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

Standard 6: Margin

A central counterparty should cover its credit exposures to its participants for all products through an effective margin system that is risk based and regularly reviewed.

6.1 A central counterparty should have a margin system that establishes margin levels commensurate with the risks and particular attributes of each product, portfolio and market it serves.

Variation (or mark-to-market) margin is called by ASX Clear on cash market positions for equities in the All Ordinaries Index and long and short LEPOs; it is collected from the participant with a mark-to-market loss and, depending on the product, either passed through in cash to the participant with a mark-to-market gain, or recognised as a credit (see CCP Standard 6.4). ASX Clear also calls premium margin on short ETO positions, updating this daily to reflect mark-to-market changes in the close-out price. ASX Clear (Futures) calls variation margin on all products.

ASX Clear and ASX Clear (Futures) apply initial margin to all products, using a variety of models.

Cash equities

ASX Clear's CMM approach involves the calculation and collection of initial margin requirements in respect of most unsettled cash securities transactions. The selected methodology for initial margin calculation for most of the more liquid securities is based on HSVaR. The HSVaR methodology uses historical price moves to calculate hypothetical changes in the value of a portfolio of securities, and determines a margin requirement from these taking into account the desired degree of confidence (see CCP Standard 6.3). For less liquid stocks, or securities with an insufficient price history to apply HSVaR, ASX Clear applies flat rate margins. Currently 49 of the 500 stocks that make up the All Ordinaries Index are margined on a flat rate basis. Margins calculated using HSVaR currently make up around 40 per cent of initial margin collected through the CMM system. Around 50 per cent of flat rate margin collections relate to trades in warrants and stocks outside the All Ordinaries Index, which attract higher margin rates. Transactions in depository interests in Australian Government securities are margined according to the flat rate applied to fixed interest products. CMM margin rates are reviewed on a three-monthly cycle.

Cash securities transactions generated by exercise of ETOs or LEPOs are also margined using CMM between exercise and settlement. The settlement obligations of the ETO or LEPO buyer include the exercise price, final margin payments and the outstanding balance of the premium. Prior to exercise, ETOs and LEPOs are margined using CME SPAN (described below).

Derivatives

Both ASX Clear and ASX Clear (Futures) use a variant of CME SPAN for the margining of derivatives positions (see CCP Standard 6.3). CME SPAN margin parameters are reviewed on a three-monthly cycle. Regular margin rate reviews are supplemented with ad hoc reviews during especially volatile market conditions.

OTC derivatives

ASX Clear (Futures) margins OTC derivatives portfolios, including interest rate futures that have been allocated for portfolio margining with OTC derivatives positions (see CCP Standard 6.5), using an FHSVaR model within the Calypso margin system.

6.2 A central counterparty should have a reliable source of timely price data for its margin system. A central counterparty should also have procedures and sound valuation models for addressing circumstances in which pricing data are not readily available or reliable.

ASX Clear and ASX Clear (Futures) have access to timely price data for the majority of exchange-traded products. Price data for cash market products and exchange-traded derivatives are sourced from the ASX Trade and ASX Trade 24 markets. For less liquid stocks (e.g. stocks outside the All Ordinaries Index and warrants) and new stocks for which there is insufficient historical price data ASX Clear applies flat rate margins. Flat rates are based on available price information for individual stocks in the All Ordinaries Index or for grouped categories of other products.

The settlement value of ETOs cleared by ASX Clear is calculated throughout the day using the Derivatives Pricing System (DPS). The DPS uses traded prices where available but the system is able to extrapolate prices from previous pricing periods or untraded bids and offers where traded price data are not available. For less liquid stock options, DPS compares calculated prices against trades in similar options, takes into account limits on implied volatilities, and smooths and imposes restrictions on the slope and convexity of deemed volatility curves. For OTC equity options, ASX Clear interpolates the value using the prices of similar ETOs.

To value cleared OTC derivatives products ASX Clear (Futures) uses a range of BBSW, ICAP and Reuters pricing points, the official cash rate, pricing from 90-day bank bill futures contracts, and swap yields for contracts greater than three years. These sources provide sufficient pricing points to value the OTC derivatives products that ASX Clear (Futures) clears, even when some pricing data are not readily available or reliable. Prices are also compared against Bloomberg prices for second source validation, and ASX may contact brokers for indicative pricing information if other sources are unavailable. Prices for the OTC IRD margin system are updated hourly. Participants are given all information necessary to create an end-of-day yield curve and independently calculate the net present value of any contract.

