Assessment of ASX Clearing and Settlement Facilities 2. Material Developments

This section discusses material developments relevant to the ASX CS facilities that have occurred during the 2020/21 assessment period (1 July 2020 to 30 June 2021). Developments between the end of the assessment period and the finalisation of this report on 31 August are noted where relevant.

To complement this section, background information on activity and participation in the facilities, and governance and risk management in the facilities is set out in Appendix B.

2.1 Operational risk

2.1.1 CHESS capacity

CHESS is the system used by ASX to facilitate clearing, settlement and other post-trade services for the Australian cash equities market. The 2020 Assessment recommended that ASX implement measures to increase the capacity of the CHESS infrastructure. These measures were intended to mitigate against the risk of processing delays, such as those experienced in March 2020 when cash equity trade volumes reached around 7 million trades on one day, well above the previous peak of 3.3 million trades.

The program of work to increase the capacity of CHESS was completed in the first half of 2021. CHESS is now able to support 10 million trades per day under business as usual (Graph 1).^[5] Work to improve processing capacity has also encompassed ASX's ‘CORE’ system, which is responsible for feeding trades submitted to the ASX trade platform into CHESS. If the capacity of CORE to process these trades is lower than the capacity of CHESS to absorb them then it may slow the registration of trades on the ASX market to CHESS if trading volumes are sufficiently high.^[6] Work to increase the capacity of the CORE system is expected to be completed in the second half of the year.

The 2020 Assessment also recommended that ASX should develop contingency arrangements to address future extreme increases in volumes that exceed CHESS processing capacity. Over the past year ASX has revised the contingency arrangements intended to help manage these situations and communicated these arrangements to participants.^[7] The types of contingency actions available to ASX now include: delaying the start of end-of-the day processes in CHESS (which normally begin at 7:00 pm); limiting the number of trades accepted from market operators; and, under the most extreme circumstances, stopping the registration of all trades for clearing and settlement for a specified period.

2.1.2 CHESS replacement

During the assessment period, ASX continued its work on replacing CHESS. The current system has generally performed well; system availability for CHESS has consistently met its service availability target of 99.80 per cent, with 100 per cent availability of CHESS between July 2020 and June 2021. However, the CHESS software was developed more than 25 years ago. Over time, this legacy system has become harder to maintain and is less flexible than contemporary software.

ASX commenced a process of evaluating replacement options for CHESS in 2015. In 2017, it selected Digital Asset (DA) as the vendor for the distributed ledger technology-based (DLT-based) platform that will replace CHESS. In 2019, ASX and DA partnered with VMware, a large US-based technology firm, to deliver the distributed ledger.

ASX's use of DLT in the CHESS replacement system differs significantly from the use of such technology in systems such as Bitcoin. It will operate a private, permissioned network application of DLT. ASX will be the only entity that can write to the ledger and it will control access to users, allowing each to see elements of the ledger relevant to them. By contrast, Bitcoin is an example of a public, permissionless DLT system.

Key areas of supervisory engagement

The Bank is working closely with the Australian Securities and Investments Commission (ASIC), the Australian Competition and Consumer Commission (ACCC) and the Treasury to oversee the CHESS replacement program. In October 2020, ASIC and the Bank issued a joint media release that outlined their expectations of ASX.^[8] This noted that ASIC and the Bank expected ASX to replace CHESS as soon as this could be safely achieved by ASX and users of CHESS.

At a minimum, ASIC and the Bank expect the new system to meet the requirements that CHESS currently meets for system availability, resilience, recoverability, performance and security. ASX has announced non-functional business requirements for the replacement system that will exceed these minimum requirements. ASIC and the Bank's oversight of the CHESS replacement program is focused on ASX's governance of the program, its engagement with stakeholders, the functional and technical aspects of the replacement system, and its management of the risks associated with the migration to the new system. In particular, ASX will be expected to provide independent assurances to ASIC and the Bank to demonstrate the readiness of the CHESS replacement system before this migration takes place.

Another key input into ASIC and the Bank's supervisory engagement is EY's independent assessments of the governance of the CHESS replacement program. ASX engages EY to undertake these assessments around every six months to provide ongoing visibility of how well the program is functioning.

