fact sheet on its segregation and portability arrangements, which it requires that participants make available to their clients. This is published on ASX's website (CCP Standard 13.4).

13.1 A central counterparty should, at a minimum, have segregation and portability arrangements that effectively protect a participant's customers' positions and related collateral from the default or insolvency of that participant. If the central counterparty additionally offers protection of such customer positions and collateral against the concurrent default of the participant and a fellow customer, the central counterparty should take steps to ensure that such protection is effective.

ASX Clear (Futures) offers clients of both OTC and exchange-traded futures participants the choice of holding their positions in either an individually segregated account or a client omnibus account.

While in the standard individually segregated structure client positions are held in individual accounts, the collateral posted to support these positions is held in a single commingled account at the participant level. ASX nevertheless maintains a record of the value of initial margin attributable to each segregated client account and guarantees each client the transfer or return of this value (net of any close-out costs), even if the return of the specific securities posted is not possible (see CCP Standard 13.2). This approach is similar to the ‘Legally Segregated Operationally Commingled’ segregation model mandated in the US by the CFTC.

As a matter of convenience, many participants lodge excess collateral such that the value of collateral held does not align with the record of initial margin. In September 2015, ASX Clear (Futures) implemented system changes that extend individual segregation to include cover for collateral lodged in excess of margin requirements, should participants choose to offer this option to their clients. Under these arrangements, ASX Clear (Futures) would transfer or return the ‘collateral value’ (i.e. margin requirements plus the value of excess collateral) that had been attributed to an individual client account in the event of a participant default (see CCP Standard 13.2).

ASX Clear (Futures) has the capacity to transfer (port) participants' clients' positions and collateral under its Operating Rules (see CCP Standard 13.3). Part 5 of the PSNA supports the transfer of client collateral in the event of the default of a clearing participant as provided for in its Operating Rules without the need to seek approval from the defaulted participant's external administrator. ASX maintains an internal policy governing the segregation and portability arrangements at ASX Clear and ASX Clear (Futures), which formally aligns these with the requirements of this standard.

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

ASX Clear (Futures) offers clients of both OTC and exchange-traded futures participants the choice of holding their positions in either an individually segregated account or a client omnibus account. Initial margin is calculated separately for positions held in each individual or omnibus client account. Portfolio-margining of interest rate futures against OTC positions (see CCP Standard 6.5) is only permitted for clients that have individual client accounts for both types of products with the same participant.

Under the standard individually segregated account structure, only positions are segregated at the individual client account level. Operationally, collateral is not segregated; gross collateral requirements are aggregated across all client accounts and managed by the participant within a single commingled client collateral account. In the event of a default, the value of the initial margin applied to the client's position in an individual client account would either be transferred to another participant or returned to the client (net of any close-out costs). Under standard arrangements, any excess collateral would be returned to the administrator of the defaulted participant. That is, ASX Clear (Futures) guarantees only the transfer or return of the value of each client's collateral, not the individual collateral securities that may have been posted.

In September 2015, ASX Clear (Futures) introduced arrangements that extend the standard account structure by providing clearing participants with the option to attribute cash and securities lodged as margin or excess collateral to individual client accounts. While all client collateral will continue to be operationally managed in a single commingled account under these arrangements, ASX Clear (Futures) would transfer or return the ‘collateral value’ for an individual client account (that is, the greater of the initial margin requirement or the value of attributed assets, net of any close-out costs). Subject to exceptions set out in the rules, ASX Clear (Futures) would transfer or return to the client equivalent (in specie) securities to those that had been attributed.

Under the individually segregated account structure, however, variation margin payments (and other cash flows) to and from clearing participants are netted. Accordingly, there is a risk that a participant could default before passing on to each client the gross flows underlying the net payment. Despite this, ASX's individually segregated model (with the option of asset attribution) provides significant protections for client collateral posted to the CCP relative to the omnibus segregation structure.

Since under either an individually segregated or an omnibus structure, the positions and collateral of clients are separate and identifiable from those of clearing participants, clients are not directly exposed to losses related to their participant's proprietary (house) activity in the event of that participant's default. Where a client opts to use an individually segregated account, its positions are also separately identifiable from those of other clients, as is the value of its margin obligations and any attributed excess collateral.

Clearing participants are not obliged to offer both individually segregated and omnibus client accounts, but must provide their clients with a client fact sheet, developed by ASX, which explains the types of accounts that are available, and the advantages and disadvantages of each option (see CCP Standard 13.4). Participants that offer individually segregated accounts are also not obliged to support the segregation of excess client collateral or attribute collateral to an individual client.

13.3 To the extent reasonably practicable under prevailing law, a central counterparty should structure its portability arrangements in a way that makes it highly likely that the positions and collateral of a defaulting participant's customers will be transferred to one or more other participants.

