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

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 ASX Clear (Futures)
Observed Observed

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 CCPs face liquidity risk from two sources:

  • Default liquidity risk. The primary source of liquidity risk in ASX Clear and ASX Clear (Futures) is the potential payment obligations arising from the default of a participant. CCPs rely on incoming payments from participants to meet their obligations to other participants. Payment obligations to and from participants may be in the form of payments for settlement of a securities transaction, or initial and variation margin, or related to the cash settlement of contracts. If a participant were to default, the CCP could face a liquidity shortfall. The size of these contingent payment obligations would generally be proportional to the credit exposures faced by the CCPs to its participants.

    In the case of ASX Clear, however, in the event of the default of a participant with net securities-related payment obligations, its liquidity needs may be significantly greater than its credit exposure. From a credit risk perspective, ASX Clear is exposed only to replacement cost risk from an adverse price movement in the resale of any securities due to be purchased, including any transaction costs that may be incurred in closing out the defaulted participant's portfolio. Funds received from the sale may be used to offset its payment obligation. However, there is a timing mismatch between the point at which ASX Clear must meet the defaulted participant's payment obligation in relation to the purchased securities and that at which it receives funds from the resale of these (typically two days later). This creates a gross liquidity exposure for ASX Clear that may significantly exceed any replacement cost exposure on the same default.

    ASX Clear also faces liquidity risk from its material holdings of equity collateral against derivative positions. If ASX Clear were to liquidate the defaulting participants' equity collateral, it would likely have to wait two days to receive the proceeds of the sale.

  • Investment liquidity risk. ASX Clear's and ASX Clear (Futures)' pooled prefunded resources, as well as a portion of margin posted by participants, are 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). ASX Clear and ASX Clear (Futures) face liquidity risk from this reinvestment 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. The day-to-day liquidity obligations primarily arise from the CCPs' collection of cash initial margin. If initial margin requirements were to decline (e.g. due to lower open positions) or participants substituted their cash collateral for non-cash collateral, the CCPs may need to liquidate investments in order to return cash margin to participants.

For the vast majority of their payment obligations, the ASX CCPs do not rely on commercial bank money settlement agents, nostro agents, or custodians in meeting their payment obligations. The only exceptions are:

  • ASX Clear has some reliance on liquidity providers, namely participants' provision of liquidity via OTAs (see CCP Standard 7.3) and liquidity provision by ASX Limited under a $150 million committed liquidity facility. ASX Clear (Futures) does not rely on liquidity providers other than the Bank in meeting its payment obligations. The Bank provides the ASX CCPs access to liquidity on a secured basis through its standing facilities (see CCP Standard 7.7).
  • ASX Clear (Futures) relies on commercial settlement banks to meet its NZD payment obligations, and to facilitate its acceptance of foreign currency collateral. Foreign currency payment obligations account for less than 2 per cent of ASX Clear (Futures)' total payment obligations.

Managing liquidity risk

ASX Clear and ASX Clear (Futures) minimise the size of their default liquidity obligations to participants through daily (and in some cases, intraday) settlement of variation margin. This prevents the build-up of large liquidity (and credit) exposures. The CCPs' framework for managing their remaining liquidity risks involves the monitoring of liquidity exposures through daily and monthly stress tests (see CCP Standard 7.8) and the maintenance of sufficient liquid resources to be able to meet these modelled potential liquidity exposures (see CCP Standard 7.3).

ASX Clear and ASX Clear (Futures) also provide participants with information to help them manage their liquidity needs and risks, which in turn protects the CCPs to the extent this enhances participants' own liquidity risk management. Participants are provided with sufficient information to understand their intraday margin call obligations, and replicate stress test outcomes. ASX publishes a daily CME SPAN and CMM margin parameter file that allows participants to estimate payment obligations associated with margin requirements for actual or hypothetical ETD or cash market portfolios. Advance warnings and communications in respect of calls for additional margin and margin rate changes also assist participants in their liquidity planning. For example, participants are notified if their stress test results approach their STELs. Also, ASX works closely with participants where new obligations are likely to affect their liquidity needs. ASX Clear also provides monthly disclosures on participants' contingent liquidity exposures, including the potential liquidity impact of the use of OTAs (see CCP Standards 7.3 and 7.9).