Go-live delay

In 2020, ASX identified the need to extend the timeline of the CHESS replacement program by at least a year. In late October, following a detailed re-planning process and a period of industry consultation, ASX announced that the target launch date for the CHESS replacement program had been delayed by two years to April 2023. This additional delay was in part driven by industry feedback, which called for more time for industry testing and vendor preparedness as part of the revised plan. It also took into account the impact of COVID-19 on ASX and industry, as well as changes required to support higher trading volumes (discussed below). ASX commissioned EY to conduct an independent review of the revised plan to provide assurance on the re-planning process to its Board and demonstrate how this process had addressed the expectations of ASIC and the Bank that any new timeline should incorporate previous stakeholder feedback and lessons learned from the program, adequate contingency for events that may cause a further delay, as well as sufficient time for users to complete readiness activities.

ASX remains confident that the replacement system will be ready to go live in April 2023. The program is in the final few months of software development, which will incorporate changes to netting and settlement processes. ASX expects that industry testing will begin later this year.

Netting and settlement changes

In light of the surge in trading activity experienced in March 2020, during the assessment period ASX consulted on modifications to the CHESS replacement system to ensure that the new system would be able to be scaled to process higher trade volumes. Under current arrangements, ASX calculates a single ‘net broker obligation’ (NBO) for each clearing participant each evening, with this replacing the individual trades registered to that participant during the day. However, the NBO process cannot easily be scaled by ASX (either under current arrangements or as part of the replacement system), creating potential delays to time-critical overnight processes that could prevent it from processing much higher volumes of transactions if that were required in the future. Other aspects of the CHESS replacement system are designed to be scalable if this process can be removed.

Following consultation, ASX announced that it would remove the NBO process from the new system. ASX also made a number of amendments to its original proposal to reduce the impact of this change and assist participants in adjusting their internal operational processes, such as providing additional reporting from the new CHESS system that will enable participants to undertake full end-to-end reconciliation.

2.1.3 Segregation and portability

Under current arrangements, ASX Clear utilises a structure that commingles house and client positions and collateral for cash market transactions. However, the standard on segregation and portability (CCP Standard 13) sets out that a CCP should maintain client positions and collateral in individually segregated accounts or in omnibus client accounts (or equivalent) to enable the segregation of positions and collateral of a participant's clients from that of the participant.^[9] ASX Clear currently relies on an exception in the FSS guidance that permits the use of alternative means to provide protection for clients' assets if this protection is materially equivalent to full segregation of client and house positions and collateral. This exception is limited to cash markets and subject to the CCP demonstrating to the Bank that the alternative protections are materially equivalent to full segregation.

The CHESS replacement system is expected to have functionality that can be configured to support either individually segregated or client omnibus accounts. The 2020 Assessment recommended that ASX conduct an assessment of whether the protections from existing client protection arrangements remain materially equivalent to those provided by individual client or omnibus segregation, which should include engagement with industry on the impact of different client segregation operating models. ASX should consult with the Bank and ASIC on the outcome of this assessment within 12 months of the CHESS replacement going live.

2.1.4 Operational risk management

In 2018, ASX commenced its Building Stronger Foundations program to address the findings of an independent external review of ASX's technology governance, operational risk and control frameworks. The program also incorporated ASX initiatives and projects to improve enterprise risk management and governance practices identified prior to the review. The review was conducted by KPMG at the instigation of the Bank and ASIC.

ASX closed the Building Stronger Foundations program during the previous assessment period, having substantively completed implementation of the review's 36 recommendations. The 2020 Assessment acknowledged the progress ASX had made, but observed that more time was needed to assess the effectiveness of new systems and processes in practice. It recommended ASX continue to embed the use of the new systems it had adopted as part of the program and use these systems to identify, monitor and manage operational risks at an enterprise-wide level.

ASX continued to embed the use of new systems, such as its Enterprise Risk, Internal Audit and Compliance Application (ERICA) and IT Service Management (ITSM) tool over the assessment period. For example, all IT change, incident, problem and knowledge management processes are now managed through the ITSM tool. This has allowed ASX to produce new dashboards and key risk indicator registers that feed into reporting processes for the ASX Boards and executive. ASX expects to continue embedding these new systems over the next year, with further improvements planned for the ITSM tool.

The 2020 Assessment also recommended that ASX internal audit conduct a review of the effectiveness of new systems and processes in practice. ASX internal audit commenced this review during the assessment period. The findings and recommendations of the review will be considered as part of the next assessment, along with any changes that ASX may make in response to the review.

2.1.5 Cyber resilience

During the assessment period, ASX continued to implement enhancements to its cyber security practices in line with actions set out in its Cyber Strategy. This included the implementation of measures to improve internal controls and enhancements to its cyber testing regime. ASX also participated in industry forums such as the CPMI-IOSCO industry working group on cyber.

