2012/13 Assessment of ASX Clearing and Settlement Facilities B1.2 ASX Clear (Futures)

Standard 4: Credit Risk

A central counterparty should effectively measure, monitor and manage its credit exposures to participants and those arising from its clearing processes. A central counterparty should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence.

Rating: Broadly observed

ASX Clear (Futures) maintains a comprehensive framework for managing its credit exposures to participants (CCP Standard 4.1). Under this framework, ASX Clear (Futures) regularly monitors information on participants' credit standing through financial reporting requirements, public information, and further investigation where required. Monitoring of participants' credit standing is risk based, and ASX maintains a list of participants deemed to warrant more intensive monitoring (CCP Standard 4.2). In responding to any issues identified through monitoring, ASX Clear (Futures) is able to impose activity restrictions or additional controls, including calls for additional collateral (CCP Standard 4.3).

ASX Clear (Futures) also monitors and measures the magnitude of exposures to participants through both daily and intraday initial and variation margin calculations (CCP Standard 4.2), and through daily stress tests to measure the effects of extreme but plausible scenarios on exposures (CCP Standard 4.5). ASX Clear (Futures) holds sufficient financial resources to cover its largest potential credit exposure to any single participant and its affiliates in the extreme but plausible scenarios covered in its stress tests (CCP Standards 4.4, 4.6). This includes the capacity to call additional margin from participants that exceed predetermined stress-test exposure limits (STELs). Responsibility for increasing financial resources in response to persistent and widespread STEL breaches that exceed available financial resources lies with the CS Boards and the ASX Limited Board (CCP Standard 4.7). In August 2013, ASX Clear (Futures) increased its financial resources to cover its largest stressed credit exposure to any two participants and their affiliates. This reflects factors set out in the Bank's supplementary interpretation of CCP Standard 4.4 (see also Section 3.7), including the Bank's view under this interpretation that ASX Clear (Futures) is systemically important in multiple jurisdictions.

The Bank notes the following steps that ASX Clear (Futures) should take to fully observe CCP Standard 4:

  • Implement plans to strengthen the analysis of its capital stress-test model, through comprehensive annual validation, periodic reverse stress testing, and more detailed monthly reviews of stress-testing scenarios, models and underlying parameters and assumptions. This should include sensitivity analysis and analysis of concentration risk.
  • In order to meet the requirements of CCP Standard 4.8, which comes into effect on 31 March 2014, implement mechanisms consistent with forthcoming CPSS-IOSCO guidance on recovery planning that fully address any uncovered credit losses and replenish financial resources following a participant default.

Based on this information, and noting that CCP Standard 4.8 is not yet in force, the Bank's assessment is that ASX Clear (Futures) has broadly observed the requirements of CCP Standard 4 during the 2012/13 Assessment period. ASX Clear (Futures)' approach to managing its credit risk is described in further detail under the following sub-standards.

4.1 A central counterparty should establish a robust framework to manage its credit exposures to its participants and the credit risks arising from its clearing processes. Credit exposures may arise from current exposures, potential future exposures, or both.

ASX Clear (Futures) maintains a comprehensive framework for managing credit exposures to its participants, including a stress-testing regime (see CCP Standards 4.5 to 4.7), the use of variation margin to mark positions to market (see CCP Standard 6) and the maintenance of financial resources. These financial resources comprise initial margin (see CCP Standard 6), other collateral calls based on participants' positions, and fully paid up pooled financial resources of $370 million as at end June (increasing to $550 million following ASX's capital raising, and to $650 million with additional contributions from OTC participants), which are invested in high-quality liquid assets (see CCP Standard 4.4).

4.2 A central counterparty should identify sources of credit risk, routinely measure and monitor credit exposures, and use appropriate risk management tools to control these risks. To assist in this process, a central counterparty should ensure it has the capacity to calculate exposures to participants on a timely basis as required, and to receive and review timely and accurate information on participants' credit standing.