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, CRPM 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, are also monitored in real time by the CRPM and treasury functions.

Portfolio Risk Management uses reports provided by CRPM to monitor CME SPAN-calculated margin flows originating from ASX Clear's DCS and 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 ASX Clear's participants must be made by 10.30 am, and margin payments from ASX Clear (Futures)' participant must be matched in Austraclear by 10.30 am and settled by 11.00 am. Outward payments to participants from both CCPs 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 and ASX Clear (Futures) are systemically important in multiple jurisdictions and therefore subject to the higher financial resource requirement that each CCP 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 the supplementary interpretation, a major objective of the ASX Liquidity Risk Policy is for the CCPs to maintain, with a high degree of confidence, sufficient liquidity to manage the default of two participants and their affiliates and meet reasonably foreseeable operational cash flows.

Default liquidity risk

The primary resources the CCPs would rely on to meet the payment obligations arising directly from the default of the two participants and their affiliates is the defaulting participant's initial margin and each CCP's Available Financial Resources (AFR). ASX Clear (Futures)' AFR is comprised entirely of the CCP's default fund, currently sized at $650 million. ASX Clear's AFR includes the CCP's default fund, currently sized at $250 million, as well as a $150 million committed liquidity facility from ASX Limited, of which $100 million is backed by a committed liquidity facility from one of the major banks to ASX Limited.

To address the timing mismatch for securities-related payment obligations discussed above (CCP Standard 7.1), ASX Clear can supplement its AFR with additional liquidity from OTAs to settle cash market transactions when due. If a participant were to default due to a shortfall of funds, the ASX DMC would first determine whether ASX Clear could inject sufficient liquidity, from the existing AFR of $400 million, to ensure that settlement of payment obligations occurred as expected.

It is expected that available liquidity resources would first be injected. In recognition of this, during the Assessment period ASX Clear introduced a target minimum cash market liquidity buffer of $100 million, which is monitored on a daily basis (see CCP Standard 7.8). However, if it was not possible or prudent to rely solely on available liquidity, ASX Clear would settle transactions by entering into OTAs with participants that were due to deliver securities to the defaulted participant. In these circumstances, ASX Settlement's back-out algorithm would identify settlement instructions in the batch that, if removed, would reduce ASX Clear's payment obligations on behalf of the defaulted participant to the amount injected by ASX Clear, while avoiding (or at least minimising) any increase in net payment obligations for other participants (see Appendix B.3, SSF Standard 10.2). ASX Clear would then settle the novated trades that have been identified by the back-out algorithm by entering into OTAs with participants due to deliver securities under these trades. OTAs enable the CCP to settle its payment obligations with these participants on the intended settlement date through an arrangement to offset the underlying settlement obligations to and from those participants.

Under the first leg of the OTA, ASX Clear would, in effect, re-deliver the stock to the relevant non-defaulting participant in return for payment equal to the amount of the payment obligation of ASX Clear to that participant. Under these arrangements, ASX Clear would agree to repurchase the stock the next business day under the second and final leg of the transaction. If this transaction was unable to be settled on the next business day, subsequent OTAs would be entered into on a daily basis until the settlement of on-market close-out trades had taken place.

Investment liquidity risk

To mitigate investment liquidity risk, ASXCC's treasury investment policy requires that a minimum portion of ASXCC's investments must be in liquid assets to meet its minimum liquidity requirements. ASX assesses the value of its liquid resources against its liquidity requirements on a daily basis.