The CPMI-IOSCO Guidance on Cyber Resilience for Financial Market Infrastructures provides a set of internationally agreed guidelines for FMIs in the area of cyber risk.^[10] Consistent with the expectations set out in the guidelines, ASX continued to evaluate current and emerging technology that could lead to further enhancements in ASX's capabilities to recover its operations safely within two hours following an extreme cyber attack.

2.2 Financial risk

2.2.1 Credit & liquidity risk

Stress testing

The results of a CCP's stress tests directly determine the level of prefunded resources it must hold. Consistent with the FSS, ASX seeks to maintain prefunded resources that would be sufficient to cover its losses from the default of any two clearing participants using a range of ‘extreme but plausible’ stress test scenarios. It is therefore critical that these scenarios reflect up-to-date information on what may be plausible risks to the CCPs. These scenarios may be based on historical events (e.g. the Lehman Brothers default), hypothetical events (e.g. geopolitical conflict), or theoretical scenarios extrapolated from historical price movements using statistical techniques.

In July 2020, ASX introduced several new stress test scenarios across both CCPs based on the market volatility observed in March 2020. Some of these scenarios introduced more severe equity or interest rate stresses than previous scenarios, extending the boundary of what ASX had previously considered ‘extreme but plausible.’ The Bank also commenced discussions with ASX on whether it was appropriate to more broadly review the boundary of ‘extreme but plausible’ stress events in light of the experience in March 2020. In response, ASX initiated a survey of clearing participants within the CCPs' Risk Consultative Committees (RCCs) in order to inform this review. Members were broadly supportive of further increases to certain equity market and interest rate stresses to better capture forward-looking risks. In response, ASX introduced two new equity stress scenarios with larger movements in volume-weighted average prices for the S&P ASX 200. ASX has also introduced two new rates scenarios, one based on possible market movements should the Bank withdraw its target for the three-year Australian Government bond yield and one based on a post-pandemic rise in inflation.

While ASX generally takes into account all historical stress events over recent decades in developing its stress test scenarios, it does exclude the October 1987 stock market crash on the basis that significant changes in market structure and functioning since that time mean that a similar event would not result in such a rapid fall in equity prices currently. A majority of Risk Consultative Committee (RCC) members agreed with this conclusion, although some considered that a 1987 scenario should be included. The Bank will discuss with ASX how it plans to validate whether its stress scenarios could cover an event of similar severity as the 1987 stock market crash, taking into account differences in the current market environment.

ASX also presented a new methodology for determining historical stress scenarios at ASX Clear, which includes a suite of 296 historical scenarios based on periods of macroeconomics stress over the past 30 years. The new methodology assumes the default occurs at the point that would have realised the worst loss under each historical scenario. A key objective of this methodology is to incorporate both systemic and idiosyncratic stresses consistent with the definition of ‘extreme but plausible’. The introduction of these scenarios remains contingent on the completion of the rebuild of ASX's credit stress testing systems.

Collateral concentration limits

During the assessment period, ASX conducted further analysis in response to a recommendation made in the IMF's 2018 assessment of the supervision, oversight and resolution planning of Australian FMIs, that ASX should apply concentration limits to equity collateral provided to meet margin obligations at ASX Clear. The analysis found only a small number of instances where a participant's posted collateral exceeded certain concentration thresholds. In these instances, ASX deemed it would be able to cover its exposure in the event of a default without crystallising concentration risk.

In addition, ASX has developed a dashboard that allows it to monitor concentration in security collateral on a real-time basis. The dashboard has been functional since October. The dashboard does not place any restriction on the amount of individual equity securities that a clearing participant can pledge as collateral. However, ASX plans to introduce additional haircuts in stress test exposure calculations for collateral holdings that exceed a predetermined concentration threshold, which will disincentivise participants holding concentrated positions in particular securities.

Treatment of excess collateral

ASX Clear currently allows clearing participants to withdraw excess collateral posted against their position at any time during the day, and therefore there is no guarantee that this collateral will be available to meet losses in the event of a default. Since stress scenarios are intended to estimate potential losses that could be incurred in the event of default, the 2018 Assessment recommended that ASX should remove the assumption made by ASX Clear that excess collateral will not be withdrawn or decreased during periods of stress. This would align ASX Clear's approach with the CPMI-IOSCO CCP Resilience Guidance. Current ASX systems do not support the ability to exclude excess collateral from stressed exposure calculations. ASX aims to fully address this recommendation as part of the rebuild of its credit stress testing systems.