ASX's Clearing Risk Management (CRM) unit is responsible for monitoring participants' credit standing and credit exposures to participants.

Within CRM, the Exposure Management team is responsible for monitoring day-to-day developments in, among other things, market price moves, open positions and settlement obligations to the CCPs. Participants' positions are marked to market and ASX Clear (Futures) calculates initial and variation margin requirements at the end of each business day, in addition to maintaining intraday margining processes to ensure that it calculates credit risk exposures on a timely basis.

For exchange-traded products, ASX Clear (Futures) performs automated intraday margin calculations at 8 am and 12 pm each business day, and may also perform ad hoc calculations if there is significant movement in prices of individual contracts. Based on these calculations, intraday margin calls will be made if margin coverage is eroded by 40 per cent or more, and if intraday margin calculations exceed $100,000 for a portfolio.

For OTC derivatives positions, including cross-margined futures, ASX Clear (Futures) will recalculate its exposures to participants on approximately an hourly basis. To manage the additional credit risk exposure arising from offering real-time novation of OTC products, ASX Clear (Futures) will place a limit on the acceptable size of new transactions (initially set to $500,000), introduce frequent portfolio exposure checks and have the ability to prevent further novation until an intraday margin call is met. By imposing pre-novation limits on the interest-rate sensitivity of each trade, which will be set using a maximum price value of a basis point, ASX Clear (Futures) will minimise the possibility that novating a single large trade results in a significant increase in credit exposure. The approximately hourly portfolio exposure checks by CRM will identify if the sum of initial and variation margin owed (beyond excess collateral held by ASX Clear (Futures)) exceeds a particular threshold, at which point ASX Clear (Futures) will call for intraday margin. The threshold is based on the most recent collateral data and will be reviewed at least daily by CRM.

ASX Clear (Futures) conducts daily stress testing to monitor the effects of extreme but plausible scenarios on participants' portfolios. Where stress-test results are above a defined limit, AIM is called (see CCP Standard 4.4).

Within CRM, the Counterparty Risk Assessment team is responsible for ongoing monitoring, assessment and investigation of matters relating to financial requirements (including participants' monthly financial statements) for any issues of concern. CRM is also responsible for determining and reviewing participants' credit standing, drawing in part on information provided by participants in regular financial returns to ASX. ASX determines an Internal Credit Rating (ICR) for each participant. The ICR takes into account the participant's external credit rating, if available, or that of its parent if either that parent provides a formal guarantee to the CCP or the participant carries the parental corporate name. Otherwise, the rating is based on the participant's capital position (or that of its parent where that parent is unrated but provides a formal guarantee to the CCP).

CRM also coordinates a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list is based on a range of factors, such as: concentration risk; concerns emerging from a specific event or media report; significant changes in a participant's own share price, bond yield or credit default swap price; ICR downgrades; calls for AIM; operational issues; compliance issues; or issues arising from ASX's routine review of financial returns, for example regular losses or breaches of minimum capital requirements. The assessment of watch list factors monitored by CRM, ASX Compliance and the Operations Division is coordinated by the CROCC. Based on such an assessment, ASX Clear (Futures) may decide to place restrictions on a participant's trading, clearing and settlement activities (see CCP Standard 4.3). During the 2012/13 Assessment period, the only ASX Clear (Futures) participants on the watch list were MF Global entities, which were suspended in late 2011 and formally resigned in early 2013.

As part of a broad review of ASX's concentration risk policy due to be finalised in early 2014, ASX Clear (Futures) has been considering steps to enhance its monitoring of concentration of participant positions in particular market segments. This monitoring is intended to identify situations where a participant's share of positions in a market segment is sufficiently large that it could create complications in closing out or transferring these positions if the participant were to default.

For details of ASX Clear (Futures)' other participation requirements and participant monitoring arrangements, see CCP Standard 17.