Liquidity Requirements

ASX's primary liquidity requirement is the Core Liquidity Requirement (CLR). The CLR is calculated as the sum of the Default Liquidity Requirement (DLR) for each CCP and the Ordinary Liquidity Requirement (OLR) across both CCPs. The DLR for each CCP is the amount required to cover the estimated payment obligations 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). ASX uses two different methodologies to calculate each CCP's DLR:

  • ASX Clear's DLR is the sum of the CCP's AFR and an estimate of the margin requirement for two defaulted participants. The AFR, in turn, is calibrated to cover the largest stressed liquidity exposures to any two participants and their affiliates arising from derivatives transactions and a portion of exposures arising from cash market transactions (see CCP Standard 7.8). The margin requirement is an estimate of the largest margin requirement for any two participants of ASX Clear and their affiliates, based on participants' margin obligations over the previous quarter.

  • ASX Clear (Futures)' DLR is the sum of:

    – 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 OLR 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' pooled prefunded resources as well as the cash margin posted at both CCPs. The OLR is calibrated to the maximum daily margin outflow in normal market conditions in the ASXCC cash collateral portfolio (as a percentage of portfolio value) over the last 12 months and is reviewed annually. The current OLR is 12 per cent.

From July 1 2017, the ASX CCPs have introduced an Additional Liquidity Requirement (ALR). This requirement is designed to reflect the potential for unexpected non-default related liquidity needs. ASX has calibrated the ALR to ensure that it has sufficient liquid assets to cover the peak historical one day outflow from the ASXCC investment portfolio in percentage terms since 2008 (the earliest date from which data are available). The current ALR is 12 per cent of ASXCC's total portfolio. ASX has created liquidity-specific stress tests to assess the adequacy of the liquidity requirements related to the CCPs' investment portfolio and the actual liquidity of the portfolio (see CCP Standard 7.8).

Definition of liquid assets

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 Bank.

ASX measures whether it has enough liquid assets to meet the combined value of the CLR and ALR on a daily basis. From August 2016, ASX has applied haircuts to the value of its investments when assessing the adequacy of its liquid resources against its core and additional liquidity requirements. These haircuts incorporate extreme but plausible (once-in-20-year) movements in the prices of securities over a three-day holding period, as well as the relevant haircut that would apply if these securities were used to collateralise a repurchase agreement at the Bank. Non-AUD denominated cash and investments held to meet AUD margin requirements are also adjusted by a haircut calibrated to the worst single-day foreign exchange movement in the last 20 years.

To meet the Bank's recommendations, from 1 July 2017 ASX has further restricted the assets that can be used to meet the CLR. The CLR must now be met using cash held in accounts at central banks or creditworthy commercial banks and securities issued by the Australian or state governments or the New Zealand government (held outright or via repo). All other liquid assets in its portfolio are eligible to meet the ALR. In addition, from July 1, the value of cash held at a single commercial bank is limited to the level of business risk capital held across the two CCPs ($75 million).

ASX assesses the value of its liquid resources against its liquidity requirements on a daily basis. If a breach of the requirements occurs at either CCP, it is reported to the CRO and CFO. ASX would also review the circumstances and nature of the breach, the size of the breach and possible mitigants.

Breaches are also reported on a quarterly basis to CALCO. In addition, if there were three breaches in a quarter, this would require an emergency meeting of CALCO, which would decide on the response. The primary potential response to a breach would be to increase the proportion of liquid assets held in ASXCC's investment portfolio.

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 Exchange Settlement Account (ESA) at the Bank to facilitate money settlements on behalf of ASX Clear and ASX Clear (Futures) (see CCP Standard 7.7). Under this arrangement, 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's and ASX Clear (Futures)' minimum liquidity resource requirements, consistent with the definition of qualifying liquid assets under this standard. 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, as well as bank bills and negotiable certificates of deposit and New Zealand Government securities. Eligible investment counterparties are discussed under CCP Standard 15. OTAs with participants (see CCP Standard 7.3) also meet the definition of qualifying liquid resources for the purpose of this standard, since they are prearranged, committed and reliable (given that they effectively utilise funds otherwise due to participants).

From July 1, ASXCC has restricted the liquid assets eligible to meet its primary liquidity target – the CLR – to cash held in accounts at central banks or creditworthy commercial banks and securities issued by the Australian or state governments or the New Zealand government (held outright or via repo). All other liquid assets in its portfolio are eligible to meet the ALR.

