2006/07 Assessment of Clearing and Settlement Facilities in Australia 5.1 Australian Clearing House (ACH)

It is the Bank's assessment that Australian Clearing House complied with the Financial Stability Standard for Central Counterparties in the nine months to June 2007.

Background on ACH arrangements

ACH operates within a sound legal framework, based on its Clearing Rules, which under s822B of the Corporations Act have effect as a contract under seal between ACH and each of its participants, and between each participant and each other participant. Among other things, the rules set out the rights and obligations of ACH and each of its participants, including the clearing support provided by ACH as central counterparty and the conditions under which the settlement of obligations occurs. In addition, the netting arrangements contained in ACH's Clearing Rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act, providing certainty for the netting process in the event of the insolvency of a participant (See Attachment 2).

ACH addresses the risks arising from the potential for a participant default through participation requirements, monitoring of exposures, margining of derivatives contracts, participant contributions and its own financial resources.

Requirements for participation are set out in the Clearing Rules and deal with business integrity, operational capacity and financial resources. Most participants are required to have minimum liquid assets, comprising a fixed component of $100,000 and a variable component based on market and operational risk characteristics. Futures-only clearing participants may elect to comply with an alternative regime. ACH requires participants to report their capital positions monthly.

ACH levies margins on equity derivatives products, but not physical equity products. Depending on the product type, derivatives margins can include premium margins (reflecting the current value of an option), risk margins (designed to protect the central counterparty against future price movements should a participant default) and variation margins (based on price movements over the preceding day). ACH also has in place a system of participant contributions which allows additional collateral to be called where participants' cash equities positions are large relative to ACH's resources.

While a defaulting participant's margins and other assets are ACH's first line of defence against losses arising from a default, ACH has access to additional resources designed to meet losses from any participant in more extreme market conditions. In order of application, these are:

  • the “Risk Resource Requirement” of $150 million, consisting of funds paid into a restricted capital reserve from the National Guarantee Fund in 2005 and other ACH capital;
  • default insurance of $100 million;
  • surviving participants' contributions; and
  • the capacity to levy ‘emergency assessments’ totalling up to $300 million on surviving participants.

ACH also has access to a line of credit to provide it with liquidity at short notice to facilitate daily settlement in the event of a default.

ACH conducts stress-testing of participants' positions on a daily basis to assess the risk it faces as a central counterparty.

At the end of the assessment period, ACH had 67 participants, including 20 broker-subsidiaries of foreign banks, 8 subsidiaries of Australian banks, and 36 Australian brokers. During the course of the assessment period two clearing participants resigned and one new participant joined.

Developments during the assessment period

ACH has overseen a number of changes to its risk management during the assessment period which have significantly increased its capacity to meet its obligations should a participant default. It has also improved its ability to assess the risks it faces through stress testing. The main changes are outlined below.

In March 2007 ACH increased its pooled resources available to meet the default of a participant. The minimum funds ACH holds for this purpose, the Risk Resource Requirement, were increased from $110 million to $150 million through an injection of capital from ASX.

This change also flowed through to the maximum ‘emergency assessments’ that ACH can call from surviving participants following a default. The potential pool of emergency assessments is twice the Risk Resource Requirement and increased from $220 million to $300 million. These resources may be called in the event that the loss to the central counterparty following a default exceeds the Risk Resource Requirement and ACH's default insurance of $100 million.

Also in March, ACH introduced requirements for individual participants to post cash or collateral to cover potential losses from large cash equities exposures. In particular, participants are now required to post collateral with ACH when their position with the central counterparty exceeds certain thresholds. This system is designed to provide a high degree of confidence that the central counterparty will be able to meet its obligations, even where losses from a participant default exceed ACH's ‘Risk Resource Requirement’ of $150 million. ACH will implement comparable arrangements for derivatives positions later in 2007, along with some adjustments to the existing arrangements.

In order to enable it to access liquidity quickly in the event of a participant default, ACH increased a line of credit it holds with a bank from $100 million to $150 million in May 2007. Combined with the Risk Resource Requirement, which is held in liquid assets, this took the liquid funds at ACH's disposal to $300 million.