2.2.2 Margin

Anti-procyclicality measures

Increasing margin requirements during periods of market stress can create liquidity challenges for a CCP's participants. Such increases can be considered ‘procyclical’ if they tend to occur during downturns in the business or credit cycle and may either cause or exacerbate market instability. This risk has been an area of focus among regulators in recent years (Box B), and international guidance has encouraged CCPs to put in place measures to maintain higher initial margin requirements ‘through the cycle’ in order to avoid sudden increases in times of stress. These measures can involve CCPs placing a floor on margin requirements or ensuring – even during periods of low volatility – that their margin calculations always take into account earlier episodes of particular stress. There may be other sources of procyclicality in CCP risk management models – for instance, where haircuts applied to collateral posted by participants are calibrated to increase in times of market stress. The 2018 Assessment identified ASX's lack of a systematic approach to assessing and mitigating the potential for procyclical changes as a weakness in its risk management framework.

During the assessment period, ASX Clear (Futures) implemented a new methodology for setting margin floors for its major exchange-traded derivative contracts. It plans to extend the methodology to the remaining contracts in coming months. Under the new methodology, ASX calibrates margin floors with reference to the most volatile five-year period over the period for which price history is available for each futures contract (up to 22 years). While the margin floors are calibrated using a confidence level of at least 99 per cent, the exact choice of confidence level is subject to management discretion. ASX has also applied expert judgement to adjust margin floors for interest rate futures contracts that it has deemed affected by the Bank's Australian Government Securities (AGS) yield target.^[12] The margin floors are reviewed quarterly and subject to oversight by the CS Boards, with any changes to the methodology for setting floors requiring approval by the CS Boards.

While the implementation of margin floors for major contracts at ASX Clear (Futures) reduces the risk of destabilising increases in margin for these contracts during periods of heightened market volatility, it does not constitute the systematic procyclicality framework needed to reduce this risk across all margin and financial risk requirements at the ASX CCPs. In particular, such a framework should cover margin floors or other anti-procyclicality measures for all remaining contracts at both CCPs, as well as non-margin risk requirements such as collateral haircuts. The framework should include an appropriate methodology for measuring the degree of procyclicality in risk models to allow management and the boards of ASX's clearing and settlement facilities (CS Boards) to assess the adequacy of anti-procyclicality tools employed by the CCPs (such as floors on margin requirements and collateral haircuts).

Late-in-day and overnight price movements

The elevated market volatility of March and early April 2020 highlighted the potential for large variation margin exposures to build up late in the day and overnight when neither CCP currently calls variation margin. While ASX Clear (Futures) calls for margin at a number of points during the day, it does not typically call variation margin between 1:30 pm and 8:05 am the next day.^[14] ASX Clear usually only calculates initial and variation margin at 5:00 pm, after market close, for collection at 10:30 am the next day. However, in response to the extreme intraday price moves seen in March 2020, both ASX CCPs made frequent use of an additional, ad hoc intraday margin call at around 2:30 pm. However, the CCPs cannot initiate a margin call that is able to be collected on the same day much later than this; this reflects the time required for ASX to calculate margin requirements and for participants to meet their margin obligations before the closure of Austraclear's day session at 4:28 pm. In the absence of an overnight variation margin call, ASX Clear (Futures) participants that are active during the overnight session are required to post additional collateral to cover potential adverse price movements overnight.

The 2020 Assessment recommended that the ASX CCPs should monitor and manage exposures arising from late-in-day and overnight price movements. At the time, it was observed that ASX Clear (Futures) had begun monitoring exposure from overnight price movements, in line with recommendations made in previous assessments. During the assessment period, ASX Clear (Futures) has investigated options for collecting overnight variation margin and plans to implement the initial phase of a multi-phase plan over coming months. ASX Clear (Futures) is not able to use its normal process for collecting variation margin overnight, since Austraclear and RITS which are typically used to settle security and AUD cash collateral, are closed during this time. More broadly, there are currently a number of obstacles to ASX Clear (Futures) collecting margin payments overnight in AUD at the scale required to accommodate potentially large variation margin obligations.

ASX Clear (Futures) therefore proposes to initially collect overnight variation margin in USD, to be paid by participants to one of three commercial settlement banks, in line with its current arrangements for collecting overnight initial margin. However, this approach involves a credit exposure to the commercial settlement bank until the first intraday margin run in AUD the next morning. Losses from the default of a commercial settlement bank would be borne by a combination of ASX Clear (Futures) and its participants in accordance with arrangements for investment loss allocation under the ASX Recovery Rules. ASX Clear (Futures) is also exploring alternative ways to collect overnight variation margin that do not involve credit exposure to commercial banks, such as using US Treasuries or settlement in exchange settlement balances using the New Payments Platform.