ASX Clear's committed liquidity facility with ASX Limited is contractually based. ASX Limited would source funds to support the facility from a combination of its own cash resources ($50 million), which are not routinely utilised in any other part of ASX's operations, and a committed liquidity facility with one of the major banks ($100 million). The bank facility is also contractually based, and could only be drawn down by ASX Limited for the purposes of funding ASX Clear's default management liquidity requirements. During the Assessment period, ASX introduced additional six-monthly due diligence to ensure that the facility could be drawn upon if needed. This included periodic checks of whether ASX Limited continues to meet the requirements set out in its agreement with the major bank liquidity provider and whether it has enough funds to deliver on its portion of the facility.

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 and ASX Clear (Futures) do not supplement their 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's qualifying liquid resources include contingent contributions from participants and other liquidity providers. ASX Clear (Futures) does not rely on liquidity providers other than the Bank. Both CCPs have similar procedures for accessing liquid resources. The Bank provides the ASX CCPs access to liquidity on a secured basis through its standing facilities (see CCP Standard 7.7).

ASX Clear's participants

ASX Clear's participants commit to provide overnight liquidity to the CCP up to the value of their outstanding cash equity exposures to the CCP. This commitment arises from ASX Clear's reliance on OTAs to meet its minimum liquid resource requirement. Unlike other liquidity providers, however, 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 cash equity 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 their contingent liquidity exposures to OTAs. Nonetheless, to assist participants to understand and manage the potential liquidity risks associated with OTAs, ASX Clear provides 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. During the Assessment period, ASX discussed with participants their ability to manage these contingent liquidity exposures.

During the Assessment period, ASX Clear released the guidance note Managing Liquidity Requirements, which sets out the minimum liquidity management arrangements a participant should have to meet its obligations under the ASX Clear Operating Rules. Under this guidance, participants other than ADIs or related bodies corporate of ADIs are generally required to have:

  • a formal liquidity risk management framework in place that is appropriate to the nature, scale and complexity of their activities
  • a nominated officer responsible for liquidity management
  • a board-approved annual liquidity plan which considers ‘normal’ and stress' conditions
  • robust liquidity-related operational processes and management reporting.[34]

Clearing Participants have been required to comply with the requirements of this guidance note since 28 February 2017.

ASX Clear's committed liquidity facility

ASX Clear also relies on a $150 million committed liquidity facility from ASX Limited in meeting its minimum liquid resource requirement. $100 million of this is backed by a committed liquidity facility from one of the major banks to ASX Limited. The contract governing this facility details, among other things, the events of default that may trigger activation of the facility. During the Assessment period, ASX introduced additional due diligence to ensure that the committed liquidity facility from ASX Limited to ASX Clear could be drawn upon if needed. This included six-monthly checks of whether ASX Limited continues to meet the requirements set out in its agreement with the major bank liquidity provider and whether it has enough funds to deliver on its portion of the facility.

Procedures for accessing liquid resources

Consistent with the guidance related to this substandard, 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 collateral 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.

During the Assessment period, ASX implemented processes to periodically test its procedures for accessing its liquid resources. ASX will now review every six months the range of transactions conducted over the period to confirm that it has tested its operational capability to conduct transactions to liquidate the full range of assets held by ASXCC. ASX will also conduct repos with the Bank and commercial banks on at least a six monthly basis to confirm operational readiness, and regularly review the terms of its committed liquidity facility to ensure ongoing compliance with those terms.

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. Under this arrangement, ASX Clear and ASX Clear (Futures) may, via ASXCC, access AUD liquidity under the Bank's standing 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, the New Zealand Government, and major banks (CCP Standard 15).[35]

ASX Clear and ASX Clear (Futures) use ASXCC's ESA to settle their 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 and ASX Clear (Futures) use daily liquidity stress tests to assess the adequacy of their liquidity arrangements in a default scenario. These daily stress tests are supplemented by monthly liquidity-specific stress tests which are used to assess the adequacy of the liquidity requirements related to the CCPs' investment portfolio and the actual liquidity of the portfolio.