4.3 A central counterparty should have the authority to impose activity restrictions or additional credit risk controls on a participant in situations where the central counterparty determines that the participant's credit standing may be in doubt.

Participants on ASX's watch list may be subject to trading restrictions, or additional credit risk controls such as additional margins, higher capital requirements, additional capital reporting or a reduced STEL. CRM will typically also carry out a detailed credit review. ASX Clear (Futures) may also call capital-based position limit (CBPL) AIM from participants with large portfolios (measured by initial margin requirements) relative to their capital. ASX Clear (Futures) may also call AIM from participants where it has other counterparty credit risk concerns.

4.4 A central counterparty should cover its current and potential future exposures to each participant fully with a high degree of confidence using margin and other prefunded financial resources (see CCP Standard 5 on collateral and CCP Standard 6 on margin). In addition, a central counterparty that is involved in activities with a more complex risk profile or that is systemically important in multiple jurisdictions should maintain additional financial resources to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. All other central counterparties should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. In all cases, a central counterparty should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount of total financial resources it maintains.

During the Assessment period, ASX Clear (Futures)' total prefunded pooled financial resources remained at $370 million. For most of the Assessment period this amount was comprised of: $30 million of ASX Clear (Futures)' own capital, $120 million of prefunded participant contributions, and a $220 million fully drawn-down subordinated loan from ASXCC, in turn funded by a $150 million principal-reducing commercial bank loan facility, and a $70 million subordinated loan from ASX Limited. The commercial bank loan facility was repaid on 28 June 2013 and replaced with additional funds from ASX Limited (see discussion of capital raising below). In addition, ASX had the ability to call on an additional $30 million in promissory commitments from futures participants in the event that paid-up resources are exhausted, although since these funds would only be available a significant time after a participant default, they were not routinely taken into account by the Bank when assessing the adequacy of ASX Clear (Futures)' financial resources.

Over the third quarter of 2013, ASX Clear (Futures) has taken steps to increase its pooled financial resources from $370 million to $650 million, using funds raised through a $533 million capital raising. This increase reflects the launch of the OTC derivatives clearing service, and a transition to testing capital adequacy against the default of the two largest participants plus affiliates in order to meet the requirements of the Bank's supplementary interpretation of CCP Standard 4.4 (see discussion below). The magnitude of this increase is based on stress tests of participant portfolios provided to ASX Clear (Futures) as part of a design study for the OTC derivatives clearing service carried out in 2012. The new composition of ASX Clear (Futures)' resources will include $200 million in pooled participant contributions (with an anticipated injection of $100 million from participants in the OTC clearing service) and $450 million of ASX capital. The additional ASX contribution represents a $180 million increase in total resources in the form of ASXCC equity, $150 million to replace the ASXCC loan funded by a commercial bank loan, and $20 million in ASXCC subordinated debt to replace contributions from existing (futures) participants. In addition, ASX Clear (Futures) has withdrawn its power to call an additional $30 million in promissory commitments from futures participants.

ASX Clear (Futures) conducts daily stress tests to ensure that the level of its prefunded financial resources is sufficient to cover the default of the participant (and its affiliates) that would potentially cause the largest aggregate credit exposure to the CCP under a wide range of scenarios (see CCP Standards 4.5 to 4.7). While over the Assessment period ASX Clear (Futures) conducted capital tests taking into account the largest single participant default, ASX Clear (Futures) has since moved to testing of the largest two participants (plus affiliates). Since ASX Clear (Futures) clears primarily transactions in exchange-traded futures and OTC IRS derivatives, the Bank does not consider that ASX Clear (Futures) is involved in activities with a complex risk profile. However, the Bank has issued supplementary interpretation that it will take into account, amongst other things, the need to seek recognition in other jurisdictions in determining whether a CCP is systemically important in multiple jurisdictions (see Section 3.7). Reflecting this supplementary interpretation, the Bank has reached a judgement that ASX Clear (Futures) is systemically important in multiple jurisdictions and therefore subject to higher financial resource requirements. This interpretation will apply in future Assessments against this standard.