ASX Clear (Futures) has the power under its Operating Rules to transfer client positions and collateral following a participant default. This power is further supported by Part 5 of the PSNA (see CCP Standard 13.1). The availability of individually segregated client accounts for both OTC and exchange-traded derivatives increases the likelihood that client positions and collateral could be transferred to another participant in the event of a clearing participant default. Under individual client segregation, margin requirements are calculated on a gross basis (i.e. individually for the positions held by each client). This supports portability by making it more likely that clients would have sufficient collateral transferred with their positions to ensure that their full margin requirements could be met after transfer.

Conversely, a fully-collateralised transfer of an individual client's positions within an omnibus account is unlikely, since these positions are margined on a net basis. ASX would therefore expect to manage a defaulted participant's client omnibus account as a single client account – that is, no individual client within an omnibus account would be transferred separately from the others. Since porting requires the consent of the receiving participant and each individual client, the simultaneous transfer of all clients within an omnibus account would be challenging.

ASX Clear (Futures) has established a direct legal relationship with clients to underpin the acceptance of instructions in the event of a participant default. In the absence of a default, ASX Clear (Futures) does not interact directly with clients, and the participant remains responsible as principal for its clients' obligations to ASX Clear (Futures). However, if the participant were to default, its clients would have the right to communicate with ASX and directly enforce the Operating Rules relating to segregation and portability of client positions and the associated value of initial margin or attributed collateral held on their behalf.^[19] To accommodate structures involving indirect clients – that is, clients of clients – ASX Clear (Futures) allows clients to hold multiple individually segregated accounts and to nominate, as appropriate, an end client for each account. In the event of the default of the relevant clearing participant, the nominated end client would have the right to communicate directly with ASX in relation to the porting of positions in that individually segregated account (and associated value of initial margin or attributed collateral).

However, portability cannot be guaranteed since it relies on clients having established arrangements with alternate clearing participants and the willingness and capacity of those participants to take on the affected clients within a short period of time. In the event of a default, ASX allows a window of up to 24 hours for porting of exchange-traded derivatives client positions and up to 48 hours for OTC derivatives client positions. Clients may nominate in advance an alternative (‘back-up’) clearing participant to which it would seek to port its positions (and any associated collateral value) in the event of its clearing participant default. Advance nomination of a back-up clearing participant is optional and, even if nominated, a ‘back-up’ clearing participant may in the event be unwilling or unable to take on the positions. However, given the short timeframe for decisions in the event of a default, pre-nomination should increase the likelihood that a successful transfer could be achieved.

In the event that a transfer could not be achieved, ASX Clear (Futures) would hedge, close out and/or auction client positions as it would those of the defaulted clearing participant (see CCP Standard 12). The Operating Rules give ASX Clear (Futures) flexibility to either extend or close the porting window, since ASX would remain exposed to market risk until such time as a defaulted participant's client positions were ported or closed out (see CCP Standard 12). For example, ASX may reduce the porting window if it became clear that a transfer could not be achieved, or if market conditions dictated that it would be beneficial to proceed with other default management processes to reduce ASX Clear (Futures)' exposure.

13.4 A central counterparty should disclose its rules, policies and procedures relating to the segregation of a participant's customers' positions and related collateral. In particular, the central counterparty should disclose whether customer collateral is segregated on an individual or omnibus basis. In addition, a central counterparty should disclose any constraints, such as legal or operational constraints, that may impair its ability to segregate or port a participant's customers' positions and related collateral.

Current arrangements for segregation and portability are described in the ASX Clear (Futures) Operating Rules and Procedures (including the OTC Rulebook and Handbook). ASX also publishes an overview of clearing participant default arrangements, which outlines the implications of different account structures and discloses the current operational constraints to portability.^[20]

ASX has published a client fact sheet outlining segregation and portability arrangements in ASX Clear (Futures) and the rights of clients in the event of a default. In January, ASX updated the fact sheet to take into account enhancements to protect excess client collateral. Participants are required make this fact sheet available to all of their direct clients. The fact sheet is also available on ASX's public website.^[21] In addition, during the current and previous Assessment periods, ASX has publicly consulted stakeholders on segregation and portability arrangements for both OTC and exchange-traded derivatives. These consultations have outlined the implications of different account structures used by ASX Clear (Futures) and identified operational constraints to portability.

Footnotes

This right is limited to clients that maintain individual client accounts and are not themselves in default. [19]

Available at: <http://www.asx.com.au/documents/clearing/131001_Default_Management_-_Public_Information_ Document_v2.pdf>. [20]

The client fact sheet is available at <http://www.asx.com.au/documents/clearing/ASXClientClearingClientFactSheet22January2016.pdf>. A related fact sheet describing the legal model used in ASX Clear (Futures)' client clearing arrangements is available at <http://www.asx.com.au/documents/clearing/ClientProtectionModelFactSheet_31August2015.pdf>. [21]