2007/08 Assessment of Clearing and Settlement Facilities in Australia 5.1 Australian Clearing House (ACH)


ACH provides central counterparty services for a range of financial products traded on the ASX market, including equities, warrants and equity-related derivatives.

ACH operates within a sound legal framework, based on its Clearing Rules. Under Section 822B of the Corporations Act, these rules constitute a contract under seal between ACH and each of its participants, and between participants. Among other things, the rules set out the rights and obligations of ACH and each of its participants in respect of ACH's provision of central counterparty services. The netting arrangements contained in ACH's Clearing Rules are further protected under Part 5 of Payment Systems and Netting Act 1998.

Given the concentration of counterparty risk in a central counterparty, effective risk-management processes are crucial. ACH manages the risk associated with the potential for a participant default through a range of measures: risk-based participation requirements and ongoing monitoring; daily stress testing of exposures; collateralisation of exposures by participants; and the maintenance of a buffer of risk resources, including own capital.

Margins are routinely collected from participants in respect of derivatives exposures, with additional cover required for large exposures. Margins are not routinely levied on cash equities positions, although participants are required to provide collateral to cover positions which generate exceptionally large exposures for ACH. The margins and other collateral posted by a defaulting participant constitute ACH's first line of defence against losses arising in the event of a default.[1]

ACH has access to additional risk resources of $550 million to meet losses arising in more extreme market conditions. The core component of these resources is the Risk Resource Requirement (RRR), which consists of ACH's own resources (funds paid into a restricted capital reserve from the National Guarantee Fund (NGF) in 2005 and a subordinated loan provided by ASX Limited) and is currently set at $150 million. The RRR is invested in high-quality liquid assets and would be immediately available for use in the event of a participant default. The RRR is supplemented by default insurance of $100 million and ‘emergency assessments’, of up to $300 million, which can be levied on surviving participants in the event of a default. ACH also has a committed standby facility with a commercial bank to access liquidity at short notice.

At the end of the assessment period, ACH had 65 participants, including 35 Australian brokers, 19 broker subsidiaries of foreign banks, eight subsidiaries of Australian banks, and three specialist clearers. Three participants resigned during the period, while two new participants joined.

Assessment of Developments in 2007/08

During 2007/08, ACH implemented a number of changes to its stress-testing and margining practices, continuing a process which began in 2006. The financial difficulties experienced by a small number of brokers during the first half of 2008, two of whom were clearing participants, also presented some important risk-management challenges for ACH. Consequently, in this year's assessment, the Reserve Bank has looked in particular at ACH's procedures in the management of financial risks and the monitoring of participants. In addition, ACH's operational performance during the period has been examined, as have the initial steps taken in relation to the provision of clearing services to prospective new trading platforms for ASX-listed securities.

Capital stress testing and risk resources

As a result of the growth in trading activity over the year to end-June, as described in Section 3, the daily average sum of participants' outstanding cash equity settlement obligations to ACH increased by 36 per cent, to $1.3 billion. This followed an increase of 30 per cent in the previous year. In this assessment, the Reserve Bank has considered the adequacy of ACH's risk resources in light of these increases.

ACH does not routinely collect margins from participants in respect of cash equities positions, instead covering the risk exposures arising from these positions through its pooled risk resources (as discussed above). The aggregate of these resources has increased significantly over the past three years, rising by 74 per cent since June 2005 (Graph 5). Excluding emergency assessments, risk resources rose by 163 per cent over this period, which compares with growth of 108 per cent in cash cash equity traded values.

One way of assessing the adequacy of ACH's risk resources is by reference to its capital stress tests, which are run daily on the basis of participants' cash equity and derivatives positions at the close of the previous day. Comparison of projected stress-test losses with the level of available risk resources offers some guidance as to the resilience of the central counterparty to a participant default in extreme market conditions.

