2015/16 Assessment of ASX Clearing and Settlement Facilities A2.1 ASX Settlement Standard 6: Liquidity risk

A securities settlement facility should effectively measure, monitor and manage its liquidity risk. A securities settlement facility 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 securities settlement facility in extreme but plausible market conditions.

ASX Settlement conducts settlement on a DvP Model 3 basis, and does not assume payment obligations in the settlement process. While participants face liquidity exposures arising from the possible reconstitution of the multilateral net batch in a default, including via the implementation of OTAs related to novated transactions, ASX Settlement's back-out procedures are designed to limit concentrated liquidity exposures for non-defaulting participants (SSF Standard 6.1). These procedures are disclosed to participants through ASX Settlement's Operating Rules and Procedures (SSF Standard 6.2). ASX Settlement does not assume liquidity risk as principal through its settlement process (SSF Standards 6.3, 6.4, 6.5, 6.6, 6.7, 6.8, 6.9).

ASX Settlement's arrangements to measure and monitor liquidity risk for its participants are described in further detail under the following sub-standards.

6.1 A securities settlement facility 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.

ASX Settlement conducts its settlements on a DvP Model 3 basis in a multilateral net batch (see SSF Standard 10). While ASX Settlement does not assume any payment obligations in the batch settlement process, and hence does not assume liquidity risk as principal, the nature of the multilateral net batch creates liquidity exposures between participants.

The default of a participant with a payment obligation in the batch may require the ‘reconstitution’ of the batch to bring the payment obligations of the defaulting participant down to zero (net of any liquidity injection by ASX Clear in respect of novated transactions).^[11] For non-novated transactions, this is done by removing transactions of the defaulting participant from the batch. These transactions are typically entered into solely to ‘prime’ the settlement accounts of participants to meet delivery obligations related to the settlement of novated transactions and occur late in the settlement cycle, at a time when the relevant participant is well positioned to meet these obligations. Non-novated transactions are bilateral and hence not subject to the protection of the CCP.

For novated transactions, however, any reconstitution of the batch is achieved by injecting new transactions by way of OTAs with participants due to deliver securities (see SSF Standard 11.3 and Appendix A1.1, CCP Standard 7.3). OTAs were introduced by ASX Clear and ASX Settlement in April 2014 to deal with shortfalls of funds related to novated transactions. Under these arrangements, ASX Clear would meet any payment obligations to allow securities delivery transactions to settle as intended, with participants providing the funds for settlement via separate repurchase transactions for the same stock to unwind the next day. These arrangements provide ex ante clarity by explicitly recognising and formalising the role of participants in providing liquidity to ASX Clear to allow settlement to occur as scheduled.

Reconstitution of the batch could create liquidity pressures for non-defaulting participants due to receive funds in respect of transactions that are removed. ASX Settlement seeks to minimise these liquidity pressures through the use of its procedures to back out non-novated transactions or to inject new transactions by way of OTAs into the batch in respect of novated transactions (see SSF Standard 11.3). Under these procedures, transactions are removed from the batch or settled by way of OTAs in such a way as to ensure that non-defaulting participants' payment obligations do not increase. While non-defaulting participants due to receive a net payment of funds in the batch may be exposed to liquidity risk associated with a reduction in expected receipts, ASX Settlement's back-out algorithm is designed to ensure that receipt expected by a participant does not become a payment obligation, and disperses this liquidity risk across a number of participants through a random allocation mechanism.

6.2 A securities settlement facility 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.

Since ASX Settlement does not assume liquidity risk as principal, it does not have payment obligations related to settlement.

ASX Settlement provides participants with information regarding their money and securities settlement obligations between trade date and settlement date. This information includes individual trade notifications, netted obligations, projected funds obligations and rescheduled settlements following delivery failures. Participants use this information to monitor and manage their funding and delivery obligations and risks.

In the event of a participant default, ASX Settlement uses its back-out algorithm to reconstitute the batch and select transactions to be settled via an OTA. The outcome of the algorithm is dependent on the mix and profile of transactions scheduled for settlement at the time it is run, so it is not possible for ASX Settlement to provide detailed ex ante information to participants on how their settlement obligations might change in the event of a default. However, ASX Settlement's back-out arrangements are described in Section 10 of the ASX Settlement Operating Rules, as well as in related Procedures available to participants. Furthermore, during consultation with participants on the introduction of OTAs, ASX released a consultation paper and subsequent explanatory note outlining the operation and potential liquidity impact of OTAs (see SSF Standard 6.1). ASX Clear has subsequently developed additional disclosures to assist participants in understanding the potential liquidity impact of reconstitution of the ASX Settlement batch arising from the use of OTAs (see Appendix A1.1, CCP Standard 7.1).