OTC valuations and exposures based on these prices are combined with data covering other positions cleared on ASX Clear (Futures) to calculate each participant's overall margin requirement. This task is performed on an hourly basis, and may also be performed on an ad hoc basis as market conditions warrant (see CCP Standard 6.4).

ASX has procedures and contingencies in place for situations in which prices are not available or are deemed to be unreliable (for example, in a market outage). The ASX CCPs rely on the last traded price unless there is evidence of material market movements from related products. In that case, ASX may model the price of exchange-traded derivatives using the underlying asset. For example, for equities in the S&P/ASX 200 ASX may use price movements in the SPI futures contract, or other indices or information from brokers, as a proxy.

6.3 A central counterparty should adopt initial margin models and parameters that are risk based and generate margin requirements sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default. Initial margin should meet an established single-tailed confidence level of at least 99 per cent with respect to the estimated distribution of future exposure. For a central counterparty that calculates margin at the portfolio level, this requirement applies to each portfolio's distribution of future exposure. For a central counterparty that calculates margin at more granular levels, such as at the sub-portfolio level or by product, the requirement should be met for corresponding distributions of future exposure. The model should: use a conservative estimate of the time horizons for the effective hedging or close out of the particular types of products cleared by the central counterparty (including in stressed market conditions); have an appropriate method for measuring credit exposure that accounts for relevant product risk factors and portfolio effects across products; and to the extent practicable and prudent, limit the need for destabilising, procyclical changes.

The ASX CCPs apply different margin models for exchange-traded derivatives, OTC derivatives and cash security transactions.

Exchange-traded derivatives (CME SPAN)

For exchange-traded derivatives transactions, ASX Clear and ASX Clear (Futures) calculate initial margin requirements using the CME SPAN methodology. For both CCPs, each house or client account is considered a separate portfolio when calculating margin under the CME SPAN methodology.

The key parameters in the CME SPAN methodology are the price scanning range (PSR) and the volatility scanning range (VSR). These scanning ranges are individually calibrated to the distribution of price and volatility movements for a set of related contracts, such that the ranges cover a pre-specified confidence interval of price and volatility movements. The scanning ranges are then varied to create a set of 16 hypothetical risk scenarios which represent different combinations of changes in price and volatility. For example, in one risk scenario, price increases by one-third of the PSR and volatility falls by the full VSR, while in another scenario price falls by the full PSR and volatility rises by the half of the VSR. The CCPs then calculate a portfolio's hypothetical loss under each of the scenarios, and the margin rate is based on the highest estimated loss across the 16 scenarios.

ASX Clear and ASX Clear (Futures) base the scanning ranges on key volatility statistics; namely, the higher of 2.75 standard deviations (a confidence interval of 99.7 per cent assuming a normal distribution) of a 60-day or 252-day sample distribution, using the higher of one- or two-day price movements for the majority of products. In using two sample periods, ASX aims to balance incorporating recent market conditions with avoiding destabilising procyclical changes. ASX does not currently have a formal process to assess the relevance of historical periods of stress in its margin sample periods.

During the assessment period, ASX updated its Margin Policy to increase the frequency at which margin parameters are reviewed from quarterly to monthly, and extended the historical sample period used to calibrate margin parameters for exchange-traded derivatives (ETD) at ASX Clear (Futures) from one year to five years, as well as reducing the target confidence level of initial margin coverage for these products from 99.7 per cent to 99.5 per cent. ASX has introduced the change in target confidence level for electricity products and plans to implement the other changes in the next assessment period.

During the assessment period ASX also amended its backtesting approach to incorporate the maximum possible time between the point at which it last collected margin from the defaulting participant and the point at which the market risk on the portfolio has been extinguished. ASX introduced ‘point of default’ tests which assess the adequacy of initial margin to cover losses on a participant's portfolio as it would be at the point of a hypothetical default. These tests take into account that initial margin held may have been collected in respect of a participant's positions as they were on the day before default, since the default may occur before the receipt of the previous day's end-of-day margin. ASX plans to develop an approach to incorporating default prior to the receipt of variation margin in its stress testing at ASX Clear (Futures) during the next assessment period.

In response to a recommendation made in the previous assessment, ASX has carried out analysis of the margin period of risk (MPOR) assumptions used in initial margin models for all products, and reviewed these assumptions in light of this analysis (also discussed in relation to OTC derivatives and cash securities below). ASX concluded that a two-day MPOR is appropriate for the majority of exchange-traded derivatives products at ASX Clear and ASX Clear (Futures), with the exception of electricity derivatives in ASX Clear (Futures) (see section 2.1.2). The MPOR used to determine initial margin parameters for electricity derivatives was increased to three days in January 2018.