Default-related liquidity stress tests

ASX's daily liquidity stress tests, which are adapted from the CCPs' credit stress tests (described under CCP Standard 4), estimate the maximum liquid funds that the CCPs would need to access in order to meet obligations arising in the event of the joint default of two clearing participants and their affiliates (including affiliations between participants involved in OTC and futures clearing at ASX Clear (Futures)) in extreme but plausible market conditions.

ASX Clear

The liquidity stress test exposure for an ASX Clear participant comprises two components: a derivatives market exposure and a cash market exposure. ASX Clear conducts separate liquidity stress tests to determine the potential liquidity exposure arising from derivatives transactions only and from both derivatives and cash market transactions. This approach reflects the fact that liquidity exposures generated by the securities settlement cycle in excess of ASX Clear's AFR could be addressed through OTAs entered into with non-defaulting participants (see CCP Standard 7.3), whereas liquidity exposures arising from derivatives transactions cannot be met using OTAs. The stress test result used in the liquidity stress test model is taken from the day with the largest cumulative requirement. The cash market and derivatives stress tests each apply three default scenarios, combined with a number of market change scenarios (described below).

For ASX Clear's liquidity stress test, two market changes are applied: an increase of either 9.8 per cent or 13.0 per cent (depending on recent market conditions), and a decrease of 15.5 per cent. These market changes are then combined with three different close-out scenarios in which four assumptions are varied, three related to the cash market and one to the derivatives market. For the cash market these assumptions relate to:

  • the priming of settlement accounts before default (either 90 per cent or 100 per cent of deliverable securities are assumed to be in the defaulted participant's settlement account)
  • the use of non-novated transactions to offset obligations in respect of novated transactions
  • whether the defaulter's sell transactions are deferred for two days or settled as soon as securities are available.

For the derivatives liquidity stress test, the assumption relates to ASX Clear's ability to transfer all, some or no loss-making client accounts.

Since securities settle on a two-day cycle, to measure cash market exposures in liquidity stress tests, projected cash inflows and outflows from settlements and margin payments are used to calculate the cumulative liquidity requirement for each of the three days following a participant default. In addition, ASX Clear's liquidity stress tests make a worst-case assumption with respect to the timing of variation margin and option premium payment receipts: default is assumed to occur just prior to receipt of the previous day's variation margin and option premium payments, if owed by the defaulter.

ASX Clear (Futures)

ASX Clear (Futures)' 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 IRD. 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. Stress test scenarios reflect the most extreme close-to-high or close-to-low price movements observed over the relevant holding period, including intraday price movements.

ASX Clear (Futures)' liquidity stress tests make a worst-case assumption with respect to the timing of AUD variation margin flows.

Reporting of Results – Both CCPs

The results of ASX Clear (Futures)' liquidity stress tests are compared with the CCP's default fund of $650 million (see CCP Standard 4.4). For ASX Clear, the results from the derivatives-only liquidity stress test are reviewed against a threshold of $300 million; this threshold reflects the level of the CCP's AFR after subtracting the cash market liquidity buffer of $100 million. This ‘buffer’ approach is designed to assess whether ASX Clear would be able to cover a pre-specified value of stressed liquidity exposures arising from cash market transactions, while continuing to maintain sufficient liquid resources to cover the stressed liquidity exposures arising from derivatives transactions.

If a liquidity stress test breach occurs at either CCP, it is reported to the CRO and CFO. ASX would also review the circumstances and nature of the breach, the size of the breach and possible mitigants. Breaches are also reported on a quarterly basis to CALCO. In addition, if there were three breaches in a quarter, this would require an emergency meeting of CALCO, which would decide on the response. Potential responses to a breach could be to increase the CCPs' prefunded resources, or establish or increase the size of committed liquidity facilities. When assessing the materiality of a liquidity stress test breach, the CCPs will consider contributing and mitigating factors, such as changes in the ICR of the participant, atypical trading activity, and any AIM that is being held.

Liquidity-specific stress test scenarios

During the Assessment period, ASX formally implemented four new liquidity-specific stress test scenarios into its liquidity risk management framework. These scenarios consider stresses to cash margin outflows arising from various sources across both CCPs.

