Assessment of ASX Clearing and Settlement Facilities – September 2024 4. Special Topic – Segregation and Portability
4.1 Summary and rating
During the assessment period, the RBA conducted a detailed assessment of the ASX CCPs’ compliance with the Segregation and Portability FSS. This included reviewing information provided by ASX and conducting industry liaison with a small cross-section of clearing participants and clients.
The RBA rated both CCPs as broadly observed. Both CCPs should include porting of client positions in their default management ‘fire drills’ and benchmark their portability arrangements against international best practice. The outcomes of these processes could be used by ASX to identify whether there are further steps that could be taken to improve the likelihood of porting for clients.
4.2 Background
The majority of positions centrally cleared at the ASX CCPs are held by ‘end user’ clients of clearing participants rather than being held by clearing participants on their own behalf. There are over 10,000 end users (clients). A clearing participant acts as an intermediary, responsible for meeting the obligations of the clients, such as paying margin to the CCP.
The FSS require that clients’ positions and collateral should be segregated from those of their clearing participant. Segregation plays an important role in protecting clients in the event of their clearing participant’s default or insolvency. Segregation can improve a client’s ability to identify and recover its collateral, which can support confidence in central clearing and the market. It can also reduce the potential for ‘counterparty runs’ on a clearing participant with a deteriorating financial position.
Segregation also facilitates the transfer (porting) of clients’ open positions and associated collateral from a defaulting participant to an alternative solvent participant. Following the default of a clearing participant, the CCP needs to restore a ‘matched book’ through a combination of closing out positions in the market and porting client positions to an alternative clearing participant. During this time, the CCP carries the market risk associated with these positions. To minimise this risk, ASX specifies a ‘porting window’ of 24–48 hours in which to find a receiving clearing participant for clients of a defaulting participant before the client’s positions are closed out. Effective porting arrangements reduce the risk of market disruption associated with position closures, especially during a period of market stress. Porting also helps clients maintain access to central clearing in the event of the default of their clearing participant.
The account structure offered by a CCP and chosen by clients can have implications for the protection of client assets and the likelihood of successful porting of positions in the event of a participant default. In general, higher levels of segregation between client positions and their collateral and that of other parties can provide better outcomes for clients in the event of a participant default. ASX offers the following account structures:
ASX Clear – cash equity market: ASX Clear offers one client account type for cash market products – a single account where client and clearing participant proprietary (house) positions are commingled together (commingled account). To date, this account structure has been considered compliant with the FSS, because of the existence of materially equivalent protections (discussed below) for client assets. Porting of unsettled positions is not likely given the short period of time before settlement.
ASX Clear – derivatives: ASX Clear offers one account type for exchange-traded options – an individual client account – which separates each client’s positions and collateral from those of their clearing participant as well as other clients. This account type offers the highest level of protection for clients and offers the highest likelihood of being ported to a willing receiving participant.
ASX Clear (Futures): ASX Clear (Futures) offers a choice of two account types – an individual client account or a ‘net omnibus account.’ In a net omnibus account, clients’ positions are netted with other clients of the same participant. Participants are only required to pay initial margin on the overall net client position to ASX Clear (Futures). The clients’ collateral in a net omnibus account is pooled and held by ASX Clear (Futures) in a single client collateral account for each participant. Porting of a net omnibus account to an alternative clearing participant would require all clients to be ported, which is not considered likely given the factors outlined below.
4.3 Detailed findings and recommendations
4.3.1 ASX Clear uses a commingled house/client account structure for cash equity market products
The Segregation and Portability FSS includes guidance that, under certain circumstances, CCPs clearing cash equity markets are permitted to achieve materially equivalent protections to segregation by alternative means.
ASX Clear does not segregate house and client positions for unsettled securities transactions, instead using a commingled account structure. It has put in place arrangements that involve the strict segregation of client cash and securities during the period between trade and settlement. This is designed to protect clients from the loss of their cash or securities during the processing of settlements in the event of a participant default.
In 2023, ASX assessed the continued material equivalence of the commingled account structure. The RBA has reviewed ASX’s assessment and considers that the existing protections provide materially equivalent protections for clients, compared with segregated house and client accounts.
The RBA considers it important for ASX to incorporate the ability to segregate house and client accounts into the CHESS Replacement system. ASX intends to build this technical capability and is consulting with industry on this as part of the redesign. Following the consultation, the RBA expects ASX to discuss its proposed next steps with the RBA and ASIC.
4.3.2 Porting may be unlikely for many clients in a default management situation
Participants and clients have suggested that porting may be unlikely in practice for many clients. First, participants indicated that it would be challenging for an alternative or ‘receiving’ participant to accept a new client within the CCP’s porting window without a pre-existing relationship. Prior to receiving a new client, clearing participants need to conduct due diligence, including undertaking customer identification or ‘know-your-client’ checks under anti-money laundering/counter-terrorism financing requirements. The challenges faced by receiving participants would be exacerbated in times of market stress, or if a receiving participant was considering multiple potential new clients. While ASX allows clients in an individually segregated account to nominate a secondary clearing participant, there are currently no individually segregated accounts with a nominated secondary clearing participant.
Second, most clients have chosen a net omnibus account structure at ASX Clear (Futures) rather than an individually segregated account. ASX requires participants to provide ‘direct clients’ with whom the participant has a clearing arrangement with a ‘fact sheet’ detailing the differences between the two account types.[6] The fact sheet advises that it is unlikely that positions in a net omnibus account would be transferred to an alternative clearing participant in a default management situation. A net omnibus account would be treated by ASX as a single account in the case of a participant default. If no clearing participant is willing to accept the transfer of all clients in the omnibus account or all clients do not agree to be ported to the receiving participant, then all client positions would be closed out.
The low uptake of individually segregated accounts at ASX Clear (Futures) and secondary clearing arrangements at both CCPs could result in many clients having their positions closed out in the event of a clearing participant default. As a result, clients may lose their ability to access central clearing, potentially exposing them to market risk. During the assessment period, ASX identified that it should develop a detailed playbook for the porting of client positions across both ASX CCPs. This would provide a framework to facilitate ASX’s decision-making about whether to allow a client to port following a default. ASX has also stated that it intends to extend its default fire drills to include porting processes. This would include testing contacts for key clients, understanding secondary clearing relationships and assessing overall knowledge of the porting process and the pre-conditions to porting.
The RBA considers these to be appropriate actions to improve ASX’s portability arrangements. In particular, the lack of comprehensive testing of porting processes in previous default management fire drills means that ASX cannot be confident that there are no further improvements it can make to the porting process.
Given the current low likelihood of porting for many clients in a default management situation, ASX should comprehensively consider whether there are further steps they should take to improve the likelihood of porting. The RBA recommends that ASX undertake benchmarking of their portability arrangements against international best practice, such as the practices outlined in a recent paper by CPMI-IOSCO on client clearing.[7] Any benchmarking should include: incentivisation of backup clearing arrangements; testing of porting processes in default management situations; improved transparency for clients about the likelihood of being ported if their clearing participant defaults; harmonisation of porting processes with international standards; opportunities for increased coordination with other relevant parties in the event of a participant default; and streamlining operational processes.
Recommendation: By 30 June 2025, ASX should benchmark its portability arrangements against international best practice and share the results with the RBA. Following this exercise, ASX should determine whether there are additional steps it should take to improve the likelihood of porting in a default management situation. ASX should also incorporate client porting into its default management fire drills.