ASX Clear and ASX Clear (Futures) also apply a series of adjustments within CME SPAN to account for correlations and specific risks.

• Intra-commodity spread charge (ASX Clear (Futures) only). This is an upward adjustment to the margin requirement for a given set of related futures contracts, to account for less-than-perfect correlation between contracts with different expiries. The adjustment is based on a participant's actual net position at each expiry month multiplied by an ‘intra-commodity charge rate’, which is itself based on observed price correlations between the different expiries. The default setting is to apply a single charge rate across all expiries of a single product. However, for some contracts ASX Clear (Futures) varies charge rates across expiries to account for differences in correlations between sets of expiries.

• Inter-commodity spread concession (ICC). ASX Clear and ASX Clear (Futures) apply ICC offsets designed to account for reliable correlations across different contract types or across different stock option positions (see CCP Standard 6.5). These offsets reflect that, while the scanning risk for each related contract – a ‘combined commodity’ in CME SPAN terminology – is set based on the worst-case risk scenario for that combined commodity, it is highly unlikely that the set of worst-case scenarios occurs simultaneously. This is particularly the case if a participant holds net long and net short positions in different related contracts that have a robust positive correlation.

  ASX applies two different types of ICCs: hedging offsets and stability offsets. Hedging offsets are provided where a participant has offsetting positions in contracts with robust positive correlations (where losses from one contract are likely to be offset by gains in the other contract). Stability offsets, only recognised at ASX Clear, are provided where a participant has long/long or short/short positions in two contracts, in recognition of the risk-reducing benefits provided by portfolio diversification.

  The ICC is calculated by applying, in a defined order, a spread ratio and concession rate to a participant's actual net positions in pairs of related contracts. The spread ratio determines the number of net positions in one related contract required to offset a position in another related contract. The concession rate is specified as a percentage of the scanning risk for both contracts in the pair. For example, for 10-year bond futures relative to 90-day bank bill futures, a spread ratio of 1:4 and a concession rate of 40 per cent would mean that one net position in the 10-year bond contract is offset against four net positions in the 90-day bank bill contract, and that the concession for that pairing will be 40 per cent of the scanning risk of the contracts subject to the offset. ASX calculates these parameters in the same manner as the price movement for the intra-commodity spread charge.

• Other adjustments. ASX Clear and ASX Clear (Futures) apply an adjustment to cover the CCP's exposure on the day of contract expiry, since expiring positions are otherwise not included in that day's initial margin calculations. ASX Clear also maintains a minimum margin requirement on short positions to ensure the collection of margin on deep out-of-the-money options that would otherwise return no scanning range.

ASX targets coverage from the major inputs (including the PSR and VSR) to a 99.7 per cent confidence level. Other inputs are calibrated to exceed a 99 per cent confidence interval.

ASX applies add-ons to key CME SPAN parameters to address the risk that bid/offer spreads widen when ASX is closing out a defaulting participant's portfolio (i.e. liquidity risk on these products).^[24] The spread risk add-ons are applied to agriculture futures and less actively traded ETOs. The add-ons are not applied to ETOs on SPI futures and the 20 most actively traded stocks, as ASX has indicated the spread risk is not significant enough to require an add-on charge. To calibrate the add-ons for each product, ASX uses a 99.7 per cent confidence interval over a 12-month sample of bid/offer spreads, using the most conservative 12-month sample from the last five years. In its September 2017 assessment, the Bank recommended ASX Clear and ASX Clear (Futures) should complete the implementation of add-ons to manage liquidity risk for cash equities and products margined using the CME SPAN model. During the assessment period, ASX began investigating a new, alternative, approach to capturing liquidity risk in its margin models. The Bank will review ASX's new approach in due course.

OTC derivatives

ASX Clear (Futures) uses an FHSVaR model to calculate margin requirements for OTC derivatives, based on a historical sample period since June 2008. The inclusion of extreme observations from the second half of 2008 aims to ensure that the methodology remains conservative and limits the need for procyclical changes during periods of elevated market volatility. ASX does not currently have a formal process to assess the relevance of historical periods of stress in its margin sample periods. ASX Clear (Futures) calibrates initial margin based on a 99.7 per cent confidence interval with an assumed holding period of five days, consistent with the Bank's supplementary interpretation of this substandard. ASX uses its OTC default management fire drills to test the MPOR assumptions used in the FHSVaR initial margin model. ASX concluded that there was no need to revise the current MPOR for OTC products, set at five days for house positions and seven days for client positions. ASX plans to develop an approach to incorporating default prior to the receipt of variation margin in its stress testing at ASX Clear (Futures) during the next assessment period (see ‘Exchange-traded derivatives’ above).