ASX has prioritised work on addressing exposure to overnight price movement in ASX Clear (Futures). Accordingly, neither CCP has made further progress in implementing arrangements to monitor and manage exposures arising from late-in-day price movements.

Inter-commodity spread concessions

The 2020 Assessment recommended that ASX Clear (Futures) should complete analysis of the costs and benefits of changing its methodology for calibrating ICCs in its SPAN margin model and resume regular reviews of ICCs, which had been suspended pending review of the methodology. ICCs allow for a reduction in CCP participants' initial margin requirements where offsetting positions are held in contracts that have a significant and reliable correlation in prices. However, such margin offsets may exacerbate losses in the case of a clearing participant default if the assumed correlation breaks down. In September 2018, margin offsets contributed to losses sustained by Nasdaq Clearing AB after the default of a clearing member.

During the assessment period, ASX Clear (Futures) completed its analysis and made minor changes to its methodology. The ICC methodology was updated in December 2020 to extend the lookback period for calibrating ICCs and quarterly ICC reviews have resumed, addressing this recommendation.

Liquidity add-ons

The 2020 Assessment included a recommendation for ASX Clear to implement a margin add-on that accounts for liquidity risk in cash market products and ETOs (which are margined using the CME SPAN model). ASX has completed its review of liquidity add-ons for ETOs, but is yet to begin its review for cash market products.

ASX concluded that add-ons are not currently needed for ETOs. This was based on its analysis (incorporating the results of a survey of major market participants), which indicated that auction demand for a defaulting participant's portfolio would be strong enough that initial margin would be sufficient to cover any losses, even under stressed market conditions. ASX will conduct regular analysis in future to assess the need for liquidity add-ons for ETOs. ASX plans to complete its review of liquidity add-ons for cash market products as part of a broader review of margin methodology, targeted for completion in June 2022.

2.3 Default management and recovery

2.3.1 Recovery and replenishment arrangements

In the 2020 Assessment, the Bank recommended that ASX should assess the risk that ASX Clear participants could default on their obligations or choose to resign as participants in the face of possible difficulty meeting their recovery or replenishment obligations. Meeting these obligations may be particularly challenging for smaller participants that could face liquidity constraints in stressed market conditions, and have more limited options for raising additional funds than a large, well-capitalised participant. It was also noted that ASX should formalise arrangements to conduct an evaluation of these risks on a periodic basis and formalise any resulting risk management actions.

Recovery assessments are called from participants to cover the CCP's losses from a participant default once all other prefunded financial resources have been exhausted, while replenishment contributions are called to restore the resources in the default fund once it has been depleted below a certain threshold.^[15] Failure to meet a recovery assessment is an event of default, while the ASX Recovery Rules allow participants to resign before any obligation to replenish the default fund becomes due. To address the Bank's recommendation, ASX assessed each ASX Clear participant's capacity to meet its maximum recovery assessment and replenishment contribution obligations based on a comparison of these obligations to the participant's capital and liquidity resources. To assess each participant's likelihood of resigning in the event of a potential replenishment contribution, ASX carried out additional analysis of the profitability of each participant's clearing business relative to its possible replenishment obligations. It also analysed a range of other qualitative factors such as support from the group structure for participants that are subsidiaries and business growth potential.

ASX's analysis did not indicate any material concerns regarding participants' capacity to meet their recovery obligations. It further suggests that only a limited number of smaller participants may choose to resign rather than pay their replenishment contributions. The financial impact from the resignation of five participants deemed to be moderately or highly likely to do so is estimated to be $8.9 million, representing around 12 per cent of the aggregate replenishment amount.^[16] ASX will conduct a similar study on a quarterly basis going forward.

2.3.2 Access to liquidity facilities

The 2020 Assessment recommended that ASX Clear (Futures) take steps to establish an ability to access liquidity from the Bank in respect of a defaulting participant's non-cash collateral. Currently ASX Clear (Futures) can access liquidity via the market in respect of all collateral that it collects. However, its access to liquidity from the Bank is limited to cash collateral, where this cash is invested in eligible assets via ASX Clearing Corporation (see Appendix [B.3]). The particular issue is that currently, it is ASX Clearing Corporation that is a member of RITS and an eligible counterparty of the Bank's domestic market operations, but the terms of the trust governing ASX Clear (Futures)' arrangement with ASX Clearing Corporation do not allow the latter to receive non-cash collateral posted to the CCP, meaning that these securities cannot be used to access liquidity from the Bank.