In order to increase its capacity to assess the risks faced by participants and the central counterparty, ACH introduced the first stage of a new stress testing framework in June 2007. The new arrangement uses a significantly expanded range of scenarios based on market-wide shifts, sector-specific scenarios and movements in individual stocks. The scenarios also incorporate options volatility shifts for the first time. ACH intends to further increase the range of scenarios used in its stress testing framework in the first quarter of 2008.

The new framework has significantly improved ACH's stress testing capacity overall. That said, this framework embodies down-side market-wide stresses which are less than those previously used – 15 per cent, rather than 25 per cent. Up-side market-wide stresses were unchanged during the assessment period, but have subsequently also been reduced – from 10 per cent to 7 per cent in normal market conditions, with triggers in place to increase the severity in turbulent market conditions. During the assessment period, participant contributions continued to be based on a market fall of 25 per cent and an increase of 10 per cent, although the new scenarios are to apply from December 2007.

ASX argues that the stresses previously used by ACH were very conservative, to take account of the fact that only market-wide movements could be tested. Now that a more sophisticated approach is available, it argues that such a conservative approach is no longer required. The Bank is satisfied ACH's arrangements remain consistent with the Financial Stability Standard for Central Counterparties.

ACH also introduced a new model to assess the adequacy of its liquidity arrangements based on a subset of its stress test scenarios. This model is significantly more sophisticated than ACH's previous methodology. It calculates the maximum funds that ACH would be required to inject in closing out a defaulter's obligations. For participants rated ‘strong’ or less, ACH assumes that all obligations that can be settled without buying in equities are settled on time. For higher rated articipants, it assumes that funds are injected only to meet losses, rather than to facilitate settlement. Hence settlement is assumed to be deferred until cash market positions can be liquidated.

ACH finalised internal default procedures which set out a framework for evaluating and dealing with a participant default. ACH has indicated that further work in this area is likely as a part of efforts to harmonise processes and procedures across ACH and SFECC.

ACH's systems were highly operationally reliable during the course of the assessment period, with no outages recorded and significant excess capacity available. ACH has arrangements in place to allow the timely recovery of its usual operations in the event of a contingency. ACH has regularly tested its ability to operate its production systems from its back-up site during the assessment period. An additional step of utilising back-up systems as the production system for a day's processing was taken in November, subsequent to the assessment period.


It is the Bank's assessment that ACH has complied with the Financial Stability Standard for Central Counterparties during the assessment period. The detailed assessment provided in the attachment indicates how ACH has met the various measures that the Bank has set out as the minimum it considers relevant for meeting the standard.

Most importantly, the various risk management measures that ACH has in place provide a high degree of confidence that ACH could settle its obligations in the event of a participant default. The changes to ACH's risk management arrangements since the previous assessment period – particularly the increased Risk Resource Requirement and the capacity to levy contributions on participants with large exposures – have clearly enhanced the central counterparty's ability to deal with the default of a participant in adverse market conditions. While the certainty with which different resources could be accessed varies, the notional value of ACH's resources at the end of the assessment period, excluding margins and participant contributions, was $550 million. ACH has supplied the Bank with stress testing data in order to enable it to verify the adequacy of these resources.

As noted above, ACH's new stress testing framework will greatly increase the risk information available to the central counterparty. It nonetheless embodies a reduction in the market-wide down-side stress applied to positions. The Bank accepts that the more targeted approach to stress testing that is now possible under the new arrangements reduces the need for conservatism in the market-wide stresses applied. It therefore considers that ACH's arrangements, including the new scenarios, remain consistent with the Financial Stability Standard for Central Counterparties. The Bank is also satisfied that ACH's stress testing arrangements are at least equivalent to those of central counterparties overseas.

At present, ACH's risk management systems do not allow it to monitor changes in its participants' derivatives exposures intraday. While ACH is able to monitor changes in derivatives prices intraday, it is not able to update participants' positions intraday. It instead relies on applying up-to-date prices to participants' positions at the close of trading the previous day. ACH anticipates that upgrades to its systems will soon allow it to monitor additional risks from new positions, as well as movements in prices, on an intraday basis. The Bank considers that this feature will represent a significant enhancement of ACH's risk management capabilities.