2012/13 Assessment of ASX Clearing and Settlement Facilities B1.1 ASX Clear
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.
Rating: Broadly observed
ASX Clear applies initial and variation margin to both derivatives products and cash securities transactions, using margin systems that are tailored to the particular attributes of these product types (CCP Standard 6.1). Timely price data are available for most products subject to ASX Clear's margining systems, and ASX Clear applies appropriate models to estimate prices when timely and reliable data are not available (CCP Standard 6.2). ASX Clear's margin models for both cash securities and derivatives ensure that initial margin meets a single-tailed confidence level of at least 99 per cent of the estimated distribution of future exposure, applying appropriate and conservative assumptions regarding close-out periods, product risks, portfolio effects and product offsets to limit the need for procyclical changes (CCP Standards 6.3, 6.5). In addition, ASX Clear applies variation margin to both securities and derivatives positions daily, and may call intraday margin on derivatives positions in the event of significant market movements (CCP Standard 6.4).
ASX Clear conducts daily checks of initial margin against variation margin requirements and performs an annual review of margin policy. ASX Clear implemented an enhanced backtesting regime in July 2013, but is still in the process of implementing its standards for comprehensive validation of its margin models, and developing its approach to sensitivity analysis of those models (CCP Standards 6.6, 6.7). The operating hours of ASX Clear's margin systems are consistent with those of related payment and settlement systems in Australia (CCP Standard 6.8).
The Bank notes the following steps that ASX Clear should take to fully observe CCP Standard 6:
- Implement plans to conduct monthly sensitivity analysis of material model assumptions (CCP Standard 6.6).
The Bank will also monitor annual validation and ongoing review of margin and stress-testing models under the ASX Model Validation Standard, and the implementation and further enhancement of the new margin backtesting regime, and will continue to monitor ASX Clear's approach to portfolio margining of cash equities in light of this enhanced analysis (CCP Standards 6.6, 6.7).
Based on this information, the Bank's assessment is that ASX Clear has broadly observed the requirements of CCP Standard 6 during the 2012/13 Assessment period. ASX Clear's margin system is described in further detail under the following sub-standards.
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.
ASX Clear applies initial and variation margin to both derivatives products, and cash securities transactions. In June 2013, ASX Clear introduced CMM, which involves the collection of initial margin and mark-to-market margin in respect of unsettled cash equity transactions. The routine margining of cash equities was identified by the Bank as a useful risk management tool in its 2008/09 Assessment, and subsequent Assessments have reported on ASX Clear's progress towards introducing CMM. The introduction of CMM in June 2013 met the Bank's expectation for the timing of implementation as set out in its 2011/12 Assessment. The selected methodology for initial margin calculation is largely based on the historical simulation of value at risk (HSVAR). The HSVAR methodology calculates hypothetical changes in the value of a portfolio of securities, using historical price moves, 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 18 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 70 per cent of total margins collected through the CMM system. Around 90 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 CGS depository interests, introduced in May 2013, are margined according to the flat rate applied to fixed interest products.
In December 2012, ASX Clear replaced its previous proprietary Theoretical Inter-market Margin System with CME SPAN for the margining of derivatives positions. The CME SPAN methodology is a widely used version of the internationally accepted Standard Portfolio Analysis of Risk (SPAN) methodology. Initial (risk) margin provides cover in the event that a participant defaults and an adverse price change occurs before the CCP can close out its exposure to the defaulted participant. ASX Clear also levies so-called ‘premium’ margin on short exchange-traded option positions, updating this daily to reflect mark-to-market changes in the close-out price, and levies variation (mark-to-market) margin on both long and short low exercise price options, and all futures positions. All margin rates are reviewed on a three-monthly cycle, supplemented with ad hoc reviews during especially volatile market conditions.
ASX Clear predominantly clears standardised, exchange-traded products with risks that are well known to both ASX Clear and its participants. The only OTC products cleared by ASX Clear are equity options that share similar characteristics to exchange-traded products.
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 has access to timely price data for the majority of its exchange-traded products. 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. These 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 exchange-traded options is calculated throughout the day using the Derivative Pricing System (DPS). Where available, the DPS uses recent traded prices, 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 OTC equity options, ASX Clear interpolates the value using the prices of similar exchange-traded options.
