2012/13 Assessment of ASX Clearing and Settlement Facilities B1.1 ASX Clear

Standard 7: Liquidity Risk

A central counterparty should effectively measure, monitor and manage its liquidity risk. A central counterparty should maintain sufficient liquid resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under 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 generate the largest aggregate liquidity obligation for the central counterparty in extreme but plausible market conditions.

Rating: Observed

ASX Clear maintains a robust framework for managing its liquidity risk (CCP Standard 7.1). Under this framework, ASX Clear provides participants with information to assist them in managing their liquidity needs and risks, and employs an experienced Portfolio Risk Manager to monitor and manage ASX Clear's own settlement and funding flows (CCP Standard 7.2). ASX Clear holds sufficient liquid resources to meet its payment obligations on time in the event that the participant with the largest payment obligation to the CCP was to default in the extreme but plausible scenarios envisaged in its stress tests, although these tests assume the ability to reschedule cash equity transactions for large participants (CCP Standards 7.3, 7.8). These liquid resources comprise a portfolio of high-quality liquid assets managed by ASXCC on ASX Clear's behalf, supported by procedures to ensure timely and reliable access to liquidity from the portfolio as required (CCP Standards 7.4, 7.6). To enhance its management of liquidity risk, ASX Clear has access, via ASXCC's ESA, to Australian dollar liquidity from the Reserve Bank against eligible collateral (CCP Standard 7.7).

The Bank also notes the following steps that ASX Clear should take to strengthen its observance of CCP Standard 7:

  • In order to observe CCP Standard 7.3, which comes into effect on 31 March 2014, develop and implement appropriate arrangements to cover its largest liquidity exposure to a single participant and its affiliates in respect of cash equity transactions, without rescheduling settlements.
  • In order to meet the requirements of CCP Standard 7.9, which comes into effect on 31 March 2014, for derivatives transactions, implement mechanisms consistent with forthcoming CPSS-IOSCO guidance on recovery planning that fully address any uncovered liquidity shortfalls, in order to settle any payment obligations on a same-day basis.

The Bank will also monitor steps taken by ASX to align its liquidity stress tests to new liquidity arrangements (CCP Standard 7.8).

Based on this information, and noting that CCP Standards 7.3 and 7.9 are not yet in force, the Bank's assessment is that ASX Clear has observed the requirements of CCP Standard 7 during the 2012/13 Assessment period. ASX Clear's arrangements to measure, monitor and manage its liquidity risk are described under the following sub-standards.

7.1 A central counterparty should have a robust framework to manage its liquidity risks from its participants, commercial bank money settlement agents, nostro agents, custodians, liquidity providers and other entities.

Sources of liquidity risk

The primary source of liquidity risk in ASX Clear is the potential default of a participant with payment obligations to the CCP, on which the CCP may rely to make payments to other participants. Payment obligations to and from participants may be in the form of payments for settlement of a securities transaction, or initial and variation margin. ASX Clear does not currently rely on commercial bank money settlement agents, nostro agents, custodians or liquidity providers in meeting its Australian dollar payment obligations.

Managing liquidity risk

ASX Clear minimises the size of its liquidity obligations to participants through daily (and in the case of significant market movements, intraday) settlement of variation margin. This prevents the build up of large (credit and) liquidity exposures. ASX Clear's framework for managing its remaining liquidity risks involves the monitoring of liquidity exposures through daily stress testing (see CCP Standard 7.8) and the maintenance of sufficient liquid resources to be able to meet payment obligations in the event of a participant default (see CCP Standard 7.3).

ASX Clear also provides participants with information to help them manage their liquidity needs and risks, which in turn protects the CCP. Participants are provided with sufficient information to understand their intraday margin call obligations, and replicate stress-test outcomes. ASX publishes a daily CME SPAN and CMM margin parameter file that allows participants to estimate payment obligations associated with margin requirements for actual or hypothetical portfolios. ASX provides advance warnings and communications in respect of calls for additional margin, and margin rate changes. For example, participants are notified if their stress-testing results approach their STELs. Additionally, ASX works closely with participants where new obligations are likely to affect their liquidity needs; for example, conducting educational workshops for the introduction of CME SPAN and CMM.

