2009/10 Assessment of Clearing and Settlement Facilities in Australia 6. Special Topic: Governance

Measure 8 of the FSS sets out the relevant requirements for licensed central counterparties with respect to governance:

The central counterparty must have effective, accountable and transparent governance arrangements. This requires that:

  1. the board of the CS facility licensee have appropriate expertise and independence;
  2. the board of the CS facility licensee be responsible for oversight of the operation of the central counterparty; and
  3. the risk-control function of the central counterparty must not be adversely influenced by its business, marketing or other operations.

The guidance provided to the measure states that it applies to the area of management specific to control of financial risk, and is not intended to address broader issues of corporate governance such as obligations in the Corporations Act or good market practice.

In this assessment period, the Reserve Bank undertook a detailed assessment against the governance measure for the two licensed central counterparties. It is the Reserve Bank's assessment that ASX Clear and ASX Clear (Futures)' governance arrangements are consistent with the measure.

This section first describes ASX Clear and ASX Clear (Futures)' governance framework with respect to the control of financial risk, before assessing the framework against the key aspects of the measure, as outlined above. Since the two ASX central counterparties are part of the same corporate group, a common governance framework is applied. In what follows, therefore, the two facilities are treated collectively.

ASX's Governance Framework

Board

ASX Clear and ASX Clear (Futures) are subsidiary companies of ASX Limited. The central counterparties are each governed by a board of directors (the CS Boards), while ASX Group is governed by the ASX Limited Board.

Ultimate responsibility for the control of financial risks faced by the central counterparties lies across the ASX Limited Board and the CS Boards. The ASX Limited Board, which is primarily responsible for the overall performance of ASX Group, has a responsibility to ensure the conduct of the ASX Group is consistent with its licence obligations, as well as ‘public policy objectives directed at financial market and payments system integrity’. However, much of the responsibility for oversight and risk management of the central counterparties has been delegated to the CS Boards. Specifically, the ASX Limited Board relies on the CS Boards to provide oversight in respect of: the management of clearing and settlement risk; compliance with the FSS; and the review of the statutory and management accounts of the central counterparties.

The ASX Limited Board also maintains an Audit and Risk Committee, and a Nomination and Remuneration Committee. The Audit and Risk Committee has responsibility for considering the risk management processes, internal controls and compliance systems within ASX (other than those matters which are the responsibility of the CS Boards), as well as overseeing the internal and external audit of ASX Group. The Nomination and Remuneration Committee is responsible for reviewing the remuneration and incentive framework of the Managing Director and CEO (hereafter the CEO), and of ASX staff more broadly. The Committee also nominates non-executive directors of the ASX Limited Board, assesses the requirements for these directors and reviews their remuneration.

The composition of the boards and committees is discussed in detail below.

Management

Within the ASX Group organisational structure there are five functional areas with at least some responsibility for central counterparty financial risk management. These are:

  • the Clearing Risk Policy unit, which has responsibility for determining policies regarding management of central counterparty risks;
  • the Clearing Risk Management unit, which is responsible for implementing clearing risk policies;
  • the Enterprise Risk and Compliance unit, which, among other things, is responsible for ensuring compliance with the FSS;
  • the Internal Audit unit, which, among other things, audits the implementation of risk policy by the Clearing Risk Management unit; and
  • the Portfolio Risk Manager, who is responsible for managing counterparty, credit and liquidity risk arising from the investment of cash margins and other cash-based funds of the central counterparty.

Each function is headed by a General Manager, with the exception of the Portfolio Risk Management function, which is solely comprised of the Portfolio Risk Manager. Each function reports to the Chief Risk Officer (CRO), an ASX Group Executive who in turn reports to the CEO. The Internal Audit unit also reports directly to the Audit and Risk Committee and to the CS Boards where appropriate. These arrangements reflect some changes made to ASX's organisational structure over the past year. Previously the Clearing Risk Management unit was called Clearing Risk Operations and sat under the Group Executive Operations. Portfolio Risk Management was previously called Treasury and sat under the Chief Financial Officer.

