Assessment of ASX Clearing and Settlement Facilities 3. Special Topic on CCP Margin Arrangements

An effective margining system is a critical component of a CCP's financial risk management framework. Margin held by a CCP is the first layer of financial protection against losses incurred due to a participant default, and is a ‘defaulter-pays’ (i.e. non-mutualised) resource. Because the amount of margin collected from a participant scales with the level of risk associated with the participant's portfolio, margin may also assist in incentivising participants to manage and contain the risk they bring to the CCP.

The amount of margin collected for a particular portfolio is sensitive to the model, parameters and assumptions chosen by a CCP in designing its margin system. The design of this system also determines the frequency with which a CCP will call its participants for margin, and the responsiveness of margin requirements to changes in market conditions. Margin represents the majority of collateral held by the ASX CCPs: during the Assessment period the CCPs collectively held around $6 billion in margin, relative to a total of $900 million in pooled financial resources.

The FSS contain a number of requirements in relation to a CCP's margin arrangements within CCP Standard 6. This section provides an overview of the ASX CCPs' margin arrangements and the results of the Bank's detailed assessment against CCP Standard 6. Consistent with the Bank's usual practice, the Bank has assigned ratings for each sub-standard within CCP Standard 6, as part of the detailed assessment. The section focuses on eight key requirements:

• Initial margin. Initial margin, which aims to cover potential future changes in the value of each participant's position, should meet an established single-tailed confidence level of at least 99 per cent with respect to the estimated distribution of future exposure (CCP Standard 6.3).
• MPOR. The initial margin model should use a conservative estimate of the time horizons for the effective hedging or close-out of the products cleared by the CCP (including in stressed market conditions) (CCP Standard 6.3).
• Portfolio margining and offsets. A CCP may allow offsets or reductions in margin across products that it clears if the risks of the products are significantly and reliably correlated (CCP Standard 6.5).
• Procyclicality. A CCP's margin system should, to the extent practicable and prudent, limit the need for destabilising procyclical changes (CCP Standard 6.3).
• Variation margin. A CCP should mark participant positions to market and collect variation margin at least daily to limit the build-up of current exposures (CCP Standard 6.4).
• Intraday margin. A CCP should have the authority and operational capacity to make intraday margin calls and payments, both scheduled and unscheduled, to participants (CCP Standard 6.4).
• Pricing. A CCP should have reliable sources of timely price data, as well as procedures and sound valuation models for addressing circumstances in which pricing data are not readily available or reliable (CCP Standard 6.2).
• Review and validation. A CCP should analyse and monitor its margin model performance and overall margin coverage through backtesting and sensitivity analysis, as well as regularly review and validate its margin system (CCP Standards 6.6 and 6.7).

3.1 Initial Margin Models

CCP Standard 6.3 states that CCPs should use margin models that generate margin requirements sufficient to cover their potential future exposure to participants and appropriately account for relevant risk factors of the products cleared.

For any margin model, a CCP must set three key parameters:

• Confidence interval. The target level of coverage of initial margin over potential future exposures. The FSS require that a CCP target initial margin to meet a single-tailed confidence level of at least 99 per cent of the estimated distribution of future exposures.^[17]
• Look-back period. The sample of historical data used to estimate the model.
• MPOR. Also known as the close-out period, this is the projected length of time between (i) the receipt of the last margin payment from a defaulting participant, and (ii) when all of that participant's positions have been closed out. That is, it is the period in which the CCP is exposed to potential losses on a defaulting participant's portfolio.^[18]

ASX's margin arrangements include a suite of initial margin models. Table 6 summarises the margin model used for each product class, including the key parameters. Notably, while ASX's policy is that margin coverage should achieve at least the regulatory minimum, in practice, ASX targets a confidence interval of 99.7 per cent in each margin model. ASX has indicated that this added degree of conservatism provides it comfort that it will not breach the regulatory minimum.

ASX's key margin models are described further in Sections 3.1.1 to 3.1.3. In addition to the amounts calculated by its margin models, ASX also levies margin ‘add-ons’ to account for certain risks which are not taken into account by its models. These add-ons are described in Section 3.1.4.