The FHSVaR model uses historical interest rate moves to calculate a hypothetical distribution of potential changes in a portfolio's value over the close-out period. In an FHSVaR model, historical price movements are ‘filtered’ or scaled to reflect the level of current market volatility. For instance, if current volatility is high relative to previous periods, price changes from previous periods would be scaled up. As a result, margin requirements better reflect the volatility observed in current market conditions compared with an HSVaR model. Volatility is calculated using an exponential decay factor (currently 0.97), which places greater weight on more recent observations.

ASX also applies a floor to its volatility scaling factor, which limits the extent to which margin requirements are reduced in low volatility conditions, helping to limit procyclicality. For the past few years, ASX has maintained this floor at or above 100 per cent. This means that while margin requirements may be scaled up in high volatility periods, they are not scaled down in low volatility periods. This reduces the potential for variability in margin requirements if a low volatility period is followed by a high volatility period.

To account for additional costs that might arise from the close-out of a large and/or illiquid OTC derivative portfolio, ASX applies a liquidity multiplier to the initial margin requirement calculated using the FHSVaR model. The size of the applicable liquidity multipliers are calculated as a percentage of initial margin requirements, based on participant estimates of the market capacity and liquidity costs that may be faced in a close-out scenario. ASX administers an annual survey asking OTC participants to report on the largest volume of OTC IRD that they believe they could execute at the quoted market price for a range of tenor points, and an estimate of the additional cost that would be incurred should a counterparty need to execute a range of larger trades. Currently, the multipliers range from 5 per cent for OTC initial margin requirements above $50 million, to 33 per cent for initial margin above $500 million.

Cash securities (CMM)

For securities in the ASX 500 All Ordinaries index with more than two years of continuous price data ASX Clear uses an HSVaR-based model to calculate margin requirements. ASX Clear splits HSVaR-margined securities into two groups – ASX 200 securities and other All Ordinaries securities – and calculates initial margin independently for each group. The HSVaR model is calibrated and adjusted to meet a single-tailed confidence interval of 99.7 per cent of the estimated distribution of future exposure. Estimates of the distribution of future exposure under this model are based on 2 years of 1-day price moves (see CCP Standard 6.5). ASX does not currently have a formal process to assess the relevance of historical periods of stress in its margin sample periods.

Since HSVaR requires reliable and uninterrupted price data, it is only applied to transactions in sufficiently liquid securities, namely those in the ASX 500 All Ordinaries with more than two years of price history. Even so, the small number of observations of price movements beyond the 99th percentile makes it difficult to construct reliable estimates of the desired 99.7 per cent margin coverage. ASX therefore applies a portfolio add-on factor (currently 30 per cent) to the HSVaR estimate of potential future exposure at a 99 per cent confidence level to achieve the desired 99.7 per cent level of cover.

For securities that do not have the required price history to apply HSVaR, ASX applies flat rate margin intended to cover 1-day price moves with a 99.7 per cent confidence at a portfolio level. Flat rates are based on available price information for individual stocks in the All Ordinaries Index, or for grouped categories of other products. Margin obligations are calculated by applying the relevant flat rate to the net novated settlement obligation for an individual security or category of products, with no offsets permitted between different flat rate groups. In order to achieve the desired confidence level at the portfolio level, confidence intervals and holding periods applied to individual stocks differ according to liquidity and available price information. Stocks in the S&P/ASX 200 target a 99.7 per cent confidence interval applied to a 1-day holding period; other stocks in the All Ordinaries target a 97 per cent confidence interval over a 2-day holding period; and all other products target a 95 per cent confidence interval over a 3-day holding period. The lower confidence intervals for the latter two groups reflect the difficulty of constructing reliable estimates of the extremities of the distributions of price movements for securities with limited price history and/or liquidity. Longer holding periods for these securities are assumed in order to approximate a higher coverage level over a 1-day holding period. Backtesting seeks to verify that the flat rates for less liquid securities provide cover for both the target confidence interval and holding period at the level of the individual security or product grouping, and to at least a 99.7 per cent confidence interval at the cash security portfolio level (see CCP Standard 6.6).^[25] ASX's analysis of MPOR assumptions used in the CMM initial margin model concluded that it should increase the MPOR from one day to two days for products margined using the HSVaR model and for ASX 200 products margined on a flat-rate basis. The analysis concluded that the current two- or three-day MPORs used for remaining flat-rate products are appropriate. ASX plans to develop an approach to incorporating default prior to the receipt of variation margin in its stress testing at ASX Clear and ASX Clear (Futures) during the next assessment period (see ‘Exchange-traded derivatives’ above).

