2015/16 Assessment of ASX Clearing and Settlement Facilities A1.2 ASX Clear (Futures) Standard 12: Participant default rules and procedures

A central counterparty should have effective and clearly defined rules and procedures to manage a participant default. These rules and procedures should be designed to ensure that the central counterparty can take timely action to contain losses and liquidity pressures and continue to meet its obligations.

ASX Clear (Futures) has powers under its Operating Rules and Procedures to manage a participant default, and has documented an internal framework setting out its default management approach (CCP Standard 12.1). Powers available to ASX Clear (Futures) include powers to suspend a defaulted participant, apply margin and pooled financial resources to meet losses, and employ a range of close-out and hedging strategies, including the auction of the defaulter's OTC derivatives positions to surviving participants (CCP Standards 12.1, 12.2). Participants are required to report default events or an expected default to the CCP. ASX Clear (Futures) has published its Operating Rules that set out its default management powers, as well as a high-level overview of its approach to default management and a fact sheet outlining the rights of clients in the event of their clearing participant's default (CCP Standard 12.3). Default management procedures are tested and reviewed on at least an annual basis. Participants clearing OTC derivatives are represented on a DMG that participates in annual tests of OTC default management arrangements, including the auction process (CCP Standard 12.4). ASX Clear (Futures)' default management arrangements are designed for the particular characteristics of its primarily Australian-based activities, and take into account potential impacts on relevant markets (CCP Standard 12.5).

12.1 A central counterparty should have default rules and procedures that enable the central counterparty to continue to meet its obligations in the event of a participant default and that address the replenishment of resources following a default. A central counterparty should ensure that financial and other obligations created for non-defaulting participants in the event of a participant default are proportional to the scale and nature of individual participants' activities.

Rules and procedures

The Operating Rules and Procedures provide ASX Clear (Futures) with the authority and flexibility to deal with a participant default using a variety of methods to manage its exposure. For exchange-traded derivatives, ASX Clear (Futures) has the ability to close out any open positions, exercise or terminate open contracts, or seek to transfer (port) client positions. For OTC derivatives, ASX Clear (Futures) is able to manage a participant default through a process of hedging then auctioning the defaulter's OTC portfolio. The specific method for managing ASX Clear (Futures)' exposures may depend on a number of factors, including market conditions and the composition of the defaulted participant's portfolio.

The formal Rules and Procedures form part of ASX's CCP DMF, a collection of internal and public documents that set out the guiding principles and procedures for managing a clearing participant default. In 2015/16, ASX undertook a wide-ranging review of its DMF documentation. As part of this review, ASX developed a new Default Management Policy and Default Management Standard, applicable to both ASX Clear and ASX Clear (Futures), to assist in the management of a clearing participant default. These new documents, together with any updates to the existing DMF documentation arising from the review, are due to be finalised in 2016/17.

The DMF is based on high-level principles regarding the management of a default that have been approved by the CS Boards. In particular, these principles specify that the key aim in handling a default is to minimise the impact of the event on ASX, its participants and the broader market. The DMSG provides oversight and review of the DMF, including discussion of proposed changes prior to submission to the CS Boards.

The Default Management Standard and accompanying procedures provide guidance on each stage of a default, from the identification of a default event, to the management of the defaulter's position, real-time monitoring of financial solvency, and financial offset and reconciliation. The Standard is intended to be flexible, rather than prescriptive, allowing ASX to adapt its default management approach to the specific circumstances as appropriate.

The DMF outlines the key roles and responsibilities in managing a clearing participant default. The ASX Group has established a DMC, comprising senior management from relevant areas within ASX, to be the primary decision-making forum for the management of a default. The DMC's responsibilities range from recommending declarations of default and suspensions, to devising a risk neutralisation plan and overseeing its implementation.