During the current assessment period, ASX Clear (Futures) has taken steps to apply for membership of RITS in its own name, so that it can become an eligible counterparty of the Bank. This would allow ASX Clear (Futures) to directly access liquidity from the Bank in respect of a defaulting participant's non-cash collateral in the event that it was unable to liquidate this collateral on market in a timely manner.

2.3.3 Other default management developments

Deferral of the CHESS batch

The 2020 Assessment included a recommendation that ASX should test the process of deferring the CHESS batch overnight and review the implications of this approach for default management. During the assessment period, ASX addressed this recommendation via a simulation exercise, in which ASX successfully cancelled all settlement obligations on a given settlement day and then rescheduled the obligations to the next settlement day.

Under current arrangements, ASX would only use this approach if a payment provider defaulted after the batch had commenced. If the default happened before then, only the obligations of the participants affected by the defaulting payment provider would be rescheduled. ASX has identified potential extensions of this fire drill to further inform its default management arrangements.

Margin period of risk assumptions

For large and complex portfolios, a CCP may face operational challenges if default management processes for different asset classes differ and cannot be run simultaneously. This could result in the actual time required to close out such a portfolio being longer than the time that is assumed in a CCP's margin models – the ‘margin period of risk’ or MPOR. The 2020 Assessment found that ASX had not completed a systematic review of the consistency between its MPOR assumptions and its operational capacity to liquidate portfolios across all asset classes. ASX plans to complete this review over the next assessment period.

Other areas of supervisory focus

The 2020 review of ASX's default management and recovery framework highlighted a number of gaps which ASX has worked to address over the assessment period.

• ASX has committed to continue increasing the complexity and comprehensiveness of scenarios and coverage of default management processes that are tested in fire drills. Enhancements to fire drills will be undertaken by ASX's internal Default Management and Recovery Working Group (DMRWG), which provides oversight of the CCPs' default management and recovery framework.
• ASX will complete a gap analysis against the CPMI-IOSCO paper Central Counterparty default management auctions – Issues for consideration by September 2021.^[17]
• ASX has updated its approach for determining default loss estimates and has added this to its Default Management Strategy Book. The default loss estimate represents ASX management's best estimate of the CCPs' potential losses on the participant's portfolio. The size of the default loss estimate provides the criteria for escalation to the Board and the participant RCCs, for decisions regarding whether to take recovery actions, and is used to inform decision-making by ASX's Default Management Committee (DMC). ASX has updated the calculation methodology to include additional information on the circumstances surrounding a participant default (for example whether the default was caused by an idiosyncratic event or a general economy-wide event) and the complexity of the defaulting participant's portfolio.
• ASX Internal Audit has confirmed to the Bank that it will review ASX's default management framework every three to five years, with the first review to take place in 2022/23. The scope of the audit will review the process by which the framework was developed and whether it has been implemented in accordance with the framework. ASX's Internal Audit team decided to defer such an audit until ASX's clearing risk management team had completed the implementation of enhancements identified during the 2015 default of BBY Limited. These enhancements are now substantively complete.
• The Bank and ASX plan to progress a review of the legal certainty of arrangements for ASX Limited to replenish contributions to the ASX CCPs' default funds. This review will be planned alongside the Bank's review of the ASX Group Support Agreement (see section 2.5).

2.4 Business and investment risk

As part of the special topic on ASX's legal basis, the 2019 Assessment recommended ASX ensure that business, operational and investment risk capital is available to the ASX CS facilities when required, even when the financial standing of the ASX Group entities holding this capital (ASX Operations Pty Limited and ASX Limited) is in doubt. The 2020 Assessment identified that, while the relevant capital had been transferred from ASX Operations to each of the CS facilities, some gaps remained in the arrangements for CCP investment risk capital and SSF business and operational risk capital.

CCPs

The CCPs' cash margin and default fund contributions are invested in a common pool held by ASX Operations. ASX Operations originally held a $75 million portion of capital to cover investment risks across both CCPs. ASX Operations has since transferred $66 million of this capital to ASX Clear (Futures) and $9 million to ASX Clear, reflecting the average contribution of each CCP to the common investment pool since July 2018. Retained earnings of the CCPs can be used to cover a shortfall if the actual proportion of a CCP's contribution to pooled investments differs from this average ratio on the day an investment loss occurs. However, the 2020 Assessment identified that these may not always be sufficient and recommended that a buffer is established along with a process for periodic recalibration.