Under ASX Clear (Futures)' AIM methodology, a participant is required to post additional collateral should stress-test outcomes reveal that the potential loss arising from its positions, as at the close of the previous day, exceeds a predetermined STEL (see CCP Standard 4.7).

The objective of this regime is to provide additional participant-specific cover against non-systematic spikes in individual participants' exposures. This mitigates the risk that the default of a participant with a large exposure, in more extreme market conditions than are contemplated by regular initial margin, may deplete or even exhaust prefunded pooled financial resources. By upholding the ‘defaulter pays’ principle, the AIM regime also provides an incentive for participants to manage the risk they bring to the CCP. However, it is not a substitute for holding sufficient pooled risk resources. There are potential shortcomings to relying too heavily on variable calls related to stress-test exposures, particularly given lags in the calculation and settlement of such calls (see CCP Standard 4.7).

4.5 A central counterparty should, through rigorous stress testing, determine the amount and regularly test the sufficiency of its total financial resources available in the event of a default or multiple defaults in extreme but plausible market conditions. Stress tests should be performed daily using standard and predetermined parameters and assumptions. On at least a monthly basis, a central counterparty should perform a comprehensive and thorough analysis of stress-testing scenarios, models and underlying parameters and assumptions used to ensure they are appropriate for determining the central counterparty's required level of default protection in light of current and evolving market conditions. A central counterparty should perform this analysis of stress testing more frequently when the products cleared or markets served display high volatility, become less liquid, or when the size or concentration of positions held by a central counterparty's participants increases significantly. A full validation of a central counterparty's risk management model should be performed at least annually.

ASX Clear (Futures) uses daily capital stress tests to monitor risk exposures to individual participants and the adequacy of its financial resources. Capital stress tests are based on a range of scenarios covering extreme price moves and volatility shifts at the market-wide, sector and individual-stock levels (see CCP Standard 4.6). The scenarios have been developed based on statistical analysis of historical market movements, which takes into account correlations between contracts and uses the ‘t distribution’, allowing for more extreme events than a normal distribution. Some important assumptions are made in this analysis. For instance, certain extreme historical price moves, such as the 1987 stock market crash, have been excluded on the basis that these are outliers from the true distribution and also do not reflect current market practices and risk management techniques. These assumptions are subject to periodic review. During the third quarter of 2013, ASX will be updating its capital stress-test methodology to incorporate enhanced sensitivity analysis based on changes to assumptions such as the number of concurrent defaults, or the timing of defaults. ASX also plans to incorporate analysis of the concentration of positions held by participants and market liquidity into a monthly review process for model scenarios. ASX has indicated that reverse stress testing will also be part of its analysis of the adequacy of margins and pooled financial resources.

ASX's Model Validation Standard requires that all models that are critical to ASX (as measured against a series of risk factors) undergo a full annual validation (see CCP Standard 2.6). Criticality to ASX is measured according to a series of factors, including the internal and external impact of the model, frequency of use, and complexity. This includes ASX's margining models and both the capital and liquidity stress-testing models. The first of these validations will be undertaken during the 2013/14 Assessment period. The validation of the models will be coordinated by internal audit, but external consultation will be sought where deemed necessary by the RQG.

4.6 In conducting stress testing, a central counterparty should consider the effect of a wide range of relevant stress scenarios in terms of both defaulters' positions and possible price changes in liquidation periods. Scenarios should include relevant peak historic price volatilities, shifts in other market factors such as price determinants and yield curves, multiple defaults over various time horizons, simultaneous pressures in funding and asset markets, and a spectrum of forward-looking stress scenarios in a variety of extreme but plausible market conditions.