ASX also maintains a number of executive committees, comprising a range of Group Executives and Executive General Managers, and in some cases, General Managers. The executive committees with some responsibility for financial risk management include the Enterprise Risk Management Committee, the Capital and Liquidity Committee, the Enterprise Portfolio Steering Committee, and the Clearing Risk, Operations and Compliance Liaison Committee.

Assessment against the Governance Measure

The central counterparty must have effective, accountable and transparent governance arrangements.

ASX's governance arrangements are relatively transparent by international standards. ASX Limited publishes information about its governance arrangements online and in its annual report. Information made publicly available includes: a high-level organisational structure; the charters of the boards and board committees; the composition of these boards and committees; and profiles of the board members. In its annual report, ASX Limited also discusses its compliance with the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations, which cover a range of issues including the roles of the board and senior management, director independence, the role of board committees and remuneration decisions.

The governance arrangements also ensure accountability. The ASX Limited Board is ultimately accountable to shareholders for the performance of ASX Group. The Board reviews its own performance annually and the Chairman meets with each non-executive director (some of whom also sit on the CS Boards) to discuss individual performance. The Chairman also meets periodically with the external CS Board directors. The Chairman, with assistance from the Nomination and Remuneration Committee, is responsible for overseeing the processes and procedures used to evaluate board members' performance.

Broadly, in order to be effective, a central counterparty's governance arrangements should balance the interests of all relevant stakeholders in corporate decision-making. One aspect of this concerns how the interests of clearing participants are considered. The interests of clearing participants are taken into account in major decisions regarding central counterparty financial risk management through the use of public consultations. Feedback is also provided through ongoing routine interactions with clearing participants (for example, participant monitoring, participant returns, collection of margins) and through quarterly meetings with the Australian Financial Markets Association. Participants also have a designated ‘account manager’ at ASX, who acts as a conduit for feedback.

The effectiveness of the governance arrangements is considered in more detail in the subsections of the measure discussed below.

  1. The board of the CS facility licensee [must] have appropriate expertise and independence.

This aspect of the measure covers the expertise of the Board members and their independence from management of the central counterparty, other entities owned by the operator and any other boards within the corporate structure in which the central counterparty sits.

Independence

The ASX Limited Constitution requires that the number of directors fixed by the ASX Limited Board should be no less than seven and no more than 15. There are currently nine members of the ASX Limited Board, comprising the ASX Group CEO and eight non-executive directors. Non-executive directors are required to stand for election or re-election, as the case may be, at the ASX Limited annual general meeting as required by the listing rules.

The ASX Limited Board Charter requires that a majority of ASX Limited Board members be independent, and that the Chair of the Board be an independent non-executive director. ASX uses the definition of independence set out in the ASX Corporate Governance Principles and Recommendations, which defines an independent director as ‘a non-executive director who is not a member of management and who is free of any business or other relationship that could materially interfere with – or could reasonably be perceived to materially interfere with – the independent exercise of their judgement.’ The interests of individual ASX Limited Board directors are tabled at every ASX Limited Board meeting. A formal assessment of each director's independence is also undertaken annually. The 2009 ASX Limited Annual Report noted that all non-executive directors were considered to be independent.

The CS Boards each have the same members: one executive director (the ASX Group CEO) and six non-executive directors, of whom four are members of the ASX Limited Board and two are external directors. This current structure came into effect in February 2010 and represented a strengthening of the independence of the CS Boards – prior to this the CS Boards comprised four executive directors and four non-executive directors, of which two were external directors and two were ASX Limited non-executive directors. Members of the CS Boards are appointed by the ASX Limited Board.

Members of the Audit and Risk Committee are also appointed by the ASX Limited Board. The Charter of the Committee requires that it have at least three members. The Charter further specifies that neither the Chair nor any executive directors of the ASX Limited Board may sit on the Committee. The Committee currently has four members, all of whom are non-executive directors of the ASX Limited Board.

The Nomination and Remuneration Committee is also appointed by the ASX Limited Board. As with the Audit and Risk Committee, it is required to have at least three members and the majority must be independent ASX Limited non-executive directors. The Charter of the Nomination and Remuneration Committee states that its Chairman will be the Chairman of the ASX Limited Board. There are currently five members of this Committee.