3.1.1 Exchange-traded derivatives

The ASX CCPs calculate initial margin for exchange-traded derivatives using CME SPAN.^[19] In the CME SPAN model, margin requirements are first calculated for groups of similar products, and are then aggregated to generate an overall requirement for a participant's portfolio. For example, at ASX Clear (Futures), all futures and options based on 90-day bank bills, at all expiries, are within a single group. Margin requirements for a product group are based on an estimate of the largest potential one- or two-day loss in value for that group, up to a given confidence level. This loss is modelled using hypothetical market shocks, based on various combinations of price and volatility changes (discussed below). In aggregating margin requirements within and across product groups, the CME SPAN model also applies a series of adjustments to account for correlations between products and certain specific risks (see Section 3.3).

To generate the hypothetical market shocks applied to product groups, ASX first calculates the ‘price scanning range’ (PSR) and ‘volatility scanning range’ (VSR) for the product group. These parameters reflect the maximum expected price and implied volatility movements for the contracts within the group. To calculate the PSR and VSR, ASX considers the higher of one- and two-day movements in price or implied volatility, using the higher of a 60- or 252-day look-back period. The parameters are set to cover a confidence interval of 99.7 per cent.^[20]

Once ASX has calculated the PSR and VSR, a set of 16 hypothetical scenarios are created using alternative combinations of price and volatility changes based on the PSR and the VSR, and the participants' portfolios are valued under each scenario.^[21] The base margin requirement for the portfolio is set at the highest estimated loss across all scenarios.

Although ASX typically sets CME SPAN parameters in accordance with the calculation described above, it may also make discretionary adjustments to parameters such as the PSR or VSR based on a forward-looking assessment of future market conditions. For example, at the end of June 2016, ASX increased margin rates applicable to the 3- and 10-year Treasury bond futures contracts in response to heightened market volatility following the UK referendum on EU membership (Graph 1). These increases were pared back towards the end of 2016. ASX reviews CME SPAN model parameters on a three-monthly cycle for all products except equity derivatives, for which the PSR and VSR are reviewed on a monthly cycle. ASX may also adjust parameters at other times on an ad hoc basis.

3.1.2 OTC interest rate derivatives

ASX Clear (Futures) uses a filtered historical simulation value at risk (FHSVaR) model to calculate margin requirements for OTC derivatives, using a sample period starting from June 2008. Value at risk (VaR) models calculate the expected loss on a portfolio by considering the (actual or simulated) distribution of changes in the entire portfolio's value over an assumed close-out period. The margin requirement is set at the expected loss of the portfolio implied by that distribution, at a given level of confidence. For example, the VaR margin requirement on a portfolio consisting of a single contract could be set using the third-worst price movement out of a sample of 1000 historical observations, corresponding to a 99.7 per cent confidence interval.

To generate margin requirements for portfolios consisting of multiple positions, the value of the portfolio at different points in history may need to be ‘simulated’ from historical price data of the constituent contracts. In the case of an OTC derivatives portfolio, the distribution of changes in the value of a participant's portfolio is simulated by revaluing a participant's portfolio under different historical interest rate scenarios. This simulation generates a history of the value of a participant's portfolio since June 2008, as well a set of five-day changes in the portfolio's value. ASX Clear (Futures) sets the base margin requirement by considering the expected loss on the portfolio based on this distribution at a 99.7 per cent confidence level.

This margin requirement is then filtered, or scaled, to reflect the level of current market volatility. For instance, if current volatility is high relative to previous periods, margin requirements may be scaled up. This recognises that the future distribution of changes in a portfolio's value may be different to the historical distribution of changes, particularly in volatile periods. ASX also applies a floor to its volatility scaling factor, which limits the extent to which margin requirements are reduced in low volatility conditions, helping to limit procyclicality (see Section 3.4).

3.1.3 Cash market products

ASX Clear uses two models to margin cash market products: a historical simulation value at risk (HSVaR) model, which is used for securities in the ASX 500 All Ordinaries index with more than two years of continuous price data (around 80 per cent of the securities in the index); and flat rates, which are used for all remaining cash market products. Collectively, these models are referred to as ASX's CMM model.

HSVaR

ASX Clear splits HSVaR-margined securities into two groups – ASX 200 securities, and other ASX 500 All Ordinaries securities – and calculates initial margin independently for each group. The HSVaR calculation for each group is similar to the FHSVaR calculation for OTC derivatives described above, although there is no filtering in the CMM model. ASX targets 99.7 per cent coverage using a two year look-back period, but approximates this coverage by using a 99 per cent confidence interval and then scaling up the resulting margin requirement by a ‘portfolio add-on factor’ (currently 30 per cent). ASX has indicated that it has chosen this process as it produces more stable margin requirements, given the small number of price observations beyond the 99th percentile in the two years of data. ASX's backtesting results have consistently verified that the CMM model has achieved at least 99.7 per cent coverage over the past few years.

