2012/13 Assessment of ASX Clearing and Settlement Facilities 4. Special Topic – ASX Strategic Initiatives

The 2011/12 Assessment identified some key strategic initiatives in train at ASX, most notably, clearing of over-the-counter (OTC) interest rate derivatives and a centralised collateral management service, and a trading, clearing and settlement service for retail investors in Commonwealth Government securities (CGS). The 2011/12 Assessment encouraged ASX to continue the detailed dialogue with regulators as these plans developed to ensure that these initiatives were pursued in a manner consistent with ASX's ongoing compliance with the Financial Stability Standards (FSS). A detailed dialogue has indeed continued over the 2012/13 Assessment period, as all three initiatives have been progressed to launch.

The Bank has taken a particularly close interest in the OTC interest rate derivatives clearing service, ultimately launched by ASX Clear (Futures) on 1 July 2013, and ASX Collateral, the centralised collateral management service, which launched on 29 July 2013, initially facilitating optimisation of collateral securities held in Austraclear. Both services represent major developments for ASX, ASX's participants and the Australian financial system more broadly. Given their importance, the Bank carried out detailed assessments of the prospective new services, with particular reference to their implications for ASX Clear (Futures)' and Austraclear's continued compliance with the relevant FSS. This section summarises some of the key design features of these services considered in the Bank's assessments, and also introduces the new retail CGS service.

4.1 Clearing of OTC Interest Rate Derivatives

ASX Clear (Futures) launched a clearing service for OTC interest rate derivatives on 1 July 2013. Initially, ASX has limited its offering to the clearing of participants' proprietary positions in standardised Australian dollar-denominated interest rate swaps (IRS) referencing either the bank bill swap rate or the overnight indexed swap rate. Nine banks have become Foundation Customers, and under the terms of the Foundation Customer Program all are expected to be admitted as participants by 1 January 2014. By the end of 2013, ASX plans to provide for client clearing, and to expand its product scope to Australian dollar-denominated IRS indexed to forward-rate agreements, and New Zealand dollar denominated IRS.

The provision of an OTC derivatives clearing service has implications for ASX Clear (Futures)' observance of several of the FSS. Prior to the launch of the service, therefore, the Bank carried out a detailed assessment of the new service against the relevant standards and sub-standards. The Bank's assessment is incorporated in the detailed assessment of ASX Clear (Futures) in Appendix B1.2. At the time of the assessment, some risk management policies and parameters had not yet been finalised, but these were addressed to the Bank's satisfaction prior to the launch of the service. One area remained outstanding at the time of launch: the development of an appropriate mechanism for ensuring competitive bidding in an auction of a defaulting participant's positions. As a condition of approval to launch, ASX committed to developing such a mechanism prior to the extension of the service to provide for client clearing, in the context of a more fully articulated ‘hedge-then-auction’ process (see Section 3.5.3).

4.1.1 Rule changes

To give effect to this service, ASX Clear (Futures) sought regulatory approval for a number of significant changes to its Operating Rules, including the introduction of a new OTC-specific Rulebook and an OTC Handbook, which sets out the procedures, timings, contract terms and other details of the service.[1] The key aspects of the rule changes are summarised below in Table 8.

As well as engaging with ASIC and the Bank during the development of the service, ASX conducted a ‘design study’ involving prospective participants, and a public consultation on its rule changes.

4.1.2 Key design features

Design features related to credit risk, margin and default management were examined particularly closely in the Bank's assessment. Some key observations and areas for continued monitoring are highlighted below.

Credit risk

ASX offers ‘real-time’ novation of interest rate swaps (IRS) transactions submitted for clearing, consistent with the existing novation process for exchange-traded products. To manage the additional risk exposure arising from real-time novation, ASX Clear (Futures) will place a limit on the acceptable size of new transactions, introduce approximately hourly portfolio exposure checks, and have the ability to prevent further novation until an intraday margin call is met. The Bank will continue to monitor the effectiveness of these risk management measures.

ASX operates a single commingled pool of default resources to support ASX Clear (Futures)' OTC and exchange-traded derivatives clearing activities. While some OTC derivatives CCPs that also clear exchange-traded products have opted for segregated default resources, others, including SGX and Eurex, also have commingled models. ASX has committed formally to reviewing the default fund arrangements annually, including considering whether a commingled default fund remains appropriate. The Bank will take a close interest in this review process.

