Assessment of ASX Clearing and Settlement Facilities Appendix C1. Financial Stability Standards for Central Counterparties

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.

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

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

ASX Clear

Initial and premium margin obligations may be met by posting either AUD cash or non-cash collateral.^[21] 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. 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.

Since February 2017, ASX Clear has prohibited the use of bank guarantees to meet ETO margin obligations subject to certain criteria and at the discretion of ASX. Prior to this, ASX Clear allowed the use of bank guarantees on a transitional basis subject to certain conditions and at the discretion of ASX. This transitional period allowed advisers and their clients to seek alternate arrangements.

ASX Clear (Futures)

The acceptable collateral in ASX Clear (Futures) depends upon the type of margin called:

• Futures participants generally meet their initial margin obligations using AUD cash, although they may also use high-quality non-cash collateral, such as eligible debt securities, and deposits in major foreign currencies. The acceptable types of non-cash collateral are Australian Government and some semi-government securities, and US Treasury bills. Acceptable foreign currencies are NZD, EUR, JPY, USD and GBP. Acceptable collateral is reviewed annually, with haircuts applied to all non-cash collateral posted and all cash collateral that is not in the same currency as the product being covered.
• Participants may meet STEL AIM obligations using AUD cash or non-cash collateral, including Australian Government and some semi-government securities. Foreign currencies are not eligible for STEL AIM calls.
• Variation margin and intraday margin must be settled in cash.

ASX Clear (Futures) does not accept collateral that is issued by a clearing participant or associated entity for any margin calls. This reduces wrong-way risk. ASX Clear (Futures) does not accept bank guarantees or letters of credit as collateral.

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 and ASX Clear (Futures) take 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
• ASX Clear (Futures) considers the debt securities that it will accept as collateral – Australian Government and some semi-government securities and US Treasury bills – 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 and ASX Clear (Futures) would also expect to be able to liquidate such collateral in a timely fashion as required. These assets are also well known and understood by participants in the Australian market and are also commonly accepted in the Australian market, including by the Bank.

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

ASX Clear

Since S&P/ASX 200 stocks and the SPDR S&P/ASX 200 Fund are highly liquid, price information is readily available. ASX values 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 has three haircut tiers for its equity securities, 15, 20 and 30 per cent.^[22] Collateral securities are assigned to each tier based to cover a fall in the collateral value of securities over a three-day period at a 99.9 per cent confidence level, based on 20 years of price history (where available). This coverage is equivalent to the fifth worst price move over the price history.^[23] To account for the lower coverage, ASX Clear values collateral in its stress testing framework based on the largest 20-year price fall (see CCP Standard 4.6).

Where participants lodge ‘specific cover’ collateral – that is, 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.

ASX Clear (Futures)

Since the eligible assets for non-cash collateral at ASX Clear (Futures) – Australian Government and some semi-government securities and US Treasury bills – are highly liquid, price information is readily available. ASX values non-cash collateral on a daily basis using end-of-day prices.

ASX Clear (Futures) sets haircuts on non-cash collateral to cover a fall in the collateral value of securities over a three-day period at a 99.9 per cent confidence level, based on 20 years of price history, where available. This coverage is equivalent to the fifth worst price move over the price history. ASX also applies haircuts using the same methodology to cash collateral lodged to meet margin requirements for products denominated in a currency other than the collateral, although using a one-day holding period.^[24]

ASX reviews collateral haircuts in both CCPs at least semi-annually. These reviews take into account any changes to historically observed volatility trends.

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.

In setting haircuts, ASX Clear and ASX Clear (Futures) use 20 years of price history, which includes the extreme volatility observed during the 2008-09 financial crisis. Determining haircuts using this long time period is intended to ensure that haircuts remain stable over the business cycle, even in stressed market conditions.

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

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 the fifth worst price move over a 20 year period. During the Assessment period, the maximum value of non-cash collateral held by ASX Clear was $3.2 billion, after haircuts, which was used to cover around $1,207 million of margin requirements (of which $495 million was met with cash). The remaining amount represented excess collateral lodged by participants on both their house and client accounts. On average, around 47 per cent of margin requirements were met using cash collateral during the Assessment period.

