2015/16 Assessment of ASX Clearing and Settlement Facilities A1.1 ASX Clear Standard 5: Collateral

A central counterparty that requires collateral to manage its or its participants' credit exposures should accept collateral with low credit, liquidity and market risks. A central counterparty should also set and enforce appropriately conservative haircuts and concentration limits.

ASX Clear limits the assets it routinely accepts as collateral to cash, or highly liquid stocks or exchange-traded funds with low credit, liquidity and market risks (CCP Standard 5.1). These assets are widely held and there is sufficient depth of liquidity of these assets that their eligibility as collateral is not considered to have any material market impact (CCP Standard 5.2). ASX Clear applies haircuts to collateral that are calibrated to stressed market conditions, to limit the need for procyclical adjustments (CCP Standards 5.3, 5.4). Collateral holdings are not sufficiently concentrated as to impair ASX Clear's ability to liquidate such assets quickly without significant adverse price effects (CCP Standard 5.5). ASX Clear employs systems that adequately support the movement of collateral for securities and derivatives trades (CCP Standard 5.7).

5.1 A central counterparty should generally limit the assets it (routinely) accepts as collateral to those with low credit, liquidity and market risks.

ASX's approach to collateral is documented in a Collateral Policy and a Collateral Standard. These documents set out ASX's collateral eligibility criteria, procedures for review of eligibility, the basis for calibrating haircuts and arrangements for the review of collateral settings.

Initial and premium margin obligations may be met by posting either AUD cash or non-cash collateral.^[12] Non-cash collateral is subject to a haircut. Variation and intraday margin obligations must be settled in cash (see CCP Standard 6).

ASX Clear specifies criteria for eligible securities collateral. Acceptable collateral includes S&P/ASX 200 index constituent stocks (with the exception of ASX Limited stock); exchange-traded funds that ASX Clear determines to be mature and liquid, and for which issuer risk is considered low (currently only the SPDR S&P/ASX 200 Fund); and other stocks lodged as specific cover for call options written on the same stock (which are a subset of the ASX 200). The list of acceptable collateral is reviewed at least quarterly, including to reflect changes to the S&P/ASX 200 index constituent list. ASX Clear prohibits the use by participants of stock issued by related entities except when it is used as specific cover for a call option written on that stock. ASX Clear also restricts the use as collateral of related entity-issued stocks to client transactions (subject to strict concentration limits), in order to manage the potential risk of the simultaneous default of a participant and the collateral issuer (‘wrong-way risk’). Collateral must be unencumbered.

For the first three years of cash market margining, the ASX Clear Operating Rules permitted participants to use bank guarantees to meet cash market margin obligations with prior permission from ASX. The transitional period subsequently lapsed in June 2016 and the ASX Clear Operating Rules were amended such that, from 1 July 2016, participants are no longer permitted to use bank guarantees to meet cash market margin obligations. ASX Clear will, nevertheless, continue to permit participants to meet their ETO margin obligations with bank guarantees subject to certain criteria and at the discretion of ASX until 3 January 2017. This six month transitional period is in place to allow advisers and their clients to seek alternate arrangements. While existing bank guarantees will be permitted to remain during this six month period, new or replacement bank guarantees are no longer accepted.

5.2 In determining its collateral policies, a central counterparty should take into consideration the broad effect of these policies on the market. As part of this, a central counterparty should consider allowing the use of collateral commonly accepted in the relevant jurisdictions in which it operates.

ASX Clear takes into account market liquidity in determining the eligibility of collateral. ASX Clear considers the equity securities that it will accept as collateral – stocks in the S&P/ASX 200 index and the SPDR S&P/ASX 200 Fund – to be sufficiently liquid that the eligibility of these assets as collateral will not have any material impact on market liquidity or price. In light of the depth of liquidity in these assets, ASX Clear would also expect to be able to liquidate such collateral in a timely fashion as required. These assets are also well known and understood to participants in the Australian market.

5.3 A central counterparty should establish prudent valuation practices and develop haircuts that are regularly tested and take into account stressed market conditions.

