2006/07 Assessment of Clearing and Settlement Facilities in Australia 5.2 SFE Clearing Corporation (SFECC)

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

Background on SFECC arrangements

SFECC 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 SFECC and each of its participants, and between each participant and each other participant. Among other things, the Clearing Rules define the nature and scope of SFECC's obligation to provide clearing support to participants and describe the conditions under which final and irrevocable settlement of obligations has occurred. The rules also set out the rights and obligations of SFECC and each of its participants, including in the event of default or suspension. The netting arrangements contained in SFECC's rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act. This provides legal certainty for the netting process in the event of the insolvency of a participant (See Attachment 2).

To manage the risks it faces as a central counterparty, SFECC relies on a combination of controls over participation, monitoring of exposures, margins, participant contributions and its own financial resources. Stress testing is used to assess risks on an ongoing basis.

The SFECC Clearing Rules set out requirements for participation, including in relation to business integrity, operational capacity and financial resources. SFECC requires its participants to have net tangible assets of at least $5 million and to report capital positions monthly.

SFECC levies margins on all derivative products, including variation margins (based on price movements over the preceding day) and initial margins (designed to protect the central counterparty against future price movements should a participant default). It also levies Additional Initial Margins (AIMs), which can be used to call collateral from participants where large exposures are identified by stress testing.

SFECC holds additional financial resources (the Clearing Guarantee Fund) to protect against losses in excess of margins held. These include capital of $80 million (which was increased from $30  million in September 2006), participant contributions of $60 million, and default insurance of $60 million. SFECC has the capacity to call additional participant contributions of up to $30 million. It can request further contributions if required, but participants may opt out of the central counterparty rather than pay the additional funds.

As at the end of June 2007, SFECC had 16 participants – predominantly large foreign banks and their subsidiaries, along with two local banks and a local futures broker. Two participants resigned during the assessment period and two joined.

Developments during the assessment period

In May, SFECC announced a widening of the collateral it accepts for satisfying AIM requirements. Previously SFECC had accepted only cash. It now also accepts Commonwealth Government securities, bank bills, negotiable certificates of deposit and letters of credit issued by selected ADIs.

From February 2007, SFECC altered the calculation of stress test exposure limits (STELs) used to derive AIMs. STELs impose a limit beyond which potential losses identified by stress tests must be collateralised by participants. For highly rated participants, the STEL had previously been set at 50 per cent of the value of SFECC's Clearing Guarantee Fund. From February the threshold was raised to 100 per cent of the Clearing Guarantee Fund.

SFECC also discontinued the practice of calling ‘double margins’ on occasions where public holidays led to the trading system being open while the banking system was closed (precluding margin payments on that day). The SFECC Board considered that existing initial margin and AIM arrangements adequately cover the risks associated with this situation.

For some time SFECC has recognised that some of the stress test scenarios that were being used had become outdated, and required modification. In particular, the scenarios being used for movements in the share price index had become less relevant over time due to the strong increase in share prices. SFECC had intended to implement more appropriate stress tests across all contract types over the assessment period, although the new arrangements were deferred twice to allow additional time for consultation with both industry participants and the Bank. The Bank did not object to these delays, recognising that any new arrangements had to consider the overall risk management framework and the efficiency of the market. The new framework was introduced on 20 November 2007, for all but the individual share price index scenarios. SFECC is planning to introduce these new scenarios in the first quarter of 2008, in conjunction with a significant increase in its financial resources.

SFECC's systems were highly operationally reliable during the assessment period; they were available for 99.98 per cent of the required time. Systems also had significant excess system capacity throughout the period. SFECC has announced its intention to bring key levels of support for its systems in-house. This work is expected to take around 12 months.

SFECC has arrangements in place to allow the timely recovery of its usual operations in the event of a contingency. In the past it has operated back-up systems as the production system from time to time, although such a test did not occur in the assessment period. SFECC plans to undertake such testing by the end of 2007.


It is the Bank's assessment that SFECC has complied with the Financial Stability Standard for Central Counterparties during the assessment period.

The various risk management measures that SFECC has in place provide a high degree of confidence that SFECC could settle its obligations in the event of a participant default.

SFECC's capital, participant contributions and default insurance totalled $200 million at the end of the assessment period. Margins totalled around $4.5 billion, while second level contributions could total up to $30 million. SFECC has supplied the Bank with stress testing data to enable it to verify the adequacy of its financial resources. The use of AIMs by SFECC provides added confidence that it could meet potential losses from a participant failure if the price movements embodied in its stress tests were to occur.

The delays in SFECC implementing its new stress testing framework resulted in SFECC continuing to rely on outdated stress tests for share price index contracts during the assessment period. Reflecting this, SFECC adopted a conservative approach to margining share price index contracts and actively monitored any large participant exposures. The Reserve Bank was consulted regularly on progress with the new arrangements over the year and recognises that the extension of the new stress testing framework to share price index contracts in early 2008 will represent a significant improvement over current arrangements.

The detailed assessment provided in the attachment indicates how SFECC has met the various measures that the Bank has set out as the minimum it considers relevant for meeting the standard.