While most of the directors on the CS Boards are also on the ASX Limited Board, the Reserve Bank is satisfied that they exhibit independence. As noted above, the ASX Limited Board has delegated responsibility for central counterparty risk management to the CS Boards, and as such the CS Boards essentially act as a specialised ‘risk committee’, with the ASX Limited Board considering broader corporate issues. Decisions on central counterparty risk management are made by the CS Boards and reported to the ASX Limited Board – the ASX Limited Board has no decision-making role in these matters. Furthermore, as noted earlier, the CS Boards have two external directors that are not directors of ASX Limited. This further bolsters the independence of the CS Boards.

Expertise

The Nomination and Remuneration Committee is responsible for establishing and evaluating the ‘necessary and desirable competencies’ of the ASX Limited Board and its committees. The 2009 ASX Limited Annual Report notes that ‘the Board considers that individually and collectively the directors bring a level of skill, knowledge and experience that enables the Board to discharge its responsibilities effectively’. The expertise of the CS Boards is enhanced by the presence of two independent directors who are appointed for their skills and expertise in clearing and settlement, and operational risk management matters. Additionally, members of the Audit and Risk Committee are required to have working familiarity with general finance and accounting practices.

  1. The board of the CS facility licensee [must] be responsible for oversight of the operation of the central counterparty.

The ASX Limited Board Charter sets out the responsibilities of the ASX Limited Board and the CS Boards with respect to their roles in ensuring the central counterparty meets its licence requirements relating to financial risk management. For example, this includes the responsibility of the ASX Limited Board for overseeing ‘the processes for identifying significant risks facing the ASX Group and that appropriate and adequate control, monitoring and reporting mechanisms are in place’, and the fact that the ASX Limited Board relies on the CS Boards to provide oversight in respect of ‘the management of clearing and settlement risk’ and ‘compliance with the FSS’.

ASX has in place a schedule of regular reporting to ensure the appropriate boards and committees are informed regarding central counterparty risk controls and compliance with the FSS. For example, the CS Boards are updated quarterly on the activities of the Clearing Risk Management and Clearing Risk Policy functions, as well as regarding any projects related to the CS facilities. Both the Audit and Risk Committee and the CS Boards are also updated regularly regarding ASX's compliance with the FSS. All reporting to the Boards is generally done through the relevant executive committee.

Through the Audit and Risk Committee the ASX Limited Board also has direct oversight of the Internal Audit function. According to the Committee's charter, its responsibilities include:

  • reviewing the adequacy of resources and governance arrangements of the internal audit function;
  • reviewing and concurring on the appointment, replacement or dismissal of the General Manager Internal Audit; and
  • reviewing the effectiveness of the internal audit function.

Board members are also encouraged to access members of senior management at any time to request relevant information in their role as a director and are entitled, with the approval of the chairman, to seek independent professional advice at the company's expense in matters relating to their role as a director.

To evaluate management, the Board assesses the performance of senior executives against group and individual performance targets, with the assistance of the CEO and the Nomination and Remuneration Committee.

  1. The risk-control function of the central counterparty must not be adversely influenced by its business, marketing or other operations.

Within ASX's governance framework, reporting lines for those units with responsibility for financial risk management are segregated from other business units. As noted above, these units report to the CRO, who in turn reports directly to the CEO. The CRO is not responsible for any other functions, and none of the units within the CRO's portfolio have a revenue or profit objective. The Internal Audit unit also has separate reporting lines directly to the Audit and Risk Committee, and to the CEO.

Summary

It is the Reserve Bank's assessment that ASX Clear and ASX Clear (Futures)' governance arrangements are consistent with the governance measure of the Financial Stability Standards. The governance arrangements are effective, accountable and transparent. Arrangements are in place to ensure the boards of ASX Clear and ASX Clear (Futures) have appropriate expertise and independence; indeed, the independence of these boards was bolstered during the year by the removal of all but one of the executive directors (the ASX Group CEO remains). The ASX Clear and ASX Clear (Futures) boards are formally responsible for oversight of the operation of the central counterparties, and arrangements are in place to ensure this oversight is effectively conducted. Finally, the risk control function of the central counterparties is independent from their other functions, with the business units responsible for financial risk management sitting under the CRO, who reports directly to the CEO.