Flat rates

For securities that are less liquid or that have less than two years of price history, ASX Clear applies a flat margin rate to each security in a participant's portfolio to calculate initial margin. Flat rates are based on available price information, targeting a 99.7 per cent confidence interval over a one-day close-out period. However, this coverage target is approximated using different confidence intervals and close-out periods according to liquidity and available price information (see Appendix C.1, CCP Standard 6.3). ASX assigns individual flat rates for securities in the All Ordinaries index with less than two years of price history. Other securities are grouped with broadly similar products, with all securities in a group assigned the same flat rate, and the margin requirement for that group calculated by applying the relevant flat rate to a participant's net settlement obligation for the group. The participant's overall margin requirement for these securities is the sum of these individual flat rate requirements; ASX does not allow offsets between different flat rate groups.

3.1.4 Initial margin add-ons

CCP Standard 6.1 requires that margin levels are commensurate with the risks and particular attributes of each product, portfolio and market that a CCP serves. To better account for these idiosyncrasies, ASX applies margin add-ons to address a number of product- and portfolio-specific risks that are not captured in its initial margin models.

• OTC derivative liquidity risk. To account for additional costs that might arise from the close-out of a large and/or illiquid OTC derivative portfolio, ASX applies a liquidity multiplier to the initial margin requirement calculated using the FHSVaR model. ASX surveys its OTC clearing participants on an annual basis to estimate the average liquidation costs associated with portfolios of a given size. The OTC derivative liquidity add-ons, which increase with a participant's initial margin, currently range from 5 per cent for OTC initial margin requirements above $50 million, to 33 per cent for initial margin above $500 million.
• Exchange-traded derivatives spread risk. During the Assessment period, ASX introduced add-ons to key CME SPAN parameters to address the risk that bid/offer spreads widen when ASX is closing out a defaulting participant's portfolio.^[22] The spread risk add-ons are applied to electricity and agriculture futures and less actively traded ETOs. The add-ons are not applied to ETOs on SPI futures or to ETOs on the 20 most actively traded stocks, as ASX has indicated the spread risk on these products is not significant. To calibrate the spread risk add-ons for each product, ASX uses a 99.7 per cent confidence interval over a 12-month sample of bid/offer spreads, using the most conservative 12-month sample from the last five years.

In addition to these add-on arrangements already in place, ASX intends to enhance its management of liquidity risk at both CCPs by introducing automatic risk-based add-ons. Currently, ASX has the discretion to call additional initial margin (AIM) if risks from illiquid or highly concentrated portfolios exceed one or more pre-specified triggers. Under the new approach, which will be implemented in December, add-ons will reflect the magnitude of the risks, and trigger automatic calls for AIM.^[23]

ASX's proposed liquidity risk add-on is intended to account for the additional costs associated with closing out a large and/or illiquid portfolio, including the risk that these portfolios may take longer to close out than assumed in ASX's MPORs (see Section 3.2). This approach allows ASX to specifically target the portfolios for which this risk arises, rather than increasing the initial margin requirement for all portfolios. These add-ons will be applied automatically if a participant holds more than a certain per cent of the average daily trading volume in a particular futures contract, or more than a certain per cent of open interest for a particular options contract. The add-ons will increase proportionally with the size of the participant's exposure. ASX is also intending to apply liquidity add-ons to cash equities products.

3.2 Margin Period of Risk

CCP Standard 6.3 requires CCPs to conservatively estimate the time it might take to close out or effectively hedge a defaulting participant's positions, including in stressed market conditions. The guidance to the FSS notes that a CCP should justify its close-out periods for each product type, taking into account: historical price and liquidity data; the concentration of participant positions; reasonably foreseeable events following the default of a participant; and the impact of a participant's default on market conditions. This recognises that the MPOR assumption should be supported by a high degree of analytical rigour, given the importance of this parameter in CCPs' margin models.

ASX has set its MPORs at one day for cash market products, two days for exchange-traded derivatives, and five days for OTC IRDs. The range of MPORs primarily reflects ASX's assessment of structural market liquidity across these products.