ASX is in the process of introducing enhancements to the DPS to improve the calculation of prices for less liquid stocks. These include new limits on implied volatilities, and cross-checks of calculated prices against trades in similar options. The pricing period has also been extended from a portion of a trading day to the whole day to increase the use of traded prices. ASX continues to review the DPS to ensure that it provides appropriate pricing data for margin calculations, and has engaged an external consultant to assist in this review. The DPS is considered a key risk model and accordingly will be subject to annual validation by ASX Internal Audit under ASX's Model Validation Standard.
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.
ASX's approach to margining takes into account price history at a granular level. Where price history is inadequate, the ASX methodology makes appropriately conservative adjustments. ASX Clear applies different margin models to securities and derivatives transactions.
Securities
For securities transactions, ASX applies a HSVAR-based model, which is calibrated to meet a single-tailed confidence interval of 99 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 applied to current participant portfolios (see CCP Standard 6.5).
To limit the need for procyclical changes, ASX applies an additional multiple to the margin rate determined via the HSVAR calculation.
For securities that do not have the required price history to apply HSVAR, ASX applies, consistent with its overall CMM approach, flat rate margins calibrated to cover 1-day price moves with a 99 per cent confidence at a portfolio level. In order to achieve the desired confidence level at the portfolio level, confidence intervals and close-out periods applied to individual stocks differ according to liquidity and available price information. Stocks in the ASX 200 target a 99.7 per cent confidence interval applied to a 1-day close-out period; other stocks in the All Ordinaries target a 97 per cent confidence interval over a 2-day close-out period; and all other products target a 95 per cent confidence interval over a 3-day close-out period. ASX Clear has developed a comprehensive backtesting methodology to verify that these parameters satisfy the desired level of cover for securities transactions at the portfolio level (see CCP Standard 6.6).
Derivatives
For derivatives transactions, ASX Clear calculates initial margin requirements using the CME SPAN methodology. The adoption of CME SPAN in December 2012 was designed to facilitate better calibration of exposures to ASX Clear's risk tolerance. The CME SPAN methodology calculates initial margin requirements that reflect the total risk of each portfolio – for ASX Clear, each house or client account is considered a separate portfolio. The key parameters in the CME SPAN methodology are the ‘price scanning range’ and ‘volatility scanning range’. These scanning ranges are calibrated to the distribution of price and volatility movements for a set of related contracts under normal market conditions. The scanning ranges are used to construct a set of 16 hypothetical risk scenarios used to measure the loss from a portfolio caused by a range of changes in price and volatility.
ASX Clear sets the scanning ranges at three standard deviations (a confidence interval of 99.7 per cent) of 60 days of historical data, using the higher of one- or two-day price movements. The sample period reflects a preference for incorporating recent market conditions. The inclusion of two-day price movements reflects a conservative assumption that a defaulter's positions may take up to two days to close out. ASX also evaluates margin rates against multiple look-back periods incorporating both short- and long-term periods (7 business days, 120 business days and 12 months).
ASX Clear also applies a series of adjustments within CME SPAN to account for correlations and specific risks. First, there is an upward adjustment to the margin requirement for a given set of related contracts, to account for less-than-perfect correlation between contracts with different expiries. ASX Clear also applies offsets designed to account for reliable and economically robust correlations across different contract types (see CCP Standard 6.5). In addition, ASX Clear applies an adjustment to cover its exposure on the day of contract expiry, since expiring positions are otherwise not included in that day's initial margin calculations. ASX 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.
Under the ASX Margin Rate Setting policy, the Manager or General Manager of ASX's CRM unit can approve adjustments to margin rates if the standard statistical analysis would result in an economically inappropriate outcome. This may be required 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 Rate Setting policy also allows the General Manager of Clearing Risk Policy to approve exceptions to the normal margin rate setting process based on a broader risk assessment.
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.
Margin requirements are calculated overnight, with variation margins based on closing prices each day, and are notified to participants the next morning. All margin obligations are settled via Austraclear and regular calls must be met by 10.30 am. When market movements exceed certain thresholds, ASX Clear will calculate intraday margin requirements on derivatives positions. This involves calculating the net mark-to-market losses on all positions, and the initial margin on any new positions opened during the day. Where a participant's margin shortfall is greater than $100,000 and represents an erosion of initial margin of 40 per cent or more, ASX Clear will call intraday margin. This must be met by participants within two hours of notification.