With reference to the relevant FSS, the Bank's particular focus in assessing the appropriateness of this structure was on:

  • The size of pooled financial resources. The initial amount of paid-up pooled financial resources is based on stress tests of OTC derivatives position data collected in a design study in 2012. Further to the recent capital raising and rule changes that provide for an additional $100 million in contributions from OTC participants, ASX Clear (Futures) is in the process of increasing the total size of its prefunded pooled resources to $650 million. It is intended that this will provide cover sufficient to meet with a high degree of confidence ASX Clear (Futures)' obligations in the event of the default of the two participants to which it has the largest exposures in extreme but plausible circumstances. ASX has also amended its stress-test scenarios to take into account the longer assumed close-out period for OTC derivatives positions (five days as opposed to one to two days for exchange-traded positions), as well as adding scenarios that consider the potential basis risk resulting from a change in the economic relationship between interest rate futures and IRS, particularly in stressed circumstances. Since actual stress-test results, and associated financial resource requirements, will depend on observed participation in the service, the Bank will remain in close dialogue with ASX around the adequacy of resources as the service evolves.
  • Proportionality. In conjunction with for the increase in pooled financial resources, ASX also took steps to equalise the futures and OTC participant contribution pools to $100 million each. To address any residual concerns around mutualisation of participant-contributed financial resources, ASX also introduced different default waterfalls (i.e. the order in which survivors' contributed default resources would be used) depending on the defaulter's share of initial margin for exchange-traded compared with OTC derivatives products (including cross-margined futures) over the previous 90 days ( Graph 11).
  • Implications for contagion. ASX regards the commingling of financial resources as appropriate in light of the homogeneity of both the products to be cleared and the clearing participants: around half of the risk (as measured by initial margin) currently managed by ASX Clear (Futures) is related to AUD interest rate products; and 11 of the 14 ASX Clear (Futures) participants at the time of the launch were active in the AUD IRS market. Accordingly, the majority of participants already have some exposures to the default of a participant in this market and therefore the commingling of the default fund may not be a material incremental source of contagion between these markets.


ASX uses historical value-at-risk (VaR) to calculate margin requirements for OTC derivatives positions, based on a five-year sample period with an assumed close-out period of five days, and a 99.7 per cent confidence interval. This is closely aligned with the methodology used by existing international OTC derivatives CCPs and consistent with the Bank's supplementary interpretation of CCP Standard 6 (see Section 3.7). ASX also offers OTC participants the ability to choose to cross margin their direct interest rate futures by allocating these positions to their OTC derivatives portfolio. If participants choose to do so, the allocated interest-rate futures are margined under VaR, rather than using the CME SPAN methodology that is currently in place for exchange-traded positions. Under the FSS, ASX is also required to analyse and monitor its model performance and overall margin coverage by conducting rigorous daily backtesting and sensitivity analysis, and its risk management processes will be subject to periodic reviews by external experts. ASX introduced backtesting arrangements in July 2013 and has plans in place to further develop its other model validation processes. The Bank will monitor progress towards delivering on these plans over the coming months (see Section 3.5.1).

Participant default rules and procedures

ASX's approach to default management is broadly in accordance with the emerging standard for OTC derivatives CCPs. In the event of the default of an OTC participant, ASX's intention is to terminate the defaulting participant's open positions and hedge the defaulter's OTC derivatives portfolio (including cross-margined futures), before auctioning the hedged portfolio to non-defaulting participants. To provide advice and assist with the hedging process, ASX will convene Default Management Groups (DMGs), comprised of experts from non-defaulting OTC participants, selected on a rotational basis for an annual term. ASX will also seek the DMGs' advice on ASX Clear (Futures)' default management policy and processes at regular intervals. The DMGs will also be involved in default simulations at least once a year.

While the default management framework articulated for the OTC derivatives service is broadly consistent with the relevant FSS, there is one key stability-relevant matter outstanding: the absence of a clear incentive for participants to bid competitively at a default management auction. ASX is currently negotiating with participants to develop an agreed mechanism for incentivising competitive bidding within the context of more fully elaborated default management processes (see Section 3.5.3).

4.2 Centralised Collateral Management

ASX launched a centralised collateral management service (CCMS), ASX Collateral, on 29 July. This service has been developed in partnership with Clearstream, a Luxembourg-based financial market infrastructure provider. Impending regulatory changes and other market developments are increasing demands on a limited pool of high-quality collateral, giving market participants a strong incentive to optimise their use of collateral. 12 participants have signalled their intention to join the service.