ASX has addressed this potential shortfall by establishing additional investment risk capital buffers in each CCP made up of paid-up equity. The buffer is calibrated to cover the maximum shortfall since July 2018. ASX's non-default risk capital policy, approved in June 2021, requires that the split of capital held by each CCP is reviewed monthly and that any necessary adjustments to the buffers are made. ASX has also established additional business and operational risk capital buffers equal to 10 per cent of the capital held for this purpose at each CCP.

SSFs

While the 2020 Assessment identified that the amount of business and operational risk capital held by the SSFs was consistent with the requirement under SSF Standard 12, the ASX and CS Boards had not updated their capital policy to reflect this. While any transfer of capital back to ASX Operations would require Board approval, such a transfer would have been permitted under the capital policy, potentially allowing the capital held by the SSFs to fall below the requirement under the SSF Standard. The 2020 Assessment recommended that ASX's capital policy be updated to reflect the new capital arrangements and provide a mechanism for ASX to review whether the level of capital held at the SSFs remains appropriate over time. The new non-default risk capital policy approved by the CS Boards in June addresses this recommendation.

2.5 Legal basis

The 2020 Assessment carried forward two recommendations first identified as part of the 2019 special topic on the legal basis standard.

• Update procedures governing legal opinions. The 2019 Assessment identified that ASX's processes and procedures governing the commissioning, reviewing and updating of legal opinions were not sufficiently comprehensive. During the assessment period, ASX updated these guidelines to take into account feedback provided by the Bank.
• Establish a periodic review of operating rules and procedures. The 2019 Assessment recommended that ASX periodically review the CS facilities' operating rules and procedures to ensure these are clear and understandable and consistent with industry standards and market protocols. During the assessment period ASX implemented a process for conducting a five-year rolling review of rules and procedures. The process aims to:
  • identify any changes required to mitigate systemic risk to the ASX CS facilities or respond to issues of importance to key stakeholders (e.g. customers and regulators)
  • benchmark new and existing rules and procedures against other CS facilities and industry standards
  • consider feedback received from participants in relation to rules and procedures that are unclear or confusing
  • update rules and procedures that ASX has identified as redundant or inconsistent, or where changes are desirable or processes in the rules can be improved.

  However, this last element of the rule review process relies on issues being identified and logged as part of ASX Legal's ongoing work. It does not include any systematic process for proactively identifying rules, procedures or processes requiring change if these are not reviewed by ASX Legal in the course of other work. Similarly, the benchmarking of rules and procedures against other CS facilities and industry standards is undertaken only in relation to rule changes that have already been identified as necessary for other reasons, although ASX does monitor regulatory developments that may impact the rules and procedures of the CS facilities more broadly.

During the assessment period ASX also completed work on enhancing, formalising and documenting its business-as-usual controls for legal risks, in line with an area of supervisory focus raised as part of the 2019 special topic. The Bank plans to re-engage with ASX on a planned review of its Group Support Agreement once any amendments arising from recent changes to its intra-group capital arrangements (see section 2.4) have been implemented.

2.6 Other developments

2.6.1 Data and reporting developments

During the assessment period, the Bank has observed some deficiencies in ASX's data capabilities and quality controls. ASX had identified a breach of its regulatory reporting obligations under the FSS after failing to detect a reporting error for several months. While the Bank views this breach as minor, together with some other data-related lapses it highlights an ongoing issue with ASX's data reporting and internal quality controls. ASX has generally kept the Bank informed of material developments at the CS facilities, but in a few instances important information was not brought to the Bank's attention in a timely and transparent manner.

ASX identified a number of control improvements in response to its identified reporting breach, including:

• introducing an assessment of the potential impact on regulatory reporting from any proposed changes to systems used in meeting data reporting requirements under the FSS
• independent review of data reports by separate functions
• introducing an ongoing assessment of regulatory reporting risks.

2.6.2 Risk systems

The Bank's 2019 Assessment recommended that the ASX CCPs should implement plans to ensure that their core systems have the functionality to fully support their risk management approach, including by migrating processes currently operated on non-core systems to core systems. This recommendation was introduced in light of ASX implementing new functionality via ad-hoc systems where, in some cases, its core systems lacked support for more sophisticated risk management functions.

In 2018 ASX established a five-year strategic roadmap for its risk management systems that included actions to address this recommendation. The first phase of this roadmap is a project to rebuild the CCPs' credit stress testing systems, which will support the introduction of a range of risk management enhancements, such as functionality that would enable intraday stress testing. In addition, ASX has completed a review of the systems infrastructure required to support its risk management approach over the long-term. ASX will share this analysis with the Bank later in the year.