Both CCPs – all products

Discretion

Under ASX's internal Margin Standard, management discretion can be used if the application of the standard statistical analysis would result in inappropriate outcomes, for example, if the backward-looking statistical analysis does not take appropriate account of expected future price movements. Other reasons for using management discretion include insufficient historical data (e.g. where a product is new), seasonality in some products, and isolated spikes in price movements that result in a distortion of statistical recommendations. The ASX Margin Standard also allows exceptions to the normal margin rate-setting process based on a broader risk assessment. Where such exceptions are made outside of a RQWG approved margin review, they require the approval of the General Manager of CRPM and the General Manager of CRQD.

Wrong way risk

Specific wrong-way risk arises when there is a direct relationship between the CCP's exposure to a participant and that participant's credit quality. This can occur if a participant clears a product directly related to them, or if they post collateral issued by them. The ASX CCPs do not accept collateral issued by a clearing participant (or associated entity) for any margin calls, except at ASX Clear when the collateral is used as specific cover for a call option written on that stock (see CCP Standard 5.1). ASX Clear also allows use of related-entity stocks as collateral for client transactions, but this is subject to strict concentration limits. ASX also monitors participants posting stock as collateral for short put options on that stock; in the event this risk was substantial or persistent, ASX would liaise with the participant and may impose additional margin requirements or require the participant to reduce their exposure to the stock.

6.4 A central counterparty should mark participant positions to market and collect variation margin at least daily to limit the build-up of current exposures. A central counterparty should have the authority and operational capacity to make intraday margin calls and payments, both scheduled and unscheduled, to participants.

ASX Clear

Margin requirements are calculated overnight, with variation, mark-to-market, and premium margins based on closing prices each day. These are notified to participants the next morning. All margin obligations are settled via Austraclear and regular calls must be met by 10.30 am.

• For cash market transactions, mark-to-market margin is calculated in respect of securities in the All Ordinaries Index and added to initial margin if prices have moved against the participant. If prices have moved in favour of the participant then an offset may be applied to the participant's initial margin requirement, but this is capped by the level of initial margin. Mark-to-market margin is not called on securities that are not within the All Ordinaries as up-to-date price data may not be available for all of these securities.
• Variation margin is levied on all LEPO and futures positions to reflect observed price movements. Variation margin is collected from the participant with a mark-to-market loss and passed through in cash to the participant with a mark-to-market gain.
• ASX Clear levies premium margin on net short ETO positions, updating this daily to reflect mark-to-market changes in the close-out price. Premium margin is conceptually similar to variation margin and based on daily mark-to-market changes in the value of the net position. Premium margin collected is held by ASX.

ASX Clear does not perform scheduled intraday margin calculations, but an intraday margin run will be triggered in response to large market movements on derivatives positions. ASX will recalculate margin requirements if there is a movement in the S&P/ASX 200 exceeding 1 per cent, or a movement in a stock price (for stocks underlying ETOs) exceeding 15 per cent. If one of these triggers is met, ASX would calculate the net mark-to-market losses on all derivatives positions and the initial margin on any new derivatives positions opened during the day.

To determine if intraday margin is required, a nominal call amount is calculated for each portfolio of the participant (house and client) based on the combined initial and variation margin that would be due at the time of the intraday calculation. This is compared with the total margin posted by the participant. Where a participant's margin shortfall relative to the calculated requirement is greater than $100,000 and represents an erosion of initial margin of 25 per cent or more, ASX Clear calls intraday margin. The settlement deadline for intraday margin calls from participants is two hours.

ASX Clear (Futures)

Margin requirements for both futures and OTC participants are calculated overnight, with variation margins based on closing prices each day, and notified to participants the next morning. All margin obligations are settled via Austraclear and regular calls must be matched in Austraclear by 10.30 am and settled by 11.00 am.

ASX Clear (Futures) offers clearing services on a 24/6 basis and so it faces intraday risk during both during the day, and overnight.