7.2 A central counterparty should have effective operational and analytical tools to identify, measure and monitor its settlement and funding flows on an ongoing and timely basis, including its use of intraday liquidity.

Daily cash flows and investment of funds across the ASX CCPs are monitored and managed by an experienced Portfolio Risk Manager. In addition, the CRM unit reviews a daily report of key risk indicators that encompasses liquidity measures, with any issues being escalated to the CRO. Funding arrangements, such as settlement flows, are also monitored in real time by the CRM and Treasury functions. Portfolio Risk Management uses reports provided by CRM to monitor CME SPAN-calculated margin flows originating from DCS, which feed into ASX's Treasury Management System. Portfolio Risk Management inputs required deals to manage cash-flow movements in the Treasury Management System, which are accessed by Clearing and Settlement Operations via daily settlement reports. These reports are used to generate settlement instructions in Austraclear. Cash flow movements are monitored in RITS. Margin payments from participants must be made by 10.30 am, while payments to participants are manually managed in the RITS queue, and are only released once all margin obligations have been settled (generally by 12.00 pm).

ASX Clear mitigates potential liquidity risks in several ways. ASX Clear maintains $250 million in prefunded financial resources (see CCP Standard 4). In addition, ASX Clear has $50 million available to it under a committed standby liquidity facility from ASX Limited. ASX Clear does not include promissory commitments in its liquidity calculations, including in its stress tests, in recognition of the potential delay in receipt of these resources.

ASX Clear's liquid assets are invested and managed on its behalf by ASXCC (see ‘ASX Group Structure’ in Appendix B). ASXCC's Investment Mandate establishes a clear definition of liquid assets: liquid assets must be available for use within two hours and held in the form of either a restricted set of highly liquid securities or securities eligible for repurchase with the Reserve Bank (see CCP Standard 7.4).

7.3 A central counterparty should maintain sufficient liquid resources in all relevant currencies to settle securities-related payments, make required variation margin payments and meet other payment obligations on time with a high degree of confidence under 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 generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions. 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 consider maintaining additional liquidity resources sufficient to cover a wider range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would generate the largest aggregate payment obligation to the central counterparty in extreme but plausible market conditions.

CCP Standard 7.3 comes into effect on 31 March 2014.

ASX Clear's liquid resources include margin and other collateral posted by participants, as well as its own holdings of liquid assets and a committed liquidity facility from ASX Limited. ASX Clear's holdings of liquid assets and cash collateral posted by participants are invested on its behalf by ASXCC in accordance with its Investment Mandate. The ASXCC Investment Mandate requires that ASX hold liquid assets sufficient to cover the sum of:

  • The total available financial resources (AFR) across the ASX CCPs. The AFR for ASX Clear is currently set at $300 million (including $50 million in respect of its committed liquidity facility from ASX Limited) and is calibrated to cover the largest stressed liquidity exposure to a single participant and its affiliates, with the exception of peak liquidity exposures to A-rated and B-rated participants (see CCP Standard 7.8). The AFR for ASX Clear (Futures) is currently $550 million and is expected to rise further to $650 million in coming months (see Appendix B1.2, CCP Standard 7.3).
  • An ‘ordinary liquidity requirement’, which is intended to cover day-to-day liquidity requirements, such as the return of margin to participants, and is specified as a percentage of the ASXCC portfolio. This is calibrated to the maximum margin outflow in normal market conditions over the last 12 months and is reviewed quarterly.
  • An amount sufficient to cover the cash margin requirement of the largest participant of ASX Clear and its affiliates and the two largest participants of ASX Clear (Futures), based on the largest margin amounts held by participants over the previous quarter.

The requirement to cover the AFR across both CCPs takes a conservative approach in that it provides for the simultaneous default, under extreme but plausible market conditions, of the largest participant and its affiliates in ASX Clear and in the two largest participants in ASX Clear (Futures).

In the event of the default of a participant with net securities-related payment obligations, ASX Clear's liquidity needs may be significantly greater than its credit exposure. From a credit risk perspective, ASX Clear is exposed only to replacement cost risk from an adverse price movement in the resale of any securities due to be purchased. Funds received from the sale may be used to offset its payment obligation. However, there is a timing mismatch between the point at which ASX Clear must meet the defaulting participant's payment obligation in relation to the purchased securities and that at which it receives funds from the resale of these (typically 3 days later). This creates a gross liquidity exposure for ASX Clear that may significantly exceed any replacement cost exposure on the same default. As a result, ASX Clear's AFR may be insufficient to meet its full liquidity exposure on a default.