In delivering this service, ASX has established a subsidiary, ASX Collateral Management Services Pty Limited, a wholly owned subsidiary of ASX Operations Pty Limited, to act as a ‘triparty’ collateral management agent. This subsidiary will have full operational control of collateral related transfers between CCMS participants' dedicated securities accounts in order to perform the operations of the new service. For the purposes of providing the CCMS, ASX Collateral Management Services Pty Limited holds an Australian Financial Services Licence (AFSL), permitting it to arrange dealings in securities.

Key functions of the service are that it automates the optimisation and allocation of collateral, substitutes collateral as required, and re-hypothecates or re-uses collateral received. Title remains and settlement continues to take place in the existing SSFs.

  • Optimisation of collateral is a process whereby a collateral provider seeks to meet its obligations by using collateral in the most efficient way. The provider aims to minimise the opportunity cost of providing collateral subject to pre-determined constraints, which may include regulatory requirements, collateral receivers' eligibility criteria and haircuts, alternative uses for collateral-eligible assets, and its own risk preferences.
  • Substitution is the process whereby collateral that has been lodged or pledged is replaced by unused collateral of equivalent or greater value – provided that it meets the eligibility criteria set by the collateral receiver. Events that may trigger substitution include sale of securities by the collateral provider, a corporate event, collateral becoming ineligible (e.g. because of a change to counterparty criteria), or optimisation of the collateral allocation.
  • Re-use is the process by which collateral received from another participant can in turn be given as collateral, thereby allowing for the creation of chains of re-use involving many participants. Where a participant in the re-use chain needs to perform a substitution of collateral, a series of substitutions may be required to retrieve the collateral.

In automating the optimisation process, ASX Collateral applies an optimisation algorithm developed and operated by Clearstream. This scans a collateral provider's portfolio to identify the securities that most efficiently meet any given collateral demand, subject to preferences established by the collateral receiver (on criteria such as issuer, security type and rating, and concentration limits). The algorithm is run regularly throughout the day and may recommend substitutions of collateral in response to relative collateral price movements and to changes in the collateral provider's portfolio of eligible assets. The CCMS then effects a transfer of collateral, in Austraclear, between participants to achieve this optimal allocation.

Initially, ASX is offering the service for collateral held in Austraclear, with plans to extend coverage in due course to collateral settled by ASX Settlement. In later phases, ASX Collateral plans to extend the service to permit participants to use collateral held in overseas depositories to meet collateral needs in Australia, and ultimately also to permit the use of collateral held in Austraclear and ASX Settlement to meet collateral needs overseas. Any such extensions would be subject to further regulatory approval.

ASX Collateral has the potential to become an important piece of infrastructure in Australian financial markets, and will be closely linked to the ASX securities settlement facilities. Accordingly, prior to the launch of the service, the Bank carried out a detailed assessment of the implications of introduction of the new service for Austraclear's continued observance of the relevant FSS. The Bank's assessment is incorporated in the detailed Assessment of Austraclear in Appendix B2.2. The Bank looked particularly closely at operational contingency arrangements. The Bank has an interest in the service beyond the oversight of Austraclear: in particular, in relation to the Bank's role as operator of RITS, for which Austraclear is a feeder system, and also the Bank's role as a potential collateral receiver via ASX Collateral.

4.2.1 Rule changes

ASX Collateral has the potential to become an important piece of infrastructure in Australian financial markets, and will be closely linked to ASX's licensed SSFs. Initially, ASX Collateral will provide for centralised management of collateral-eligible assets held in Austraclear to meet domestic collateral obligations. Clearstream will perform portfolio optimisation and operate the web interface for users of the service, while ASX Collateral will provide a gateway between Clearstream and Austraclear, feeding price and account information into the optimisation engine and generating settlement instructions for Austraclear based on collateral movements recommended by the optimisation engine or delivered via the web interface.

Austraclear has implemented a number of changes to its Regulations to provide for a Collateral Management System within Austraclear (Table 9). While many of the changes are not, in principle, materially different from prior amendments to facilitate other special types of settlement, the heightened regulatory attention on the collateral management functionality reflects the likelihood that this will become critical functionality for the financial system.

4.2.2 Key design features

In the Bank's assessment, particular attention was paid to interdependencies between ASX Collateral and Austraclear related to legal basis, operational risk, settlement, and participant default rules and procedures.