ASX Clear (Futures)

At ASX Clear (Futures), to date non-cash collateral has comprised only a relatively small share of total initial margin and cash remains the sole form of collateral utilised by the majority of participants. The maximum holding of non-cash collateral during the Assessment period was $242 million (around 4.5 per cent of total initial margin). ASX also considers that the assets eligible for non-cash collateral – Australian Government and some semi-government securities and US Treasury bills – are sufficiently liquid that concentration is unlikely to be a significant concern. However, should the materiality of non-cash collateral increase, ASX would expect to apply a similar policy on concentration limits to that applied in the investment mandate (see Standard 15.4). Concentration risk in foreign currencies is considered whenever a participant approaches ASX for approval to lodge foreign currency collateral (see CCP Standard 5.6).

ASX maintains a risk-based policy for managing concentration risks in both CCPs (see CCP Standards 4.2, 18.4). However, this policy does not address concentration risk in ASX Clear's and ASX Clear (Futures)' collateral holdings.

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.

ASX Clear (Futures) accepts cross-border collateral for initial margin; namely, selected foreign currencies and US Treasury bills. During the Assessment period, maximum foreign cash holdings were around $692 million (AUD equivalent) in comparison to average total collateral holdings of around $5.3 billion (daily average of collateral holdings during the Assessment period), while no US Treasury bills were held.

ASX Clear (Futures)' acceptance of cash margin denominated in a currency other than the currency of the product is subject to its discretion and pre approval on a case-by-case basis. Participants must lodge a request to post foreign currency, which is reviewed and then approved or denied by the Portfolio Risk Management team. In making this determination, the Portfolio Risk Manager takes into account the limits on foreign currency, as well as the concentration risk in accepting the request.

In addition, ASXCC's Investment Mandate specifies metrics for large or concentrated holdings of non-AUD collateral. Escalation is triggered if non-AUD holdings exceed 25 per cent of liquid assets held by ASXCC, or if the net present value of a basis point in any single non-AUD currency exceeds $5,000. Haircuts are applied to both foreign cash collateral and US Treasury bills (see CCP Standard 5.3).

ASX Clear (Futures) has the ability to use foreign exchange swaps to facilitate the timely use of collateral posted in foreign currencies to cover payment obligations that would arise from a participant default. Arrangements for the settlement of foreign currencies are described in CCP Standard 9.

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.

ASX Clear (Futures) manages the calculation and execution of margin calls through internal risk analysis and margin management systems. These are linked to its core Genium system for information on positions, SPAN Margin Engine Service for margin parameters and margining, and Austraclear's EXIGO system for the lodgement of settlement instructions. These systems help ASX Clear (Futures) monitor initial and variation margin levels and flows on an intraday basis. The direct link to Austraclear facilitates the timely deposit, withdrawal and substitution of non-cash collateral and settlement of cash collateral.

ASX Clear (Futures)' participants can also make use of ASX's collateral management service, ASX Collateral, for the management of non-cash collateral lodged with the CCP. However, ASX Collateral was not used for the lodgement of any collateral at ASX Clear (Futures) during the Assessment period.

Re-use of collateral

ASX Clear and ASX Clear (Futures) do not re-use non-cash collateral posted by participants and the re-use of such collateral is not permitted under their Operating Rules.

Footnotes

Premium margin is used to cover the amount that would be required to close out short positions in ETOs (see CCP Standard 6.1). [21]

Before September 2016, a flat 30 per cent haircut was imposed on all eligible securities. The new approach enables haircuts to better reflect the volatility of the underlying security. [22]

Before September 2016, ASX Clear calibrated haircuts to cover the largest price fall in the past 20 years. [23]

ASX Clear (Futures) is planning to introduce the capability to additionally stress collateral in credit stress tests to cover once-in-20-year events. These changes will be implemented through enhancements to credit stress test system. [24]