Day Session (8.30 am to 4.30 pm)

ASX Clear (Futures) conducts two scheduled intraday margin runs during its Day Session, at 11.10 am and 1.30 pm. ASX Clear (Futures) is also able to conduct ad hoc intraday margin runs during the Day Session, and will do so in response to large price movements in key contracts. Ad hoc runs are triggered if the change in price of an individual contract exceeds 100 per cent of its margin rate (the PSR in CME SPAN)^[26] or the ASX/S&P 200 index price changes by 1 per cent or more intraday. Intraday margin calls must be met by participants within one hour of notification.

ASX also recalculates margin on OTC derivatives hourly, and may call for additional margin during the Day Session if one or more participants' margin requirement exceeds their excess collateral lodged with ASX. ASX also runs pre-novation checks on back-loaded OTC trades or trades transferred from another CCP and may require pre-collateralisation on these trades. Relative to new trades, ASX has a low appetite for accepting pre-existing trades on an uncollateralised basis, given the potential for these trades to have larger immediate exposures. During the assessment period, ASX Clear (Futures) also halved the previous risk-based erosion thresholds that applied to intraday calls. These changes are designed to ensure that a greater proportion of intraday exposures are collateralised in the lead-up to the Night Session.

Night Session (5.10 pm to 7.00 am)

ASX Clear (Futures) runs hourly margin calculations during the Night Session; however, participants are unable to make AUD margin payments overnight since the Australian payments system is closed. During the assessment period, ASX Clear (Futures) implemented a number of measures to improve its management of intraday exposures created during the Night Session:

• ASX Clear (Futures) introduced a 2am call for initial margin from Futures and OTC clearing participants that meet certain criteria.^[27] Calls are made in USD to cover any initial margin shortfalls greater than $3m for house accounts and $5m for client accounts.
• Participants subject to the 2am call are also required to post additional collateral to reduce the likelihood that a call for variation margin would be required overnight. The size of the required buffer for each account is calculated based on the 80th percentile of daily mark-to-market movements between the final call of the day session and the 2am call. ASX calculates the buffer based on one years' worth of data and plans to recalibrate the buffer quarterly.
• An additional intraday margin run at 8.05 am, which applies to all ASX Clear (Futures) clearing participants, was introduced, reducing the duration of overnight margin exposures by around two hours.
• In line with a recommendation from the previous assessment, ASX is continuing its work to put in place arrangements to monitor and manage intraday exposures created during the Night Session on a near real-time basis. ASX expects to implement its proposed arrangements for ASX Clear (Futures) by end 2018.

Both CCPs

Under ASX Clear's and ASX Clear (Futures)' AIM methodology, a participant is required to post additional collateral should stress test outcomes reveal potential losses that exceed a predetermined STEL, or if certain participants have large portfolios relative to their capital (see CCP Standards 4.3 and 4.7). During the assessment period, ASX also introduced processes to monitor net settlement positions at ASX Clear on an intraday basis and call for AIM if necessary. This aims to address the risk that a large intraday build-up in a participant's cash equities positions could contribute to a breach of the Cover 2 requirement.

For all intraday and end-of-day margin calls, ASX monitors the payment progress of participants in the period prior to the time payment is due, in order to identify any participant that hasn't matched and settled. In most cases, the early intervention and relevant escalation processes result in any operational problems being solved ahead of the payment deadline. If a margin payment is not made by the required time, ASX has the right to call a default event. Such circumstances are rare.

6.5 In calculating margin requirements, a central counterparty may allow offsets or reductions in required margin across products that it clears or between products that it and another central counterparty clear, if the risk of one product is significantly and reliably correlated with the risk of the other product. Where a central counterparty enters into a cross-margining arrangement with one or more other central counterparties, appropriate safeguards should be put in place and steps should be taken to harmonise overall risk management systems. Prior to entering into such an arrangement, a central counterparty should consult with the Reserve Bank.

CME SPAN

In applying the CME SPAN methodology to derivatives transactions, ASX Clear and ASX Clear (Futures) allow offsets in the form of ICCs (see CCP Standard 6.3). These offsets reduce margin requirements to account for reliable correlations observed across related contracts. ASX applies two different types of ICC: hedging offsets and stability offsets. Hedging offsets are provided where a participant has offsetting positions in contracts with robust positive correlations (where losses from one contract are likely to be offset by gains in the other contract). Stability offsets, which are only recognised at ASX Clear, are provided where a participant has long/long or short/short positions in two contracts, in recognition of the risk-reducing benefits provided by portfolio diversification.

ICCs are only applied at ASX Clear where measures of correlation between contracts exceed 30 per cent, while at ASX Clear (Futures) ICCs may be applied if either the correlation coefficient or the calculated ICC exceeds 30 per cent. Hedging offsets are subject to a cap of 40 per cent at ASX Clear and 80 per cent at ASX Clear (Futures), and stability offsets are subject to a 20 per cent cap.