ACH implemented the first phase of a new capital stress-testing regime towards the end of the 2006/07 assessment period. The regime comprises 24 scenarios, combining conservative close-out assumptions with extreme price moves and volatility shifts at the market, sector and stock levels. Some refinements were made to the regime during the 2007/08 assessment period and ACH plans to further expand the range of stock-specific stress scenarios by the end of 2008.[2]

During the assessment period, there were 23 instances of stress-test exposures exceeding the immediately available component of risk resources (as measured by the RRR). Eight of these also exceeded the aggregate of the RRR and default insurance, but none exceeded the total of ACH's risk resources. These excesses have tended to be concentrated at quarter ends, reflecting sizeable cash equity trades associated with the quarterly expiry of equity futures contracts.[3] Nevertheless, although relatively infrequent, the scale of projected stress losses can be significant, exceeding $450 million in September 2007 (Graph 6, top panel).

During the assessment period, ACH completed the second phase of implementation of a Contributions and Additional Cover (CAC) regime to address the risks arising from these large exposures. Under this regime, individual participants are required to post collateral to cover projected stress losses in excess of the RRR on their cash equity or derivatives positions. ACH aims to notify participants of any collateral requirement under the CAC regime by 9.30am, with participants then required to post the collateral within two hours of the call. Accordingly, since the full implementation of the CAC regime in December 2007, all projected stress losses in excess of the RRR have been covered by collateral calls (Graph 6, lower panel).[4]

Overall, it is the Reserve Bank's assessment that ACH's capacity to manage increased risk exposures arising from participants' trading activity has been enhanced significantly by the combination of measures described above. It is, however, important that an appropriate balance be struck between variable collateral calls and fixed capital resources. Indeed, should the incidence of large projected stress losses in excess of the RRR and default insurance increase materially, the Reserve Bank would expect to see an increase in the fixed component of ACH's mutualised risk resources.

Notwithstanding that it compares favourably with international best practice, one limitation of the CAC regime is that, should collateral be called under stressed market conditions, the participant may face difficulties in meeting its obligation to ACH. In extremis, this could itself precipitate a default. Furthermore, given the timing of ACH's daily stress tests, collateral can only be called in respect of the position at the close of the previous day's trading, meaning that ACH can retain uncovered exposure for more than 24 hours (and longer over weekends). While acknowledging the likely system and technological challenges, and recognising other mitigants in the broader risk-management framework, the Reserve Bank sees a case for ASX to give further consideration to how the regime might be enhanced so as to allow for calls to be made sooner after a large position is executed.

Since the end of the assessment period, ACH has announced further prospective refinements to the CAC regime. As noted above, the threshold beyond which collateral is called is currently set equal to the RRR for all participants. Going forward, ACH proposes that highly rated participants be required to post collateral only once projected stress losses have risen above a threshold – the so-called Stress-test Exposure Limit (STEL) – somewhat higher than the RRR. Low-rated participants will be required to post collateral at a lower threshold. Furthermore, in normal market conditions, highly rated counterparties will be required to cover only a proportion of the excess exposure beyond the stated threshold.[5] A similar ‘discounting’ regime was introduced recently at SFECC (see Section 5.2).

While the imposition of ratings-dependent stress-test exposure limits and discounting will reduce the level of cover provided by some participants under the CAC regime, the Reserve Bank accepts the rationale for acknowledging credit quality in the application of the CAC regime. This approach also recognises that ACH has access to additional risk resources beyond the RRR in the event of default, even though these are not immediately available.

Margin setting and settlement of margin calls

Margin-setting practices at ACH have been reviewed recently, with a common approach established across ACH and SFECC. Under the new regime, initial margins for ASX derivatives positions continue to be set on the basis of a three-standard-deviation (99.73 per cent) confidence interval for price movements, although the assumed close-out period has been amended to the higher of one or two days. Furthermore, an extended price history of 60 days is now considered in setting margin levels, with a greater emphasis placed on implied volatility and qualitative factors.[6] Going forward, margin levels are to be reviewed at least once a quarter, with ad hoc reviews taking place in response to market developments.[7]

ACH also expects to proceed in the near future with implementation of systems changes to allow for intraday margin calls to be made in response to sizeable changes in participants' positions. Currently, the impact on exposures arising from changes in market prices can be reflected in margin calls intraday, but the impact from changes in positions cannot. In the absence of such changes, ACH does not have the capability to cover mark-to-market exposures in respect of new derivatives positions until the routine settlement of margin on the following morning. As is the case for calls under the CAC regime, this can lead to uncovered exposure on new positions for more than 24 hours. The proposed system changes were to have been implemented during 2007/08 and their importance was noted in the 2006/07 assessment report. ACH has plans to proceed with implementation during the forthcoming period and is encouraged to do so.