The stress-testing regime comprises a suite of portfolio and single-contract stress-test scenarios based on statistical analysis of historical market movements. The stress-test scenarios are tailored to ASX Clear (Futures)' risk tolerance, as defined by its Board. All stress-test scenarios are based on historical moves and have been set so that they replicate extreme market moves which have a probability of occurrence of once in 30 years for single-asset scenarios and once in 100 years for multi-asset scenarios. In order to meet these targeted probabilities, stress-test scenarios are calibrated to cover 99.987 per cent of daily price and volatility movements for the single-asset scenarios and 99.996 per cent of daily price and volatility movements for the multi-asset scenarios, based on a sample distribution constructed from 20 years of price and volatility data. Although each multi-asset scenario individually has a once in 100 year probability of occurring, many other scenarios are possible and one which generates a loss as large or larger than the selected portfolio scenarios is likely to occur once every 30 years.

There are 30 scenarios involving movements of price and volatility across the four major futures contracts, which are SPI 200 futures, 90-day bank accepted bill futures, three-year bond futures, and 10-year bond futures.

  • Twenty ‘multi-asset’ scenarios model combinations of price movements across all four contracts. Sixteen of these scenarios model a range of tilts, twists and bends of the yield curve, as represented by different price shocks across the 90-day, three-year, and 10-year contracts; for example, the ‘tilt (back end up)’ scenario has progressively increasing price shocks from short-term to long-term interest rate contracts, with a 0 per cent move in the price of the 90-day contract, a 2 per cent move in the price of the three-year contract, and a 5 per cent move in the price of the 10-year contract. The remaining four of the multi-asset scenarios model moves in equities with balanced movements in the three interest rate contracts, equivalent to a ‘parallel’ move of the yield curve.
  • Eight ‘single contract’ scenarios model extreme price movements in the four contracts individually.
  • Two ‘internal’ scenarios model large movements in the interest rate contracts with no movement in equities, but are used for internal risk analysis only, i.e. they do not contribute to a participant's maximum stress-test result for AIM purposes.

For participants that clear OTC derivatives, ASX Clear (Futures) applies the same multi-asset and single-asset scenarios, with extensions for movements in the bank bill swap rate (BBSW) and Australian overnight index average (AONIA) for overnight indexed swaps. Accordingly, the scenarios test shocks to exchange-traded derivatives and IRS simultaneously. The BBSW and AONIA curves are split into segments based on differences in participation and activity in the underlying market. The price shocks have been calibrated with 20 years of data history for the Australian interest rate derivatives market, and take into account the five-day assumed close-out period for OTC derivatives transactions. As for the futures-only scenarios, the combined futures and OTC scenarios have been sized to be equivalent to one in 30 year price movements for single-asset shifts, and one in 100 year outcomes for multi-asset shifts.

Since ASX Clear (Futures) plans to offer cross-margining between interest rate futures contracts and IRS, it has added two new scenarios that consider the potential basis risk resulting from a change – either temporary or permanent – in the economic relationship between interest rate futures and IRS. These scenarios combine parallel up and down movements in exchange-traded curves with shocks to the absolute spread between futures and IRS yields, alternating between positive and negative at adjacent OTC maturity points. By alternating shocks to spreads, ASX Clear (Futures) is targeting portfolios with offsetting positions that may have similar but not identical maturities, since these are considered to be the most vulnerable to basis risk. Each pairwise basis risk spread had been sized as a once in 30 year event, but since these spreads are assumed to apply simultaneously, ASX Clear (Futures) estimates that the scenarios are closer to representing a once in 100 year event.

4.7 A central counterparty should have clearly documented and effective rules and procedures to report stress-test information to appropriate decision-makers and ensure that additional financial resources are obtained on a timely basis in the event that projected stress-test losses exceed available financial resources. Where projected stress-test losses of a single or only a few participants exceed available financial resources, it may be appropriate to increase non-pooled financial resources; otherwise, where projected stress-test losses are frequent and consistently widely dispersed across participants, clear processes should be in place to augment pooled financial resources.