Changes to ICCs must be approved by the RQWG, which considers whether changes identified by CME SPAN appropriately reflect underlying economic relationships, including in periods of market stress.

During the assessment period, ASX completed implementation of its revised sensitivity analysis framework (see CCP Standard 6.6). The revised framework includes tests of the robustness of the offsets in ASX's margin models to changes in correlations, including the impact of a complete erosion of correlations underlying its ICC offsets.

VaR Models

ASX's VaR-based models for cash market products and OTC derivatives calculate margin based on the historical distribution of the portfolio's value over the sample period. As a result, offsets based on historically observed price correlations between products are inherently recognised in the margin calculation.

ASX Clear (Futures) also facilitates the allocation of a set of interest rate futures in an OTC participant's house account to be margined (using FHSVaR) within the portfolio of the participant's cleared OTC derivatives. Offsets for these futures, including against OTC derivatives, are similarly implicitly recognised within the FHSVaR model. ASX offers participants a tool which can automatically optimise the allocation of futures positions to a participant's OTC derivatives portfolio. This tool identifies and allocates eligible futures contracts within a participant's portfolio that will, if reallocated to the participant's OTC derivatives portfolio, lead to a reduction in total calculated OTC exposure – and therefore also total initial OTC margin – without increasing the aggregate of OTC and ETD margin. Prior to the introduction of this tool, participants had to manually identify and allocate specific futures contracts for portfolio margining.

Portfolio margining recognises the economic relationship between AUD IRD and AUD interest rate futures and, to the extent that positions are indeed offsetting, would be expected to result in a reduction in the amount of initial margin required relative to the case in which positions were margined independently. The robustness of the empirical relationship between AUD IRD and AUD interest rate futures in a variety of market conditions is addressed through the Historic VaR margining process, which captures variation in the basis during a variety of market conditions. In particular, the use of an extended look-back period helps to validate the reliability of the historical correlations during periods of market stress. The significance and reliability of the correlations underlying offsets in both the CMM HSVaR and the OTC FHSVaR models are also subject to regular verification through backtesting (see CCP Standard 6.6).

In the case of the NZD IRD contracts, ASX uses the existing VaR model used to calculate AUD OTC margins to calculate margins on a combined AUD and NZD OTC portfolio, with initial margin payable in AUD and variation margin payable in NZD. The model reflects the correlation of AUD interest rate and foreign exchange movements.

ASX Clear and ASX Clear (Futures) do not currently have any cross-margining arrangements with any other CCPs.

6.6 A central counterparty should analyse and monitor its model performance and overall margin coverage by conducting rigorous daily backtesting and at least monthly, and more frequent where appropriate, sensitivity analysis. A central counterparty should regularly conduct an assessment of the theoretical and empirical properties of its margin model for all products it clears. In conducting sensitivity analysis of the model's coverage, a central counterparty should take into account a wide range of parameters and assumptions that reflect possible market conditions, including the most volatile periods that have been experienced by the markets it serves and extreme changes in the correlations between prices.

Backtesting

Under ASX's Model Validation Standard, daily backtesting of the CME SPAN, CMM and the OTC IRD FHSVaR margin models is used to test, on an ongoing basis, whether the margin models reliably cover price movements to a 99.7 per cent confidence interval. Daily backtesting is performed against participant and client portfolios. ASX also tests key model parameters, including the PSR and VSR in CME SPAN, and flat rates for cash market products. In the case of a participant or client portfolio, backtesting involves the comparison of actual initial margin collected from a participant or client against hypothetical variation margin calculated over the relevant close-out period, while holding the portfolio composition constant.^[28] This simulates initial margin erosion on a defaulted participant's portfolio prior to successful close-out or hedging of the portfolio by ASX. When total variation margin is greater than initial margin an ‘exception’ is recorded. Validation and Oversight compares the number of exceptions to the expected number of exceptions, based on a 99.7 per cent confidence interval. ASX also backtests key model parameters, including the PSR and VSR in CME SPAN and flat rates for cash market products.

A report summarising the results of backtesting is automatically generated and circulated to relevant staff in the Risk division. Results are also disclosed to participants and the Bank on a quarterly basis. Further analysis is undertaken by ASX when an exception is recorded, both to investigate model performance and to investigate the potential financial implications of the exception given the particular participant and portfolio affected. Where an exception is recorded against an individual client account, this investigation will proceed only if the dollar value of the exception breaches a materiality threshold. Further investigation also takes place if the actual number of exceptions exceeds the expected number. By investigating further, ASX determines whether any follow-up actions are required, such as the calling of additional margin or the managing down of positions.