ASX is in the process of developing and documenting the analytical basis of its MPORs for all classes of products it clears. ASX's analysis will consider a range of factors, including: historical turnover, liquidity and price data; concentration of participant portfolios; and likely market conditions in default scenarios. ASX will also introduce backtests which vary the assumed timing of a participant's default relative to the last margin payment, in order to assess the impact of this assumption on margin coverage.

ASX expects its final analysis to be completed for all products in the next nine months, and has already conducted preliminary analysis on some products. This preliminary analysis has included an initial assessment of the impact of the one-day MPOR assumption on margin coverage in the CMM model; this analysis has indicated that initial margin coverage has exceeded 99.7 per cent for both one-day and two-day price moves for the past few years, and exceeded 99.7 per cent for three-day price moves over the past year. The Bank expects that ASX will conduct a full analysis of the adequacy of MPOR assumptions for all products, including those subject to the CMM model.

3.3 Portfolio Margining

CCP Standard 6.5 states that a CCP may allow offsets or reductions in margin across products that it clears if the risk of one product is significantly and reliably correlated with the risk of the other product. All of ASX's margin models permit some form of offset, except for the flat rates applied to cash market products.^[24]

ASX's VaR-based models for cash market products and OTC derivatives calculate margin using the historical distribution of the portfolio's value over the sample period. As a result, offsets based on historically observed price correlations between products are implicitly recognised in the margin calculation. ASX Clear (Futures) also allows an OTC participant to select a set of interest rate futures in its house account to be margined (using FHSVaR) within the portfolio of the participant's cleared OTC derivatives. Offsets for these futures, including against OTC derivatives, are similarly implicitly recognised within the FHSVaR model. The use of an extended look-back period helps to validate the reliability of the historical correlations underlying calculations in ASX's FHSVaR model for OTC derivatives.

The CME SPAN model, which ASX uses for exchange-traded derivatives, allows for margin offsets between related contracts via inter-commodity spread concessions (ICCs). These offsets recognise correlations observed across related contracts and are only applied where measures of correlation exceed certain predefined thresholds.^[25] ASX applies two different types of ICCs:

• Hedging offsets are provided where a participant has offsetting positions in contracts with robust positive correlations (where losses from one contract are likely to be offset by gains in the other contract).
• Stability offsets, which are only recognised at ASX Clear, are provided where a participant has long/long or short/short positions in two contracts, in recognition of the risk-reducing benefits provided by portfolio diversification.^[26]

During the Assessment period, ASX introduced enhancements to its sensitivity analysis framework (see Section 3.8); the revised framework includes tests of the robustness of the offsets in ASX's margin models to changes in correlations, including the impact of a complete erosion of correlations underlying its ICC offsets. The Bank will monitor the results of this analysis over the next assessment period.

3.4 Procyclicality

Procyclicality in margining refers to changes in margin that are positively correlated with market fluctuations. Margin will often increase in periods of heightened volatility. Such increases may be automatic – as volatile price observations are incorporated into the model's look-back period, or due to the effect of ‘filtering’ in an FHSVaR model (see Section 3.1.2) – or they may be discretionary, based on the CCP's assessment of expected future volatility (see Section 3.1.1). These increases may be appropriate and necessary to ensure the CCP maintains sufficient margin coverage. However, rapid increases in margin rates during a period of heightened volatility may exacerbate financial stress (for example, by increasing liquidity strain on clearing participants). CCP Standard 6.3 requires that CCPs limit the need for destabilising procyclical changes in margin requirements, to the extent practicable and prudent.

To manage procyclicality, ASX's CME SPAN and FHSVaR models incorporate parameter floors to prevent margin requirements from falling too low when volatility is low; this helps to reduce the variability in margin requirements between low and high volatility periods. For the CME SPAN model, these floors are applied to the PSR or VSR on a discretionary basis, and are set based on a range of quantitative and qualitative information. For the FHSVaR model, a floor is applied to the factor used to ‘filter’ historical interest rate changes. This factor scales margin requirements higher or lower in response to the current level of volatility, ensuring margin requirements are responsive to current market conditions. For the past few years, ASX has maintained this floor at or above 100 per cent. This means that, while margin requirements may be scaled up in high volatility periods, they are not scaled down in low volatility periods. This reduces the potential for variability in margin requirements if a low volatility period is followed by a high volatility period.