Capital stress-test exposures are regularly reported to ASX management, the CS Boards and the Bank. Participant stress-test losses are used to gauge the adequacy of ASX Clear (Futures)' available financial resources, with widespread and/or large STEL breaches an indicator that resources may need to be increased. STEL breaches are reported to management and persistent breaches are escalated in the first instance to the RQG and CALCO. The CS Boards and ASX Limited Board are responsible for approving any increase to pooled financial resources where this is considered necessary (see below).

The maximum STEL at 30 June 2013 was $370 million for participants with the highest internal credit rating of A, equivalent to the value of prefunded financial resources then available to ASX Clear (Futures). B-rated participants were subject to a $295 million STEL, and C-rated participants a $220 million STEL. In normal market conditions, highly rated (i.e A-rated and B-rated) participants are eligible for discounts on their STEL AIM calls. However, these discounts have not applied since April 2010 because ASX has not considered market conditions to be normal. Given the increase in financial resources, and the move to stress testing against two participant defaults (plus affiliates), ASX Clear (Futures) has adjusted participant STELs to ensure they are consistent with the amended level of cover, initially by decreasing the STELs of A-rated and B-rated participants to $275 million. The STELs of A-rated and B-rated participants are expected to increase to $325 million and $295 million respectively once additional contributions are received from OTC participants (see CCP Standard 4.4). In addition, ASX Clear (Futures) may call AIM from participants with large portfolios (proxied by initial margin requirements) relative to their net tangible assets. ASX Clear (Futures) may also call AIM from participants where it has counterparty credit risk concerns.

Where the projected stress-test losses of a participant exceed its STEL, STEL AIM calls are made. Like other margins, STEL AIM is calculated overnight, notified to participants by 6.00 am the next day, and must be met by 11.00 am. Participants may meet these obligations using cash or non-cash collateral, including Australian Government securities and bank bills or negotiable certificates of deposit from authorised deposit-taking institutions (ADIs). ASX Clear (Futures) does not accept collateral issued by a clearing participant or associated entity, in order to reduce the possibility that it might face the default of both a clearing participant and a collateral issuer.

In deciding whether ASX Clear (Futures) has sufficient pooled financial resources, ASX considers the size, frequency, duration and distribution of additional collateral calls across participants. This process is documented in guidance on the circumstances in which ASX would consider increasing ASX Clear (Futures)' pooled resources. ASX Clear (Futures) would consider increasing its pooled resources if stress-test results in excess of pooled resources were persistent and widespread. In other cases, ASX Clear (Futures) would generally rely on additional collateral collected under the AIM regime.

4.8 A central counterparty should establish explicit rules and procedures that address fully any credit losses it may face as a result of any individual or combined default among its participants with respect to any of their obligations to the central counterparty. These rules and procedures should address how potentially uncovered credit losses would be allocated, including the repayment of any funds a central counterparty may borrow from liquidity providers. These rules and procedures should also indicate the central counterparty's process to replenish any financial resources that the central counterparty may employ during a stress event, so that the central counterparty can continue to operate in a safe and sound manner.

CCP Standard 4.8 comes into effect on 31 March 2014.

ASX has documented a process for making decisions regarding replenishment of a CCP's pooled financial resources following any draw down arising from a participant default. Responsibility for determining if resources will be replenished and, if so, how this should be achieved, ultimately lies with the ASX Limited Board, which would make this decision in consultation with the ASX Clear (Futures) Board. ASX has documented replenishment intentions, which include several options; the particular approach taken to replenishment will depend on the specific circumstances, including the severity of the loss and the market environment (see CCP Standard 12.1). ASX Limited has also committed to maintaining a certain level of equity capital in ASX Clear (Futures) (including via ASXCC), provided certain conditions are met, including that the CCP is solvent.

Following the release of finalised CPSS-IOSCO guidance on recovery planning, expected in late 2013, ASX Clear (Futures) will consider additional mechanisms to fully allocate credit losses and processes for replenishing financial resources following a participant default.