Legal basis

ASX Collateral Management Services Pty Limited is a special class of Austraclear participant, which is permitted to send instructions to the Austraclear system on behalf of ASX Collateral service users in relation to collateral movements. Recognising that the CCMS has the potential to be a crucial Austraclear dependency, ASIC, in consultation with the Bank, has required that the Austraclear Regulations and Procedures set additional operational resilience and business continuity requirements for this class of participant.

Transfer of title to securities occurs through Austraclear accounts. Accordingly, a prerequisite for use of the CCMS is participation in Austraclear. ASX Collateral participant arrangements are specified in Collateral Management Services Agreements (CMSAs), with separate agreements covering the receipt and provision of collateral. These agreements give ASX Collateral Management Services Pty Limited, as Collateral Manager, full operational control of collateral related transfers between CCMS participants' dedicated securities accounts in order to perform the operations of the new service, and intend to preserve participants' rights and obligations under bilateral counterparty contracts (Principal Agreements).

Operational risk

To facilitate the operations of the CCMS, the new Austraclear Regulations give effect to two new types of sub-account in Austraclear:

  • ‘Source Account’. A participant transfers to the Source Account the pool of securities from which ASX Collateral can allocate securities to meet collateral demands. Source Accounts may be controlled by both the participant (since collateral may need to be withdrawn for sale or other uses outside of the system) and ASX Collateral (in performing optimisation and allocations).
  • ‘Collateral Account’. These accounts maintain a record of all securities provided and received. Collateral Accounts are solely managed by ASX Collateral. These securities may be re-used within the CCMS (unless received via a pledge or otherwise agreed between the collateral provider and collateral receiver) to collateralise other obligations of the collateral receiver. The collateral receiver may also instruct ASX Collateral to transfer such securities to another account (e.g. for sale or repo outside of the CCMS), as long as equivalent replacement securities are transferred to the Collateral Account.

A key difference between these arrangements and existing bilateral collateral arrangements is that participants no longer have direct access to all securities held in their own name at Austraclear. While a collateral receiver's title to collateral held is not altered by these arrangements, participants' access to collateral securities received may, to some extent, be constrained relative to existing bilateral contractual and operational arrangements. This introduces new operational dependencies for market participants.

Particularly in light of these dependencies, the Bank has sought to establish that the standards for operational resilience at ASX Collateral are appropriate for a critical system and equivalent to those of Austraclear. Targets for system availability and capacity utilisation, as well as standards for operational redundancy and failover, are indeed equivalent; that is, 99.9 per cent availability and minimum capacity headroom of 50 per cent of total capacity. Further, ASX Collateral's domestic systems are located at ASX's primary and backup sites, with failover to occur within one to two hours. More generally, ASX's operational risk management framework applies equally to ASX Collateral, involving the documentation of operational processes and procedures, with independent external and internal audits. As with other operational services provided to the clearing and settlement corporate entities, a written support agreement between ASX Collateral and ASX Operations Pty Limited aims to ensure continuity of service (to the extent permissible by law), even in the event of insolvency of ASX Operations Pty Limited.

Key operations of the new CCMS are outsourced to Clearstream in Luxembourg. As noted, Clearstream operates the optimisation engine and the web interface for service users, while ASX Collateral Management Services Pty Limited operates the gateway between the outsourced Clearstream operations and Austraclear. This ‘Clearing Services Gateway’ (CSG) communicates with Clearstream systems over dual dedicated leased lines between Sydney and Luxembourg, sending price and account information to Clearstream's Collateral Management Exchange (CmaX) system and receiving recommended settlement instructions from the optimisation engine and web interface. It then converts the settlement recommendations into the appropriate sets of settlement instructions for Austraclear (or ASX Settlement in future).

Reliance upon externally supplied software is not new, and Austraclear has for some time outsourced certain core system services to a third-party vendor. Clearstream provides ‘round the clock’ operational and technical support via its network of operational centres. In addition, ASX has established a local service desk to deal with all participant requirements and queries, including liaison with Clearstream as required. Clearstream reliability targets are broadly equivalent to those of ASX Collateral: 99.8 per cent availability and average capacity utilisation of no more than 20 per cent.[2] Clearstream also has broadly equivalent security practices to ASX, including the use of geographically separated underground data centres with security huts, managed firewalls, anti-virus and anti-malware protection for email, and data encryption.