Under ASX Clear's AIM methodology (discussed above in relation to CCP Standard 4) a participant is also required to post additional collateral should stress-test outcomes reveal that the potential loss arising from its positions, as at the close of the previous day, exceeds a predetermined STEL or if participants have large portfolios relative to their capital (see CCP Standards 4.3 and 4.7).
Where margin payments are not made by the required time, ASX will contact the participant to determine the reasons for the delayed payment. Delayed payments are commonly the result of communication or technical issues involving the participant and/or its payment provider, and early communication by ASX is intended to ensure that, in such cases, payment can still be made within a short period of the required time. Where the matter is more serious, ASX will investigate to decide whether a default event should be declared, and if so how the default should be managed (see CCP Standard 12).
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.
ASX Clear applies margin at a portfolio (clearing participant) level for its securities products using its HSVAR methodology. This implicitly reduces the margin requirements for any products within the portfolio that have displayed negatively correlated risks over the previous 2 years. The use of historical simulation over a 2-year period establishes the significance and reliability of these correlations. ASX Clear also implicitly applies offsets to its flat-rate margining of less liquid products, such as warrants, fixed interest products and stocks outside the ASX 200, as the flat rates for these products are calibrated to confidence intervals of less than 99 per cent. The reliability and significance of the correlations underlying these offsets, which do not represent a significant proportion of ASX Clear's overall risk exposure, are subject to regular verification through backtesting (see CCP Standard 6.6). The Bank will continue to monitor ASX Clear's approach to portfolio-based margining of cash equities in light of the results of enhanced backtesting analysis.
In applying the CME SPAN methodology to derivatives transactions, ASX allows offsets in the form of ‘inter-commodity spread concessions’. These offsets reduce margin requirements to account for reliable and economically robust correlations observed across different ‘combined commodities’ – sets of contracts related to the same underlying. Inter-commodity spread concessions are only applied where measures of correlation between contracts exceed 30 per cent, and the correlation is based on economic fundamentals. Changes to inter-commodity spread concessions must be approved by the RQG, which considers whether changes identified by CME SPAN appropriately reflect underlying economic relationships, including through periods of market stress.
ASX Clear does not have any cross-margining arrangements with any other CCP, although at a later date ASX plans to reconsider introducing margin offsets between certain contracts cleared by ASX Clear and ASX Clear (Futures).
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.
CRM conducts daily checks of initial margin requirements against observed variation margin calls. Mark-to-market price movements that exceed particular thresholds relative to initial margin coverage trigger additional actions. Variation margin calls that exceed 30 per cent of initial margin trigger a discussion with the participant and are brought to management's attention, while calls that exceed 50 per cent constitute a margin breach that will require further investigation of margin settings.
Under its new Model Validation Standard, daily backtesting has been enhanced so as to test whether the margining models reliably cover price movements to a 99 per cent confidence interval. Initial margin collected from each participant is compared against variation margin collected over the following one or two days, depending on which is the larger amount. Where variation margin is greater than initial margin an ‘exception’ is recorded. CRM compares the number of exceptions to the expected number of exceptions, based on a 99 per cent confidence interval. The magnitude of exceptions is also reviewed. As part of its broader review of model validation procedures, ASX is considering extending its backtesting approach to the analysis of hypothetical portfolios, in order to decompose exceptions caused by a change in participant position from those that may reveal a shortfall in margin coverage, and thereby further ensure the robustness of the margining model. The Bank will monitor the progress of work to further enhance backtesting over the coming Assessment period.
As well as enhancing its daily margin backtesting, ASX intends to commence monthly sensitivity analysis of all material model assumptions by the end of 2013, including the look-back period used in backtesting, the liquidation (close-out) period, and the confidence interval used.
6.7 A central counterparty should regularly review and validate its margin system.
ASX Clear's margin methodologies will also be subject to a comprehensive annual validation and ongoing review under ASX's Model Validation Standard (see CCP Standard 4.5). The RQG will be responsible for performing the regular reviews of models, while Internal Audit will coordinate the independent validation process, including the use of external experts where this is deemed necessary by the RQG. This independent validation process will occur annually.
At ASX, the margining process is governed by a Margin Rate Setting policy, which is reviewed annually, with material changes approved by the CS 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 margining information on its website, including descriptions of the margining methodology, schedules of margin rates, and daily SPAN margin parameter files – allowing 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.
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 primarily provides clearing services for the Australian-based ASX market and Chi-X, as well as some OTC equity options on Australian stocks. 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)).