For the FHSVaR model, ASX also mitigates procyclicality by using an extended look-back period that begins in June 2008. This look-back period incorporates several periods of market stress, including the 2008 financial crisis. All else being equal, including periods of market stress in a model's look-back period will increase base margin requirements and reduce the likelihood that margin requirements need to be increased in high volatility periods, or the magnitude of any increase that is required.^[27]

In light of evolving regulatory expectations in this area, over 2017/18 ASX intends to review the effectiveness of its arrangements to limit the need for destabilising procyclical changes in its margin requirements. This review will cover all of ASX's margin models. The Bank will monitor this work as it progresses as part of its broader review of the CCPs' arrangements against the recently published CPMI-IOSCO Resilience Guidance.

3.5 Variation Margin

CCP Standard 6.4 requires CCPs to mark participant positions to market and collect variation margin at least daily, to limit the build-up of current exposures. ASX's approach to cover current exposures varies by CCP and by product:

• For exchange-traded derivatives and OTC derivatives cleared by ASX Clear (Futures) and low-exercise-price options (LEPOs) at ASX Clear, variation margin is collected at least daily. Variation margin is collected from participants with a mark-to-market loss and passed on to participants with a mark-to-market gain.
• For ETOs for which a participant has a net short position, ASX Clear calculates and collects ‘premium margin’ daily from participants. This is conceptually similar to variation margin and is based on daily mark-to-market changes in the value of the net position. Premium margin collected is held by ASX. Premium margin is not levied on net long ETO positions (i.e. where the potential exposure on the position cannot fall below zero).
• For equity trades in the constituents of the All Ordinaries index, ASX collects ‘mark-to-market margin’, which is conceptually similar to variation margin collected on other exchange-traded products. However, rather than being passed through directly, mark-to-market gains are offset against the participant's posted initial margin (with the offset capped at the level of initial margin).

ASX does not collect variation, premium or mark-to-market margin on cash equity trades outside the All Ordinaries Index or on other cash market products (such as warrants); these products are subject to initial margin only. On these products, ASX Clear is exposed to up to two days of potential initial margin erosion between the point at which initial margin is called and the point the trade is settled. This effectively increases the margin period of risk on these trades by two days, as a participant may default immediately prior to the point of settlement. Although these products make up a small share of total risk exposure at ASX Clear (around 15 per cent of average initial margin over 2016/17), ASX will nevertheless assess the appropriateness of its MPORs for these products as part of the comprehensive MPOR analysis it will conduct over 2017/18 (see Section 3.2). This analysis will include consideration of whether MPORs appropriately account for the potential accumulation of exposures.

The Bank will review this analysis during the next assessment period. In the interim, ASX Clear has reviewed backtesting results for the CMM model to confirm that the model achieved margin coverage above 99.7 per cent over one-, two-, and three-day close-out periods over the past year.

3.6 Intraday Margin

CCP Standard 6.4 also requires that CCPs have the authority and operational capacity to make intraday margin calls and payments, both scheduled and unscheduled, to participants. Both ASX CCPs conduct a scheduled end-of-day margin run, which is calculated at 4.30 pm and settled the next morning at 11.00 am. Between each end-of-day run, the CCPs' exposures to their participants may increase due to changes in the composition and/or the value of participants' cleared portfolios. ASX Clear and ASX Clear (Futures) have different processes for managing this intraday exposure, which reflect differences in the materiality of intraday changes in exposures and the operating hours of the two CCPs.^[28]

3.6.1 ASX Clear

ASX Clear does not conduct scheduled daily intraday margin runs, but an intraday run may be triggered on an ad hoc basis by large price moves.^[29] In the event that an intraday margin run is triggered, a margin call is only made if the call exceeds a minimum margin erosion threshold of 25 per cent (i.e. the account's margin balance has eroded by 25 per cent of its initial margin) and the call is greater than $100,000.^[30] During the Assessment period, ASX shortened the settlement deadline for ASX Clear intraday margin calls from two hours to one hour.

3.6.2 ASX Clear (Futures)

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

Day Session (8.30 am to 4.30 pm)

ASX Clear (Futures) currently conducts two scheduled intraday margin runs during its Day Session, at 11.10 am and 1.30 pm.^[31] ASX Clear (Futures) is also able to conduct ad hoc intraday margin runs during the Day Session, and will do so in response to large price movements in key contracts. Intraday margin calls must be met by participants within one hour of notification. ASX Clear (Futures) also recalculates margin on OTC derivatives hourly, and may call for additional margin during the Day Session if a participant's margin requirement exceeds their excess collateral lodged with ASX Clear (Futures).