Daily backtesting reports are aggregated into a monthly backtesting report which compares the number of observed exceptions to expected exceptions for the previous month, quarter and year. This report is reviewed by the RQWG and used to identify the need for further investigation of margin model performance. RQWG will take into account the frequency and magnitude of any breaches in determining whether to commission additional analysis from CRQD.

Sensitivity analysis

During the assessment period, ASX implemented an updated sensitivity analysis framework and expanded the product scope covered by this analysis. ASX's approach assesses the sensitivity of margin requirements to changes in all key margin parameters, including the MPOR, look-back period and confidence interval. ASX also conducts ‘reverse sensitivity analysis’ on CME SPAN margin models, to determine the degree to which key CME SPAN parameters need to be varied in order to breach target initial margin coverage. ASX performs its sensitivity analysis on the CME SPAN, OTC FHSVaR and CMM models on a monthly basis. The revised sensitivity analysis framework extends ASX's CMM backtesting to test the coverage of the HSVaR component of the CMM model and the flat rate component of the CMM model both separately and at a combined level.

6.7 A central counterparty should regularly review and validate its margin system.

ASX's Model Validation Standard requires that all models relating to ASX Clear's and ASX Clear (Futures)' margin methodologies (Calypso, CME SPAN, Margin Optimiser and CMM/Razor) undergo a full annual validation and ongoing review (see CCP Standard 2.6). The RQWG is responsible for reviewing the regular reviews of models carried out by CRQD, while Internal Audit coordinates the independent validation process with CRQD input.

At ASX, the CCPs' margining processes are governed by an internal Margin Policy and Margin Standard which is reviewed annually, with material changes approved by the Clearing Boards. The authorisation and documentation process for margin parameter changes and guidelines for the application of management discretion are also reviewed annually.

ASX publishes detailed information on the CCPs' margining arrangements on its website, including descriptions of the margining methodology, schedules of margin rates, and daily CME SPAN margin parameter files. These files allow participants to perform margin calculations on hypothetical or actual portfolios. A number of third-party vendors use this information to provide margin estimation software to participants. ASX also maintains a web-based margin estimator that participants and their clients can use to calculate margin requirements on ETO positions, as well as a margin simulator that allows OTC participants to estimate margin requirements on OTC derivatives and portfolio-margined futures positions.

6.8 In designing its margin system, a central counterparty should consider the operating hours of payment and settlement systems in the markets in which it operates.

ASX Clear's services are limited to CCP clearing of ASX-quoted cash securities and derivatives transactions executed on the ASX markets, as well as ASX- and non-ASX-quoted cash market securities transacted on AMO platforms under the TAS. ASX Clear's operating hours are consistent with the relevant payment and settlement systems (ASX Settlement, Austraclear and the Reserve Bank Information and Transfer System (RITS)).

ASX Clear (Futures) primarily provides clearing services for the Australian-based ASX 24 market and the AUD-denominated OTC interest rate swap market. ASX Clear (Futures)' timetables for margin calculation and collection are consistent with the operating hours of the relevant payment and settlement systems (Austraclear and RITS, as well as NZClear for NZD margin). However, as ASX Clear (Futures) clears trades during a Night Session it also needs to have arrangements to manage exposures from trades entered into outside of these hours (see Section 3.6.2).

Footnotes

CME SPAN parameters are typically calculated using mid prices. [24]

Flat rates effectively assume independence of price movements between securities subject to flat rates. Unless a portfolio is highly concentrated in a small number of flat rate securities, it is likely that this assumption would lead to coverage at the portfolio level that exceeds the targeted confidence interval for individual securities. [25]

For the NZ 90-day bank bill traded on the New Zealand Futures & Options Exchange, an ad hoc run is triggered if the change in the price of the contract exceeds 50 per cent of its margin rate. [26]

The criteria are that the participant: accounts for more than 2 per cent of total initial margin and experiences a build up in overnight exposures of $10 million (over the review period) for either of its house or client accounts; or the clearing participant accounts for more than 25 per cent of clearing for night session activity. [27]

For the CME SPAN and CMM models, initial margin is compared against variation margin collected over the following one or two days, depending on which is the larger amount. For the OTC interest rate swap FHSVaR model initial margin is compared against variation margin collected over the following five days. [28]