2.6.3 Cross-border regulatory developments

Brexit

Following the exit of the United Kingdom (UK) from the European Union (EU) on 31 January 2020, the UK entered a transition period that ended on 31 December 2020. During this transition period FMIs operating in the UK continued to be governed by the EU regulatory regime. When the transition period ended, FMIs operating in the UK became subject to the UK regulatory regime and the UK's Temporary Recognition Regime (TRR) for CCPs came into effect. The TRR allows eligible non-UK CCPs that were recognised under the EU regulatory regime to continue to provide clearing services and activities in the UK until 31 December 2023. If required, the UK Treasury can extend the TRR by increments of up to 12 months.

Both ASX CCPs entered the TRR when it came into effect, and accordingly were taken by the Bank of England (BoE) to be eligible for temporary deemed recognition in the UK. Both ASX CCPs formally applied to the BoE in March 2019 to maintain recognition in the UK.

European Union

The EU is in the process of implementing a set of changes to its regulation on OTC derivatives, CCPs and trade repositories, known as European Market Infrastructure Regulation (EMIR) 2.2. EMIR 2.2 updates the EU's approach to the recognition and supervision of third-country CCPs, including ASX Clear and ASX Clear (Futures). Under the new regime, the European Securities and Markets Authority (ESMA) is required to review the recognition of the ASX CCPs, and assign them to a tier based on their degree of systemic importance to the EU by March 2022. The tiering decision will affect the degree of oversight that ESMA applies to the CCPs under EMIR 2.2.

New Zealand

ASX Clear (Futures) was designated as a settlement system under the Reserve Bank of New Zealand Act 1989 (RBNZ Act) on 14 August 2020.^[18] Designation provides ASX Clear (Futures) with additional settlement finality protections under the RBNZ Act.

In May 2021, the New Zealand Parliament passed legislation establishing reforms to the regulatory regime governing FMIs in New Zealand. While ASX Clear (Futures)' designation under the RBNZ Act remains in place during a transitional period, a re-designation process will be undertaken under the new regime prior to the repeal of the designation provisions of the RBNZ Act. The re-designation of ASX Clear (Futures) is anticipated to occur by the end of 2022.

Footnotes

CHESS may be able to accommodate higher trade volumes for short periods, for instance by delaying end-of-day processing. [5]

Spare capacity in CHESS would, however, remain available to process trades on alternative market operators such as Chi-X or NSX. [6]

See: https://www.asxonline.com/public/notices/2020/sept/1164.20.09.html [7]

See: https://www.rba.gov.au/media-releases/2020/mr-20-23.html [8]

Under an individually segregated account structure, each client's positions and collateral are held in a separate account at the CCP, segregated from the positions and collateral of the participant and each other client. Under an omnibus account structure, all positions and collateral belonging to omnibus segregated clients of a particular participant are held together in a single account segregated from the positions and collateral of that participant. [9]

Guidance on cyber resilience for financial market infrastructures (bis.org) [10]

A CCP must seek to maintain pre-funded financial resources sufficient to cover a default of any two of its participants (and their affiliates) in extreme but plausible market conditions – a requirement known as ‘Cover 2’. [11]

This includes the 3-year AGS futures, 90-day bank bill futures, and 30-day interbank cash rate futures contracts. [12]

See <https://www.fsb.org/wp-content/uploads/P171120-2.pdf> [13]

ASX Clear (Futures) usually makes three intraday margin calls per day for initial and variation margin at 8.05 am, 11.30 am and 1.30 pm. It also makes an end-of-day call for initial and variation margin at 5.00 pm, which is settled the following morning at 11.00 am. In addition, ASX Clear (Futures) makes an initial margin-only intraday call during the overnight session at 2.00 am and calls AIM between 5.00 and 8.00 am. [14]

ASX Clear may call up to $300 million in recovery assessments from participants immediately following a default that is expected to exhaust prefunded financial resources, and up to $75 million in replenishment contributions within 22 business days of a default. [15]

In aggregate, provided participants resign prior to calling of replenishment contributions, ASX Clear would still receive the same level of replenishment contributions, redistributed amongst the remaining participants. [16]

Available at <https://www.iosco.org/library/pubdocs/pdf/IOSCOPD657.pdf> [17]

The RBNZ Act defines settlement systems broadly, in a way that encompasses ASX Clear (Futures)' activities as a derivatives CCP. [18]