ASX Clear would currently address any liquidity shortfall by rescheduling trades. It would employ ASX Settlement's back-out algorithm to remove transactions from the batch in a way that would allow ASX Clear to remove its payment obligations on behalf of the defaulting participant, while avoiding an increase in net payment obligations for other participants (see Appendix B2.1, SSF Standard 10.2). Before the back-out procedures were initiated, the ASX Default Management Committee would determine whether ASX Clear would inject sufficient liquidity to ensure that settlement of payment obligations occurred as expected. If not, ASX Clear would rely on the back-out procedures to complete settlement.

ASX Clear has acknowledged that its liquid resources are insufficient to meet this standard under current arrangements, and ASX has recently consulted on a proposal to address this issue. ASX is proposing to amend the ASX Settlement Operating Rules to give effect to a set of transactions that enable the CCP to settle its payment obligations on the intended settlement date in the event of a participant default. This would occur through an arrangement with non-defaulting participants to which ASX Clear has payment obligations, such as the purchase of stock, to offset the underlying settlement obligations to and from those participants with a separate ‘offsetting transaction arrangement’ – also referred to as a stock repurchase arrangement. Under the first leg of the offsetting transaction arrangement ASX Clear would, in effect, re-deliver the stock to the relevant non-defaulting participant in return for payment equal to the amount of the payment obligation of ASX Clear to that participant. Under these arrangements, ASX Clear would agree to repurchase the stock the next business day under the final leg of the transaction. If this transaction was unable to be settled on the next business day, subsequent offsetting transactions would be entered into on a daily basis until the settlement of on-market close-out trades took place.

Under the proposed solution, in the event of a participant default, ASX Clear would use the existing $300 million of available financial resources prior to executing offsetting repurchase transactions with non-defaulting participants.

7.4 For the purpose of meeting its minimum liquid resource requirement, a central counterparty's qualifying liquid resources in each currency include cash at the central bank of issue and at creditworthy commercial banks, committed lines of credit, committed foreign exchange swaps and committed repos, as well as highly marketable collateral held in custody and investments that are readily available and convertible into cash with prearranged and highly reliable funding arrangements, even in extreme but plausible market conditions. If a central counterparty has access to routine credit at the central bank of issue, the central counterparty may count such access as part of the minimum requirement to the extent it has collateral that is eligible for pledging to (or for conducting other appropriate forms of transactions with) the relevant central bank. All such resources should be available when needed.

ASXCC holds an ESA at the Bank to facilitate money settlements on behalf of ASX Clear (and ASX Clear (Futures)) (see CCP Standard 7.7). As an ESA holder, ASXCC is eligible for access to Australian dollar liquidity under the Bank's overnight and intraday liquidity facilities (against eligible collateral within its investment portfolio), including in times of market stress.

The ASXCC Investment Mandate requires the Portfolio Risk Manager to maintain high-quality liquid assets to meet ASX Clear's minimum liquidity requirements, consistent with the definition of qualifying liquid assets under this standard. Liquid assets must be available for use within two hours and held in securities eligible for repurchase transactions with the Bank. Investments held in the form of bank bills, negotiable certificates of deposit and floating rate notes issued by approved counterparties or obligors are required to be tradable on a robust secondary market. Over the Assessment period, term deposits averaged just over 40 per cent of the ASXCC investment portfolio, at-call deposits around 30 per cent, with holdings of other approved securities making up the balance. The arrangements for offsetting repurchase transactions proposed in ASX's recent consultation (see CCP Standard 7.3) would also meet the definition of qualifying liquid resources for the purpose of this standard, since they would be prearranged, committed and reliable (since they effectively utilise funds otherwise due to participants). Eligible investment counterparties are discussed under CCP Standard 15.

ASX Clear's committed liquidity facility with ASX Limited is contractually based, and can be considered highly reliable due to the corporate relationship between the two entities. These funds would be sourced from ASX Limited's cash resources, and are not routinely utilised in any other part of ASX's operations.