From the end of September, ASX Clear (Futures) plans to eliminate minimum margin erosion thresholds that had previously applied to intraday margin calls and discontinue its practice of returning excess intraday margin as part of the 1.30 pm call. ASX Clear (Futures) also plans to eliminate risk-based erosion thresholds, replacing them with a flat $1 million minimum call amount.^[32] These changes are designed to ensure that a greater proportion of intraday exposures are collateralised in the lead-up to the Night Session.

Night Session (5.10 pm to 7.00 am)

ASX Clear (Futures) runs hourly margin calculations during the Night Session; however, participants are unable to make AUD margin payments overnight as the Australian payments system is closed. As a result, any margin erosion following the final intraday margin run at 1.30 pm can currently only be covered by a margin call the following morning.

ASX has recently commenced work on developing and implementing additional arrangements to manage potential exposures during the Night Session. These additional arrangements have been prompted in part by steady growth in activity in the Night Session. Between 2011 and 2016 the proportion of trading volume executed in the Night Session increased by 9 percentage points to represent around one third of transactions executed at ASX Trade 24 (Graph 2). The additional arrangements have also been motivated by the potential for events outside the Australian trading day to have a large impact on the Australian market. ASX Clear (Futures)' long-term plan to manage its overnight risks is to implement real-time margining capabilities on a 24/6 basis, including scheduled overnight margin runs. Overnight margin calls would reduce the size and duration of ASX's overnight exposures and provide ASX with greater flexibility to respond to changes in exposures during the Night Session. ASX expects to implement this proposal by mid-2020.

In the interim, to address uncovered overnight margin exposures ASX is in the process of implementing a number of short-term enhancements to its intraday and overnight risk management arrangements. By the end of September, ASX Clear (Futures) plans to introduce an additional intraday margin run at 8.05 am. This change will reduce the duration of overnight margin exposures by around two hours.

ASX Clear (Futures) has also recently put in place a requirement for certain participants to lodge an AIM ‘buffer’ to cover a portion of potential margin erosion during the Night Session. The requirement was effective from July 2017 and applies to participants with overnight activity over 2016/17 above certain thresholds. To determine the amount of AIM each participant was required to post, ASX reviewed the participant's daily overnight margin erosion over the previous 18 months and set the requirement based on the average monthly 80th percentile of that participant's peak overnight exposures. Ten participants, representing 97 per cent of overnight activity and over 90 per cent of total initial margin at ASX Clear (Futures), are currently subject to this requirement.^[33]

ASX is planning to implement a daily overnight USD margin call on the participants who meet the minimum overnight activity thresholds described above. Once this is implemented, ASX will remove the AIM buffer requirement (although participants may choose to post excess margin overnight in order to reduce the operational burden associated with regular overnight margin calls). ASX expects to implement the daily overnight margin call in September 2017.

3.7 Pricing

Price data are a key input into a CCP's margin models – correct prices are needed to ensure that margins are set at the right level. CCP Standard 6.2 requires that CCPs have timely sources of price data and have in place procedures and valuation models for situations when price data are not available or are unreliable. The guidance to CCP Standard 6 further requires that CCPs continually evaluate the accuracy and reliability of price data and that pricing models are independently validated at least annually under a variety of market scenarios.

The ASX CCPs source price data for cash market products and exchange-traded derivatives from the ASX Trade and ASX Trade 24 markets. OTC IRDs are priced using third-party data sources. Some settlement prices, including for electricity and other commodity derivatives, are also sourced from third parties.^[34] ASX maintains separate models to calculate prices for ETOs and OTC IRDs, which are independently validated as part of ASX's regular model validation process (see Section 3.8).

ASX runs a set of checks and validations for its price data each day to ensure they are correct. These include comparing daily price movements against predefined tolerance levels and independent third-party data where possible. ASX also checks price data for consistency across products. Potentially erroneous prices are investigated and, if the prices are deemed to be incorrect, the ASX CCPs have the authority to amend them.