  • Market contraction resulting from a market stress event. An extreme but plausible market event is assumed to result in a significant decline in cash market turnover and derivatives open interest, resulting in margin outflows.
  • Market contraction resulting from the default of two ASX participants. In addition to the default-related liquidity stresses outlined above, the close-out of the defaulted participants' portfolios is assumed to result in margin outflows from non-defaulting participants. ASX assumes that the decline in non-defaulter derivatives open interest over a three day period is equal to 50 per cent of the net positions held by the two defaulted participants.
  • Historical scenario (decline in open interest from other sources). ASX applies historical declines in open interest to current portfolios in order to determine hypothetical margin outflows. The liquidity stress test result is based on the largest hypothetical margin outflow based on historical three-day changes in open interest since 2004.
  • Collateral substitution. Participants are assumed to replace 25 per cent of cash collateral with non-cash collateral, across all markets.

ASX conducts its liquidity-specific stress tests on a monthly basis. The results from these scenarios are presented to the CALCO, and are used to assess the adequacy of the liquidity requirements related to the CCPs' investment portfolio and the actual liquidity of the portfolio. To date, the results from these scenarios have been less than the value of the liquid resources, as well as being less than the sum of the CLR and ALR (see CCP Standard 7.3).

Review and validation

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). During 2016/17, ASX reassessed the risks inherent in each model and changed the thresholds in its model validation framework, resulting in a potential reduction of the frequency of independent validations for some of the CCPs' risk models.

During the Assessment period, ASX conducted sensitivity analysis on the effect of the priming assumption on ASX Clear's liquidity stress test exposures. The analysis involved varying the priming assumption to 70 and 80 per cent in its liquidity stress tests in ASX Clear, from the current assumption of 90 and 100 per cent. The results suggested that the change in stress test exposures is immaterial (below 2 per cent) when the assumption is lowered to 70 per cent. ASX intends to run this sensitivity analysis annually.

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's OTAs aim to enable the CCP, in all circumstances, to fully address any liquidity obligations related to the settlement of securities transactions (see CCP Standard 7.3). Although OTAs cannot be directly used to address liquidity shortfalls related to derivatives transactions or the return of cash market margin, OTAs used to meet payment obligations for settlements may allow for greater use of prefunded liquid resources for these other obligations.

ASX Clear and ASX Clear (Futures) have arrangements that allow them to comprehensively address a liquidity shortfall (including on derivatives transactions). Under these arrangements, prefunded liquid resources (and OTAs at ASX Clear) are supplemented by the following additional tools:

  • Recovery Assessments. 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). ASX Clear's Recovery Assessments would be capped at $300 million; ASX Clear (Futures)' Recovery Assessments 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.[36] Both CCPs 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.
  • Payment haircutting. 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 RCC in determining whether to continue payment haircutting if losses allocated via this tool exceed $650 million. ASX Clear also has a limited capacity to haircut payments, but this only applies to settlement payments in the context of complete termination (see below).
  • Complete termination. 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 Bank as resolution authority if current proposals for a special resolution regime for FMIs are implemented). Under complete termination, all open contracts at the CCPs would be settled with participants at their current market value, with any residual liquidity shortfall of the CCPs addressed by haircutting settlement payments to participants. Prefunded liquid resources and Recovery Assessments at ASX Clear are set at a level that seeks to minimise the potential for reliance on complete termination to address a residual derivatives-related liquidity shortfall. Similarly, reliance on complete termination is extremely unlikely at ASX Clear (Futures), since payment haircutting provides an uncapped mechanism to address liquidity obligations associated with the majority of payment flows.

Footnotes

ASX exempts ADI participants from these requirements as these entities are subject to more stringent liquidity risk management requirements under APRA regulations. Related bodies corporate of ADIs are also exempt under certain conditions, including that the related ADI is responsible for the entity's liquidity risk management. [34]

A list of securities eligible for use in the Reserve Bank's domestic market operations is available here: Eligible Securities. [35]

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. [36]