The delay to cash equity settlement in late January 2008 illustrated some potential issues with the current process for settling margin calls in respect of ASX derivatives positions. Currently, margins can be paid either via Austraclear or via ASTC's daily batch settlement process in CHESS, in which case margin obligations are netted against other cash flows arising from cash equity transactions.[8] [9] If paying via Austraclear, participants must ensure that settlement is complete by 10.30am; if paying via the CHESS batch, payments are typically authorised and settled by around noon. The delay to the CHESS settlement process in late January revealed the vulnerability of settling margin payments in this way. The Reserve Bank considers that timely settlement of margins is a critical component of ACH's risk management process and hence should not be dependent on the settlement of other transactions. Therefore, the Reserve Bank sees a strong case for considering whether the robustness of the system would be improved by settling margin payments via a Real-time Gross Settlement (RTGS) channel, thereby helping to ensure that such dependence was avoided. The Reserve Bank is in ongoing dialogue with ASX on this matter and understands that ASX intends to consult with the marketplace on the operational implications of such a change, in the wider context of potential modifications to the settlement processes in CHESS (see Section 5.3).

Treasury investments

An important development during the assessment period was the creation of a new corporate entity, ASX Clearing Corporation (ASXCC), to manage the treasury function for the two central counterparties. The corporate structure is now in place, with the new entity sitting between ASX Limited and the two central counterparties. Subject to ASIC approval of associated changes to the Clearing Rules, ASXCC will in future manage the investment of all assets held by ACH and SFECC, including margins and other participant contributions. The new structure will also add flexibility to the central counterparties' funding and capital-management processes.

The Reserve Bank has reviewed the prospective new treasury arrangements and accepts that they add flexibility to both ACH's treasury investment function and the management of its risk resources. The Reserve Bank is currently reviewing the legal robustness of the terms and conditions associated with potential market-based funding of ACH's risk resources via ASXCC.

It is also intended that, in the short term, ACH will apply to hold an Exchange Settlement (ES) account at the Reserve Bank. Currently, obligations to and from ACH are settled across an account with a commercial bank. Although ACH's claim on funds held with its banker is final and irrevocable once interbank settlement has occurred in the Reserve Bank Information and Transfer System (RITS), ACH retains counterparty exposure to its banker. The Reserve Bank welcomes the prospective shift to settlement in central bank money, which will remove this risk from ACH's settlement arrangements. In the medium term, ASXCC may also apply to hold an ES account at the Reserve Bank.

At its May 2008 Board meeting, ASX revised – and harmonised – the central counterparties' treasury investment limits; that is, the parameters within which the central counterparties' risk resources, including margins and other cash collateral posted by participants, may be reinvested. It is intended that this harmonised policy will form the basis for the investment mandate to be applied by the new ASXCC entity. The policy restricts treasury investments to liquid assets – such as bank bills and certificates of deposit – and applies issuer investment limits scaled according to the credit standing of the issuing counterparty. With the exception of investment in instruments issued by the four largest domestic banks, the maximum exposure to any issuer is set equal to the value of ACH's capital resources: currently $150 million. Lower exposure limits apply for lower-rated institutions and concentration limits restrict investments with any issuing counterparty to 33 per cent of the total portfolio.

Notwithstanding the application of such limits, the policy does leave open the potential for large and concentrated credit exposures to the four largest domestic banks. This in part reflects the general shortage of suitably high quality and liquid Australian dollar assets, which makes it difficult to achieve diversification in the treasury portfolio. A further issue arising from investment in bank-issued assets is that, where an entity related to the issuer counterparty is also a clearing participant, the performance of investments in the portfolio may be correlated with the very default event against which ACH's risk resources seek to provide cover. The Reserve Bank will continue to discuss these issues with ASX during the forthcoming period as new treasury arrangements via ASXCC are finalised.

Participant monitoring

Financial difficulties experienced by a small number of brokers during early 2008, two of whom were clearing participants, highlighted the importance of close monitoring of participants by ACH and the swift implementation of risk-mitigating policy actions. The Reserve Bank has therefore focused particular attention on monitoring processes in this year's assessment.