7.5 A central counterparty may supplement its qualifying liquid resources with other forms of liquid resources. If the central counterparty does so, these liquid resources should be in the form of assets that are likely to be saleable or acceptable as collateral for lines of credit, swaps or repos on an ad hoc basis following a default, even if this cannot be reliably prearranged or guaranteed in extreme market conditions. Even if a central counterparty does not have access to routine central bank credit, it should still take account of what collateral is typically accepted by the relevant central bank, as such assets may be more likely to be liquid in stressed circumstances. A central counterparty should not assume the availability of emergency central bank credit as part of its liquidity plan.

ASX Clear does not supplement its qualifying liquid resources with other forms of liquid resources.

7.6 A central counterparty should obtain a high degree of confidence, through rigorous due diligence, that each provider of its minimum required qualifying liquid resources, whether a participant of the central counterparty or an external party, has sufficient information to understand and to manage its associated liquidity risks, and that it has the capacity to perform as required under its commitment. Where relevant to assessing a liquidity provider's performance reliability with respect to a particular currency, a liquidity provider's potential access to credit from the central bank of issue may be taken into account. A central counterparty should regularly test its procedures for accessing its liquid resources at a liquidity provider.

The Portfolio Risk Manager, in consultation with the CRO, is responsible for the provision of timely liquidity to fund margin and settlement obligations to non-defaulting participants. The Default Management Framework (see CCP Standard 12.1) covers liquidation of participant non-cash collateral, as well as the liquidation of treasury investments representing participant cash collateral and other prefunded financial resources. While the order of use of particular collateral types will depend on the particular circumstances, a typical order of use may be cash first, followed by other non-cash collateral. The order of liquidation of non-cash collateral to meet funding requirements will depend on factors such as prevailing market conditions, liquidity needs and the amount of funds required relative to the size of each collateral lodgement. Procedures for dealing with liquid assets in the treasury investment portfolio are documented, and are available for Portfolio Risk Management staff at both primary and backup sites.

7.7 A central counterparty with access to central bank accounts, payment services or securities services should use these services, where practical, to enhance its management of liquidity risk. A central counterparty that the Reserve Bank determines to be systemically important in Australia and has obligations in Australian dollars should operate its own Exchange Settlement Account, in its own name or that of a related body corporate acceptable to the Reserve Bank, to enhance its management of Australian dollar liquidity risk.

ASXCC holds an ESA, making it eligible for access to Australian dollar liquidity under the Bank's overnight and intraday liquidity facilities (against eligible collateral). Updates to its Investment Mandate in 2012/13 clarified ASXCC's ability to make use of these services, by specifying the list of securities (from the Bank's approved list) available for repurchase, including the securities of the Commonwealth, certain states and major banks (CCP Standard 15).

ASX Clear uses ASXCC's ESA to settle its AUD margin and cash settlement obligations in RITS (see also CCP Standard 9).

7.8 A central counterparty should determine the amount and regularly test the sufficiency of its liquid resources through rigorous stress testing. A central counterparty should have clear procedures to report the results of its stress tests to appropriate decision-makers at the central counterparty and to use these results to evaluate the adequacy of, and adjust, its liquidity risk management framework. In conducting stress testing, a central counterparty should consider a wide range of relevant scenarios. 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. Scenarios should also take into account the design and operation of the central counterparty, include all entities that might pose material liquidity risks to the central counterparty (such as commercial bank money settlement agents, nostro agents, custodians, liquidity providers and linked FMIs) and, where appropriate, cover a multiday period. In all cases, a central counterparty should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount and form of total liquid resources it maintains.

ASX Clear uses daily liquidity stress testing to assess the adequacy of its liquidity arrangements. The stress-testing model, which is adapted from ASX Clear's capital stress tests (described under CCP Standard 4), calculates the maximum liquid funds that ASX Clear would need to access in order to meet obligations arising in the event of the joint default of a clearing participant and its affiliates. The liquidity stress tests assume that a default occurs just prior to receipt of the previous day's variation margin payments, if owed by the defaulter, or just after any variation margin payments have been paid, if owed to the defaulter. The stress tests thereby calculate the worst-case liquidity requirement under each stress-test scenario.