The Service Level Agreement between ASX Collateral and Clearstream sets out contingency plans for a range of scenarios that identify potential service issues and impacts, as well as actions and responsibilities. Provided that Austraclear is still operational, there is the option to fall back to manual submission of repos and other instructions for collateral transfers, based on existing bilateral functionality. It is acknowledged, however, that once the transition to centralised collateral management has occurred, market participants' functional knowledge of pre-existing processes is likely to decay.


Substitutions of collateral are settled in such a way as to prevent any occurrence of principal risk – even if only for a very short time in the settlement process. Where substitutions occur between two participants, settlement is on a delivery-versus-delivery basis (i.e. the transfer of title to one security is dependent upon the simultaneous transfer of title to the second security). However, since transferred collateral may be re-used, chains of substitutions may be necessary to recall collateral from the ultimate holder of a particular security to a collateral provider that seeks its return. Potentially, collateral substitutions between two participants may need to pass through intervening participants. To achieve this, the CCMS may generate sets of settlement instructions that must all successfully settle, or all instructions are rejected if one element fails to settle. The Bank is satisfied that this mechanism does not give rise to principal risk. However, a long re-use chain may have implications for timely completion of transactions at end of day. Use of cash as collateral of last resort is intended to mitigate this risk where participants engage in re-use of collateral.

Default management

The intent of the CMSAs is to preserve participants' rights and obligations under the Principal Agreement, including in the circumstances of a participant default. A default event is as defined by the Principal Agreement and would typically include situations such as a participant becoming subject to external administration or failing to meet its obligations in relation to a collateral transaction. Upon notification of a default under a Principal Agreement, ASX Collateral will act as the collateral receiver's agent and, upon instructions from the collateral receiver, instruct Austraclear to transfer collateral held from the receiver's Collateral Account to its Source Account or Austraclear trading account. ASX Collateral's role as an agent is strictly limited. Nothing in its contractual arrangements obligates ASX Collateral Management Services Pty Limited to enquire into the validity of any matters in connection with the Principal Agreement. Any such dispute is a matter for the parties to the Principal Agreement.

4.3 Retail Commonwealth Government Securities

On 21 May 2013, ASX launched a service to trade, clear and settle interests in CGS via its existing ASX Market, ASX Clear and ASX Settlement infrastructure. This initiative was launched in 2010 by the Australian Government, in order to facilitate trading of CGS by retail investors. Under the new service, investors trade depository interests, which represent units of beneficial ownership of CGS held in Austraclear. Securities traded include both Treasury Bonds and Treasury Indexed Bonds (with face value indexed to the consumer price index), of varying maturities and coupon rates.

Trades entered into via the new service are novated to ASX Clear and settled on a T+3 basis in ASX Settlement, as for cash equities. This is a departure from existing arrangements for wholesale trading in CGS, which occurs on an OTC basis, with no central clearing, and with settlement in Austraclear. In clearing CGS, ASX Clear applies the same risk management framework as for cash equities, levying initial and mark-to-market margin on transactions. Retail CGS are currently margined at a flat rate in accordance with ASX Clear's policy for cash equities and fixed-interest securities with an insufficient price history to apply the full HSVAR margin methodology. The flat rate applied to calculate initial margin for retail CGS aims to cover one or two day movements in price for a single security type to a 95 per cent confidence level. ASX's recent enhancements to margin backtesting will be used to verify that, at a portfolio level across all securities (including cash equities), the desired 99 per cent confidence level for margin coverage is met.

The Bank noted in its 2011/12 Assessment that it would be concerned if wholesale activity in CGS, which currently settles in Austraclear, migrated to the new facility. While Austraclear settles wholesale CGS on a delivery-versus-payment (DvP) model 1 basis, retail CGS are settled in a single multilateral net batch with cash equity transactions in ASX Settlement (i.e. DvP model 3). The settlement arrangements for the new facility would be acceptable only if the facility remained retail oriented. Since launch, settlement activity in retail CGS has indeed remained low. The Bank will continue to monitor developments in the service.


The OTC Rulebook and OTC Handbook are available at <http://www.asxgroup.com.au/asx-clear-futures-operating-rules-and-waivers.htm>. [1]

Clearstream is subject to assessment by the Central Bank of Luxembourg against relevant international principles (including operational risk), as are Austraclear and RITS. [2]