The participant-monitoring function is split between ASX Clearing Risk Operations and ASX Markets Supervision. ASX Clearing Risk Operations is responsible for stress testing and position monitoring, while ASX Markets Supervision is responsible for monitoring ACH participants' capital and liquidity requirements, as well as compliance monitoring, investigations and enforcement. A ‘Supervisory Code of Conduct’ and ‘Commercial and Supervisory Conflict of Interest Policy’ govern the flow of information between the two business units, to address potential conflicts between ASX's supervisory responsibilities and its commercial interests.

Procedures were tested in late January, when one participant was late in meeting its margin obligations and experienced difficulties in settling its cash equity positions. ASX responded with an ad hoc review of the participant's capital adequacy and put in place arrangements for closer ongoing monitoring. A range of additional collateral and reporting requirements were also imposed, as well as restrictions on the participant's access to clearing and settlement services. In particular, the participant faced: restrictions on trading interest-rate and warrant products; prohibitions on short selling; and restrictions on participation in the daily CHESS settlement batch. Another broker participant was placed into administration in late March, but as all of its trades were cleared through another participant it had no outstanding obligations to ACH at the time administrators were appointed. Nevertheless, an ad hoc review of all participants was carried out in response to gauge the potential spillover impact of the participant's failure.

These events revealed some potential gaps in the general framework for market supervision and regulation. This supervisory gap was also acknowledged in ASIC's recent assessment of the ASX group licensees. In particular, it was observed that certain business activities, such as margin lending and securities lending, fell outside of the scope of existing industry-wide arrangements. In the Reserve Bank's view, this episode also suggested that ASX's participant-monitoring arrangements did not adequately capture risks to ACH arising from clearing participants' engagement in these off-market activities.

Further to this episode, ASX Markets Supervision has initiated a review of its participant capital and liquidity-monitoring arrangements. This will include a review of participants' business models and their product offerings, assessing these against the way in which the participant currently submits financial information to ASX. The review will be supported by an international survey of other exchanges to provide a benchmark for ASX's own procedures; this is expected to be completed by the fourth quarter of 2008.

This experience has also highlighted a number of operational and legal matters to consider in respect of the management of a participant default. In particular, ACH has been able to work towards refining procedures around data access and risk calculations; internal and external communications; and the practicalities of closing out or transferring positions. Some important policy questions were also raised for ongoing review, including the criteria for declaring a default and assessment of the potential behaviour of an administrator.

Participation requirements and internal credit ratings

Separately, ACH recently made some changes to its internal credit ratings framework and also announced plans to revise its admissions criteria. In January 2008, a new common internal credit ratings framework was introduced at both ACH and SFECC. At ACH, ratings of ‘Extremely Strong’ through to ‘Vulnerable’ were replaced with ratings of ‘A’ through to ‘E’. Ratings are based on the external rating of the clearing participant (where available) or its parent if that parent provides a guarantee to the clearing participant.[10] Otherwise, ratings are based on net tangible assets adjusted for subordinated debt. The introduction of the new methodology resulted in the downgrading of a number of participants into lower credit rating categories.

At the end of the assessment period, one of ACH's 65 participants was rated A; a further 34 were rated B or C; and 30 were rated D or E. Going forward, ACH plans to take steps to increase the average financial strength of its participants.

Currently, ACH clearing participants must hold liquid capital in excess of a ‘total risk requirement’, while maintaining minimum core liquid capital of $100,000.[11] ACH intends to raise the minimum core liquid capital requirement to $2 million by the end of 2008, increasing this further to $10 million by the end of 2009. ACH also intends to invite bank Authorised Deposit-taking Institutions (bank ADIs) to become clearing participants. There are currently no bank ADI participants of ACH, which largely reflects legacy arrangements in respect of contributions to the NGF.[12] Bank ADIs would be exempt from ACH's capital requirements, with ACH relying on the participant's compliance with APRA's prudential regime.

Participation criteria are an important determinant of the risk exposure assumed by a central counterparty and hence the Reserve Bank supports ACH's efforts to raise the average financial standing of its participants. It is important, however, that access criteria continue to be risk based and that a higher threshold for access complements and does not substitute for rigorous ongoing monitoring of participants. This is acknowledged by ASX. It is also noted that the proposed policy does not differentiate between participants clearing only for themselves and those also providing third-party clearing services. To the extent that greater concentration in direct participation may give rise to increased dependence on a small group of large third-party clearers, such differentiation may be appropriate. Indeed, new minimum capital requirements announced by SFECC will differentiate in this way (see Section 5.2).