Since S&P/ASX 200 stocks and the SPDR S&P/ASX 200 Fund are highly liquid, price information is readily available. ASX revalues collateral on a daily basis using end-of-day prices. If there is no price information available for a particular day (for example due to a corporate action), ASX Clear uses the previous day's price to value the relevant asset.

ASX Clear sets haircuts on non-cash collateral to cover a fall in the collateral value of stocks over a three-day period in a once-in-20-year scenario. Haircuts are based on the largest price falls used in corresponding capital stress test scenarios (see CCP Standard 4.6), currently 30 per cent. Haircuts for individual stocks that are not included among the 25 individual stock stress test scenarios are similarly set at 30 per cent. Collateral haircuts are reviewed at least annually to take into account any changes to historically observed volatility trends, with the ongoing review of capital stress test scenarios also verifying the appropriateness of haircut rates (see CCP Standard 4.4).

ASX Clear is planning to change the definition of ‘stressed market conditions’ for haircut setting purposes in Q3 2016, to bring it into line with the methodology used for ASX Clear (Futures) (see Section 3.5.1).

Where participants lodge ‘specific cover’ collateral – i.e. a participant lodges as collateral the exact amount of a specific stock underlying a short call option position – ASX does not apply a haircut to the collateral. If such a participant were to default, any increase in the price of the call option would be matched or exceeded by an increase in the price of the posted collateral.

5.4 In order to reduce the need for procyclical adjustments, a central counterparty should establish stable and conservative haircuts that are calibrated to include periods of stressed market conditions, to the extent practicable and prudent.

ASX Clear's collateral haircutting policy is designed to cover extreme but plausible scenarios based on the most extreme market price and volatility movement observed in the past 20 years, which includes the extreme volatility observed during the 2008–09 financial crisis. This is intended to ensure that haircuts remain stable over the business cycle, even in stressed market conditions.

ASX Clear is planning to change the definition of ‘stressed market conditions’ for haircut setting purposes in Q3 2016, to bring it into line with the methodology used for ASX Clear (Futures).

5.5 A central counterparty should avoid concentrated holdings of certain assets where this would significantly impair the ability to liquidate such assets quickly without significant adverse price effects.

ASX Clear limits and mitigates concentration risk in its collateral holdings by restricting non-cash collateral (other than specific cover) to the constituent securities of the S&P/ASX 200 index and applying haircuts calibrated to cover a fall in the value of these securities equivalent to a once-in-20-year scenario. During the Assessment period, the maximum value of non-cash collateral held by ASX Clear was $3.9 billion, which was used to cover less than $670 million of margin requirements, after haircuts. The remaining amount represented excess collateral lodged by participants on both their house and client accounts. On average, around 53 per cent of margin requirements were met using cash collateral during 2015/16.

ASX maintains a risk-based policy for managing concentration risks in its CCPs (see CCP Standards 4.2, 18.4). However, this policy does not address concentration risk in ASX Clear's collateral holdings. The Bank will continue to discuss with ASX its approach to monitoring collateral concentration risks.

5.6 A central counterparty that accepts cross-border collateral should mitigate the risks associated with its use and ensure that the collateral can be used in a timely manner.

ASX Clear does not accept any cross-border non-cash or cash collateral.

5.7 A central counterparty should use a collateral management system that is well designed and operationally flexible.

Collateral management system

ASX Clear manages the calculation and execution of margin calls for its equity derivative products through its Derivatives Clearing System (DCS) and Intraday Margining System, and for cash securities, through its CMM Razor System. These systems monitor initial and variation margin levels and flows on an intraday basis (although intraday margin is not calculated or called for cash securities). The timely deposit, withdrawal and substitution of non-cash collateral are facilitated by CHESS.

Re-use of collateral

ASX Clear does not re-use non-cash collateral posted by participants and the re-use of such collateral is not permitted under its Operating Rules.

Footnote

Premium margin is used to cover the amount that would be required to close out short positions in ETOs (see CCP Standard 6.1). [12]