ASX has procedures and contingencies in place for situations in which prices are not available or are deemed to be unreliable (e.g. in a market outage). For OTC IRDs, ASX has multiple third-party data sources which it can use, and may contact brokers for information if other sources are unavailable. For exchange-traded products, the ASX CCPs would rely on the last traded price unless there is evidence of material market movements from related products. For instance, ASX may model the price of exchange-traded derivatives using the price of the underlying asset, if available. For the constituent equities of the S&P/ASX 200 index, ASX may use price movements in the SPI futures contract as a proxy.

Following the ASX Trade outage in September 2016 and in response to a recommendation from ASIC, ASX reviewed its process for setting the prices used for margining purposes (i.e. settlement prices) in the event of a market disruption (see Section 2.4.1). As a result of this review, ASX has published a consultation paper to seek feedback from its stakeholders on its processes for determining settlement prices in ASX Clear during a market outage. Separately, ASX will also consult with the Risk Consultative Committee for ASX Clear (Futures) on its methodologies for determining settlement prices for ASX 24 products if the market is unavailable. The Bank will monitor the ASX CCPs' consultation with their participants on the determination of settlement prices during an outage of ASX Trade and ASX 24.

3.8 Review and Validation

CCP Standard 6.6 requires CCPs to analyse and monitor model performance and overall margin coverage through backtesting and sensitivity analysis. Backtesting is a comparison of actual model performance against predicted model outcomes. ASX conducts backtesting at the portfolio level for each of its margin models. It also tests key model parameters, including the PSR and VSR in CME SPAN, and flat rates for cash market products. ASX conducts backtesting daily and reports the results showing the coverage rate for each model over the previous month, quarter and year to relevant staff in the Risk division, along with the results of sensitivity analysis. Backtesting results are also disclosed to participants and the Bank on a monthly basis. ASX is also planning to implement enhancements to its backtesting approach by the end of 2017. This will include new backtests incorporating changes to the assumed timing of default and enhanced statistical tests of backtesting results. Recent results indicate that ASX's margin models have achieved coverage above 99.7 per cent over the past year (Table 7). See Appendix C.1, CCP Standard 6.6 for a comprehensive overview of ASX's backtesting methodology.

During the Assessment period, ASX refined and documented its approach to sensitivity analysis. ASX's refined approach assesses the sensitivity of margin requirements to changes in all key margin parameters, including the MPOR, look-back period and confidence interval. ASX also intends to conduct ‘reverse sensitivity analysis’ on CME SPAN margin models to determine the degree to which key CME SPAN parameters need to be varied in order to breach target initial margin coverage. ASX will perform its new sensitivity analysis on the CME SPAN and OTC FHSVaR models on a monthly basis from September 2017, with the analysis extending to the CMM model from the end of December 2017. The Bank will monitor the refinement of this framework and the results of this analysis over the coming assessment period. This will be done as part of the Bank's broader review of the ASX CCPs' alignment with the new CCP Resilience Guidance (see Section 2.2).

The CCPs' margin methodologies are also subject to comprehensive validation and ongoing review under ASX's Model Validation Standard (see Appendix C.1, CCP Standard 4.5). Clearing Risk Quantification and Development (CRQD) is responsible for conducting the regular reviews of models, while Internal Audit coordinates the independent validation process with CRQD input. The results of these reviews and independent validations are reported to the CRQD and the CCPs' Boards. ASX made changes to its model validation framework during the Assessment period, including changes to the frequency of independent validations for some margin models (see Section 2.1.4).

3.9 Conclusions and Recommendations

ASX has well-established margining arrangements, which it has continued to enhance over recent years. The Bank's assessment is that ASX Clear ‘observes’ all of the sub-standards in CCP Standard 6: Margin. ASX Clear (Futures) ‘observes’ all of the sub-standards under CCP Standard 6 except sub-standard 6.4, which it ‘broadly observes’. In the case of sub-standard 6.4, the Bank assesses that the lack of operational capacity to make scheduled or unscheduled margin calls and payments during ASX 24's Night Session is an issue of concern that should be addressed by ASX Clear (Futures) in a defined timeline. ASX has already made progress to address this issue, in particular through the introduction of the requirement for certain participants to lodge AIM to cover a portion of potential intraday exposures during the Night Session. ASX also has planned both short-term and long-term enhancements to ASX Clear (Futures)' risk management arrangements to more comprehensively manage these exposures, which it plans to complete by September 2017 and mid-2020, respectively. The Bank recommends that ASX implement these plans or take other steps to ensure comprehensive management of intraday exposures created during ASX 24's Night Session.