ASX Clear's liquidity stress tests apply different assumptions depending on the size and credit standing of the defaulting participant. For A-rated and B-rated participants, liquidity stress-test results are derived directly from the capital stress test. This is based on the assumption that, for these large participants, excess liquidity exposures generated by the securities settlement cycle would be addressed through the rescheduling of trades (and in future by the proposed offsetting repurchase transactions entered into by participants, see CCP Standard 7.3). For other participants, the liquidity stress test combines the results from two independent models: one for derivatives transactions and one for the cash market. Since securities settle on a three day cycle, the liquidity stress test for the cash market uses projected cash inflows and outflows from settlements and margin payments to calculate the cumulative liquidity requirement for each of the four days following a participant default. The stress-test result used in the liquidity stress-test model is taken from the day with the largest cumulative requirement.

The cash market and derivatives stress tests each apply three default scenarios, combined with a number of market change scenarios.

For the cash market stress test, two market change scenarios are applied: an increase of 10 per cent and a decrease of 15 per cent. In the cash market stress test, the default scenarios apply different assumptions to:

  • the priming of settlement accounts before default (either 90 per cent or 100 per cent of deliverable securities are assumed to be in the defaulting participant's settlement account)
  • the use of non-novated transactions to offset obligations in respect of novated transactions
  • whether the defaulter's sell transactions are deferred for three days or settled as soon as securities are available.

In the derivatives stress test the market change scenarios are based on the price and volatility changes set out in the capital stress-test scenarios (see CCP Standard 4.6). The three default scenarios for the derivatives stress test assume that ASX Clear is able to transfer all, some or only profit-making client accounts.

The results of the liquidity stress tests give a ‘default liquidity requirement’ (DLR), which is compared with ASX Clear's AFR (currently set to $300 million). A stress-test result above the AFR for three consecutive trading days is considered a breach of the AFR and triggers a detailed investigation into the breach. When assessing the materiality of a liquidity stress-test breach, the CCPs will consider contributing and mitigating factors, such as changes in the ICR of the participant, atypical trading activity, and any AIM that is being held. In order to test the sufficiency of ASX's overall liquid resources, the results of liquidity stress testing are also aggregated across both CCPs to calculate the worst-case aggregated DLR.

The results of liquidity stress testing are regularly reported to ASX senior management, the CS Boards and the Bank. All liquidity stress-test breaches are reported to the CRO, the General Manager of Clearing Risk Policy, and the Portfolio Risk Manager. A sustained or widely distributed breach may lead to a review of the adequacy of the AFR. Over the Assessment period there were a number of liquidity stress-test breaches caused by ASX Clear's exposures to C-rated participants. ASX's review of these breaches concluded that an increase in the AFR was not required, due to the narrow base of participants affected, the ability to call additional margin under the AIM regime (see CCP Standard 4.7), and the proposed introduction of new offsetting repurchase transaction arrangements with participants (see CCP Standard 7.3). The change in the composition of available liquid resources implied by the last of these factors suggests that ASX Clear should review its liquidity stress-test approach alongside the introduction of new liquidity arrangements.

7.9 A central counterparty should establish explicit rules and procedures that enable the central counterparty to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations on time following any individual or combined default among its participants. These rules and procedures should address unforeseen and potentially uncovered liquidity shortfalls and should aim to avoid unwinding, revoking or delaying the same-day settlement of payment obligations. These rules and procedures should also indicate the central counterparty's process to replenish any liquidity resources it may employ during a stress event, so that it can continue to operate in a safe and sound manner.

CCP Standard 7.9 comes into effect on 31 March 2014. Following the release of finalised CPSS-IOSCO guidance on recovery planning, expected in late 2013, ASX Clear will be considering arrangements to ensure settlement of payment obligations can be achieved on time in circumstances in which its liquid resources under CCP Standard 7.3 have been exhausted.

ASX Clear's proposal to enter into offsetting repurchase transaction arrangements with participants would be expected to meet the requirements of this sub-standard for liquidity exposures generated by securities transactions. However, additional mechanisms may be required to address uncovered liquidity shortfalls generated by derivatives transactions. The Bank will continue its dialogue with ASX on these matters over the coming Assessment period.