Operational performance

ACH's core systems are the Derivatives Clearing System (DCS) and CHESS. Developments in respect of CHESS are considered in the assessment of ASTC in Section 5.3. For DCS, average capacity utilisation over the period was 22 per cent, peaking at 61 per cent. ACH carried out regular connectivity and procedural tests throughout the period with satisfactory results, and a major business-continuity test simulating loss of the primary Sydney site was carried out for DCS in August 2007, again with a satisfactory outcome. Other enhancements to operational risk-management policies were implemented during the period, including in respect of pandemic response planning, fraud control and incident management.

New market operators

In response to the application for market licences by three prospective new market operators (see Section 3), ASX launched a project to establish how new trading platforms with a need for clearing and settlement services will connect and communicate with ACH and ASTC, including consultation with clearing participants and other stakeholders. Subject to the government's decision, this is likely to be an important issue during the 2008/09 assessment period, with the Reserve Bank's interest being in the implications of the prospective new arrangements for the risk profile of ACH and the settlement arrangements at ASTC.


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

The assessment highlights a number of important developments in respect of ACH's risk-management practices. In particular:

  • refinements to the new stress-testing framework: Some refinements were made to the new stress-testing framework introduced late in the 2006/07 assessment period. Additional stress scenarios are to be added during the remainder of 2008.
  • the continuing implementation of the new regime for Contributions and Additional Cover: The second of three phases of implementation of the CAC regime was completed in December 2007. The direct mapping from stress-test outcomes to risk resources should help to ensure the adequacy of ACH's risk resources, even when its participants are holding large and concentrated positions. The remaining third phase, which includes the introduction of stress-test exposure limits and discounting for highly-rated participants, will proceed during the forthcoming assessment period.
  • enhancements to margin-setting processes: A new harmonised margining process was introduced late in the assessment period at ACH and SFECC. For ACH, the new regime continues to capture three standard deviations of price moves, but amends the assumed close-out period to be the higher of one or two days and takes into account qualitative factors and implied volatility in setting margins.
  • new arrangements for the management of treasury investments and funding of risk resources: A new corporate entity, ASXCC, has been created, which will be used in the future to manage the treasury function for ACH and SFECC. The new structure will also add flexibility to the central counterparties' funding and capital-management processes. It is also intended that ACH will apply to hold an ES account at the Reserve Bank, allowing for settlement of obligations in central bank money. This will eliminate commercial-bank risk from the settlement process.

Notwithstanding the significant improvements made to risk-management practices in the 2007/08 period, the environment in which ACH operates continues to evolve. Accordingly, the assessment identifies a number of areas for further consideration by ACH during the forthcoming period. These include:

  • the arrangements for the ongoing monitoring of participants: In light of the financial difficulties experienced by two broker participants over the past year, this assessment has looked closely at ACH's arrangements for monitoring participants. These problems highlighted that certain business activities fall outside of the scope of existing industry-wide arrangements for market supervision and regulation. This episode also suggested that ASX's participant-monitoring arrangements did not adequately capture risks to the clearing and settlement facilities arising from participants' engagement in these off-market activities. In this regard, the Reserve Bank welcomes the review of capital- and liquidity-monitoring policies currently underway at ASX Markets Supervision and will continue to pay close attention to developments in this area over the coming year.
  • participation requirements: Relatedly, ACH recently announced its intention to raise minimum capital requirements for participants. The Reserve Bank supports efforts to raise the average financial standing of clearing participants, but notes the importance of continued rigorous monitoring of participants and a risk-based approach to setting access criteria. This is acknowledged by ASX.
  • the timing of collateral calls on participants with very large positions: The new CAC regime is an important component of ACH's risk-management process, which compares favourably with international best practice in this area. However, under these arrangements, calls can only be made in respect of participants' positions at the close of the previous day's trading, leaving a window of uncovered exposure. While acknowledging the likely technological challenges involved, and other mitigants in ACH's risk framework, the Reserve Bank sees a case for ASX to give further consideration to how the regime might be enhanced to allow for the calling of collateral sooner after a trade giving rise to a large exposure is established.
  • the monitoring of intraday positions: In a similar vein, the 2006/07 assessment report noted the importance of planned system enhancements at ACH to facilitate the calling of intraday margin in response to changes in participants' positions. ACH is strongly encouraged to proceed, as planned, with the implementation of these enhancements over the coming year.
  • arrangements for the settlement of ACH margin calls: Margin calls in respect of ASX derivatives can currently be made either via Austraclear or within the daily CHESS settlement batch operated by ASTC. The disruption to CHESS settlement in late January revealed a vulnerability in using this channel to settle margin payments. The Reserve Bank and ASX see a strong case to consider whether the robustness of the system would be improved by settling margin payments via Austraclear or an alternative RTGS channel. Such a change would help ensure that the timely settlement of margin was not dependent on completion of the cash equity settlement process. Indeed, the Reserve Bank is in dialogue with ASX on this matter and understands that ASX intends to consult with the marketplace on the operational implications of such a change.
  • treasury investment policies: A new harmonised treasury investment policy was established for ACH and SFECC during the assessment period, which will form the basis for the investment mandate to be applied by the new ASXCC entity. The policy restricts investments to high-quality, liquid assets and, except in the case of the four largest domestic banks, sets counterparty limits within the value of capital allocated to treasury investment. The Reserve Bank acknowledges the improvement over previous arrangements but notes that the policy leaves open the potential for large exposures to the four largest domestic banks. The Reserve Bank will be discussing the treasury investment mandate further with ASX during the forthcoming period.


This is not strictly the case currently in respect of cash equities, where collateral posted in respect of large exposures (‘Contributions’) are currently a mutualised resource. ACH will be seeking to introduce margining powers to its Clearing Rules to allow for such Contributions to be treated as equivalent to margin and hence available only in the case that the participant posting the collateral defaults. [1]

Some further changes were made to the stress-testing model in August 2007. The size of the largest market-wide upside stress scenario was reduced from 10 per cent to 7 per cent. At the same time, a ‘rebound’ scenario was introduced in recognition of the increased potential for upside stress during turbulent market conditions. This rebound scenario was amended in January in light of experience in a particularly volatile market environment. [2]

These positions are related to index arbitrage transactions. Index arbitrage is a trading strategy which seeks to profit from a difference between the actual and theoretical spread between futures prices and prices in the underlying physical market. The trading strategy involves taking either a long futures position and selling stock, or taking a short futures position and buying stock. The gains from the trading strategy are realised when the futures position expires – the futures position is liquidated and the stock is either bought (if stock had originally been sold) or sold (if the stock had originally been bought). The scale of these cash equity trades can cause spikes in ACH participants' projected stress losses. [3]

The lower panel captures the aggregate of collateral called from all participants with stress losses in excess of the RRR, rather than collateral called from only the participant with the largest projected stress loss. [4]

ACH would suspend discounting if the exponentially-weighted moving average (EWMA) of SPI S&P/ASX 200 volatility was 30 per cent higher than historical volatility. [5]

The new regime also allows for discretion to consider both longer and shorter time-frames in setting margin levels. [6]

Reviews currently take place weekly and monthly, depending on the particular contract. [7]

The RTGS facility in CHESS is potentially another available channel, although in practice this has never been used. [8]

CHESS is not available for settlement of intraday margin calls, which must be settled via Austraclear. [9]

The parent entity's rating is also taken into account where the clearing participant shares its parent's name and hence may be subject to reputational risk. [10]

The total risk requirement is based on a participant's exposures to counterparty risk, large exposure risk, position risk and operational risk. A higher minimum capital requirement – of at least $5 million in net tangible assets – applies for two participants clearing futures only. Core liquid capital is defined as the sum of: paid-up issued share capital; non-cumulative preference shares; reserves (including revaluation reserves); and retained earnings. [11]

ADIs have, in the past, been unable to become ACH participants because of the possibility of an unlimited levy being imposed to recapitalise the NGF. APRA's prudential standards prohibit ADIs from entering into arrangements that could result in such unlimited liability. However, following a recent amendment to relevant Corporations Act provisions in respect of the NGF, ADIs are now able to participate directly in ACH if they wish. [12]