6.3 A securities settlement facility should maintain sufficient liquid resources in all relevant currencies to effect same-day settlement and, where appropriate, intraday or 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 payment obligation in extreme but plausible market conditions.

As described, ASX Settlement does not assume liquidity risk as principal, though liquidity risk may arise for participants in the settlement process should the multilateral net batch need to be reconstituted in the event of a participant default. ASX Settlement does not maintain additional liquid resources to manage liquidity risk arising for participants beyond those maintained by ASX Clear as CCP. That is, ASX manages any liquidity risk arising for participants should the multilateral net batch need to be reconstituted through the use of its procedures to back out non-novated transactions or, in the case of transactions novated to ASX Clear, to inject additional prefunded resources from new transactions into the batch by way of OTAs (see SSF Standard 6.1).

6.4 For the purpose of meeting its minimum liquid resource requirement, a securities settlement facility'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 securities settlement facility has access to routine credit at the central bank of issue, the securities settlement facility 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.

See SSF Standard 6.3.

6.5 A securities settlement facility may supplement its qualifying liquid resources with other forms of liquid resources. If the securities settlement facility 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 securities settlement facility 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 securities settlement facility should not assume the availability of emergency central bank credit as part of its liquidity plan.

See SSF Standard 6.3.

6.6 A securities settlement facility 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 securities settlement facility 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 securities settlement facility should regularly test its procedures for accessing its liquid resources at a liquidity provider.

ASX's management of any liquidity risk arising for participants should the multilateral net batch need to be reconstituted relies on ASX Clear's use of OTAs to meet its minimum liquid resource requirement.

As described in Appendix A1.1, CCP Standard 7.6 participants' capacity to perform on these commitments is guaranteed, as participants entering into OTAs with ASX Clear provide liquidity in the form of funds they were due to receive as part of that day's settlement.

The exact size of a participant's potential liquidity exposure to OTAs in the event a participant were to default is dependent on the mix and profile of transactions scheduled for settlement after the event of default. Consequently, it is not possible for ASX to provide detailed ex ante information to participants on how their contingent liquidity exposures to OTAs. Nonetheless, to assist participants to understand and manage the potential liquidity risks associated with OTAs, ASX Clear introduced in June 2016 monthly disclosures on participants' contingent liquidity exposures. This disclosure shows the daily ‘worst-case’ liquidity exposure for each participant arising from the default of the two participants and their affiliates that would cause the greatest liquidity exposure for the clearing house on a particular day.

ASX Clear consulted on new requirements in respect of participants' liquidity risk management frameworks during the Assessment period. Under the new standards, participants would be required to establish a formal liquidity risk management framework and prepare an annual liquidity plan, which should consider both normal and stressed market conditions. The requirements are expected to be implemented in the Q3 2016.

6.7 A securities settlement facility with access to central bank accounts, payment services or securities services should use these services, where practical, to enhance its management of liquidity risk.

ASX Settlement does not directly manage liquidity risk.

6.8 A securities settlement facility should determine the amount and regularly test the sufficiency of its liquid resources through rigorous stress testing. A securities settlement facility should have clear procedures to report the results of its stress tests to appropriate decision-makers at the securities settlement facility and to use these results to evaluate the adequacy of, and adjust, its liquidity risk management framework. In conducting stress testing, a securities settlement facility 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 securities settlement facility, include all entities that might pose material liquidity risks to the securities settlement facility (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 securities settlement facility should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount and form of total liquid resources it maintains.

See SSF Standard 6.3.

6.9 A securities settlement facility should establish explicit rules and procedures that enable the securities settlement facility 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 securities settlement facility'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.

See SSF Standard 6.3.

Footnote

ASX Clear will seek to meet payment obligations of the defaulting participant out of its prefunded liquid resources where possible and prudent. However, if it was not possible or prudent to rely solely on prefunded liquidity, ASX Clear may rely on the use of OTAs with participants to allow novated transactions of the defaulting participant to settle. [11]