Apart from the recommendation on intraday risk, the Bank has made two recommendations outlining steps required for the CCPs to continue to observe the requirements in the margin Standard. These recommendations are consistent with plans ASX has already initiated and relate to:

• the management of liquidity risk in the CCPs' margin models for exchange-traded derivatives (CCP Standard 6.1)
• the analytical basis for the CCPs' MPOR assumptions (CCP Standard 6.3). ASX also has other work underway to enhance its margining arrangements:
• engagement with participants on prices used during a market outage
• a review of the effectiveness of its margin arrangements to limit destabilising procyclical changes
• implementation of a new sensitivity analysis framework.

The Bank will monitor ASX's implementation of these enhancements in coming assessment periods and report on ASX's progress in future assessment reports.

Footnotes

As discussed in the introduction to Appendix C, the Bank applies a supplementary interpretation of the CCP Standards to any domestically licensed derivatives CCP that provides services to participants that are either established in the EU or subject to EU bank capital regulations. As part of this interpretation, such CCPs would typically be expected to apply a higher confidence interval, of at least 99.5 per cent, in relation to less liquid products such as OTC derivatives. [17]

As part of the Bank's supplementary interpretation of the CCP Standards, any domestically licensed derivatives CCP that provides services to participants that are either established in the EU or subject to EU bank capital regulations would typically be expected to use a close-out assumption of at least five days for less liquid products, such as OTC derivatives, and the higher of a one- or two-day close-out period for more liquid exchange-traded products. [18]

Although ETOs and low-exercise-price options are margined using CME SPAN, the cash securities transactions generated by their exercise are margined with other cash market products (discussed in Section 3.1.3). [19]

For example, if ASX sets the PSR for a particular contract at $1,000, ASX's expectation is that the likelihood of a one-or two-day price move in the contract exceeding $1,000 is around 0.03 per cent. [20]

For example, one scenario has a price increase of two-thirds of the PSR, and volatility fall by the whole VSR. [21]

CME SPAN parameters are typically calculated using mid prices. [22]

Other AIM calls are subject to minimum call amounts of $1 million for cash market products and $2 million for other products. [23]

Further detail on portfolio margining is available in Appendix C.1, CCP Standard 6.5. [24]

Additional details on how ICCs are applied in margin calculations are available in Box A of the Bank's 2011/12 ASX Assessment, available at <https://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/assessments/2011-2012/pdf/report-2011-2012.pdf>. [25]

ASX applies caps to these offsets: hedging offsets are capped at 40 per cent at ASX Clear and 80 per cent at ASX Clear (Futures) (except for a small number of look-alike contracts with almost 100 per cent correlation); and stability offsets are capped at 20 per cent. [26]

A caveat to this is that extreme observations may become ‘diluted’ by less extreme observations in a long look-back period. This can be avoided by appending one or more periods of stress onto a rolling look-back period of fixed length. For example, a CCP may use the most recent five years of data plus the 2008/09 financial crisis as its look-back period. [27]

Further detail on both CCPs' intraday risk management practices is available in Appendix C.1, CCP Standard 6.4. [28]

A movement in the S&P/ASX 200 above 1 per cent, or a movement in an individual stock price above 15 per cent would trigger a review by ASX of the materiality of the exposures in relevant contracts. Where open interest and exposures are material, an intraday margin run will be performed. [29]

For both CCPs, the minimum payment or margin erosion thresholds do not apply to the end-of-day margin run. [30]

ASX Clear (Futures) also calculations intraday margin obligations at 8.05am but does not currently call for intraday margin based on these calculations. [31]

Margin erosion thresholds at ASX Clear (Futures) had previously varied depending on the participant's internal credit rating and the product class of the portfolio; the highest thresholds applied to client accounts of A- and B-rated exchange-traded derivatives participants and were set at the lower of $35 million or 25 per cent, meaning that significant margin erosion was required before a call would be made. [32]

ASX plans to apply this requirement to an additional participant in the near future. [33]

Settlement prices are used to determine settlement obligations for derivatives contracts and margin obligations for all products. For securities products, the settlement price will typically be the same as the market price (i.e. the last traded price executed on the ASX market). In the case of derivatives, the settlement price may be derived from one or more inputs (for example, the settlement price for an exchange-traded option is derived from the settlement price of a security). [34]