In the event of the default of an OTC participant, ASX Clear (Futures) would convene the relevant DMG, which comprises non-defaulting clearing participants seconded on a rotating basis. Currently there is only one DMG, since ASX Clear (Futures) clears only one category of OTC derivatives (AUD IRD), comprising representatives of all the OTC participants. The DMG would advise and be consulted by ASX Clear (Futures) on the management of an OTC participant default. ASX Clear (Futures) is not obliged to follow the recommendations of the DMG, but would be required to provide reasoning where it did not accept the DMG's advice.

Default management – futures

Under the Operating Rules and Procedures, ASX Clear (Futures) is allowed to employ a variety of methods to close out or otherwise manage a defaulted participant's positions in exchange-traded futures. These include transfer, on- or off-market liquidation, expiry, exercise and hedging (see Section 4.4.1 for more information on close-out arrangements). If standard close-out processes could not be successfully carried out, ASX's enhanced recovery approach would allow ASX Clear (Futures) to terminate (on a pro rata basis to the extent practicable) positions held by non-defaulting participants that were opposite to those that the CCP had inherited from the defaulter. These positions would be terminated at their current market value, restoring the CCP to a matched book. As a last resort, ASX Clear (Futures) would have the power to completely terminate all open contracts in order to restore its matched book.

Default management – OTC derivatives

In the event of default of an OTC participant, ASX Clear (Futures) may first suspend the defaulted participant and would first look to hedge its exposure arising from the defaulting participant's portfolio. ASX Clear (Futures) may engage the relevant DMG to assist in this process. To close-out the defaulter's portfoilio, ASX Clear (Futures) may then conduct one or more auctions of the portfolio (including the hedges) to non-defaulted participants (see Section 4.4.1). ASX Clear (Futures) may set a reserve price on the default auction(s).

All OTC participants that have positions in the relevant products are required to bid in the auction of a defaulter's portfolio. ASX utilises a ‘juniorisation’ mechanism that is designed to ensure that non-defaulting participants bid competitively in the auction of a defaulter's portfolio. For the participants obliged to take part in the auction, the juniorisation mechanism determines the order in which their contributions to the ASX Clear (Futures) default fund would be applied to losses on the default in the event that the auction crystallises losses beyond the defaulter's margin and the first tranche of ASX capital. The order of application is related to the size of participants' bids in the auction, so that the winner of the auction has its contribution applied last and the participant with the lowest bid has its contribution applied first, subject to bids exceeding a minimum threshold determined by ASX. Participants that are not required to take part in an auction (for example, participants that lack the capacity to manage particular product types within an auction pool) would have their contributions applied at the same point as the winner of the auction. ASX Clear (Futures), in consultation with the DMG, could conduct the auction in one of the following forms:

  • The defaulted participant's portfolio could be auctioned in a single pool to the single highest bidder, or split into multiple identical units auctioned off to several bidders. In the latter case, the order of application of participant contributions to losses would be based on the lowest bid for any unit within the pool.
  • Alternatively, the defaulted participant's portfolio could be broken up into separate pools with shared characteristics (for example currency, product, tenor, carry or trade volume), with separate auctions in respect of each pool. Each of these pools could be auctioned off in a single unit or multiple identical units. The application of bidding participants' contributions to losses would be based on the ranking of bids in each of these pools, weighted according to the relative risk of each pool.

As an alternative to an auction, ASX Clear (Futures) could agree the transfer of equivalent contracts with a non-defaulting participant, but in doing so would seek to avoid crystallising losses that would require the application of non-defaulting participants' commitments. If neither an auction nor transfer could be successfully carried out, ASX's enhanced recovery approach would allow ASX Clear (Futures) to apply partial or (as a last resort) complete termination powers in order to restore its matched book.

Use and sequencing of financial resources

Following a declaration of default, ASX Clear (Futures) may suspend the defaulted participant's authority to clear. Suspension, rather than termination, ensures that the participant remains bound by the CCP's rules. ASX may restrict the clearing participant's access to trading, clearing, settlement and payment systems, and there would be no further payments or collateral movements to the participant. This enables the CCP to ‘crystallise’ the defaulted participant's position and generate detailed account and position data (including collateral held). This establishes the basis for the close out of exposures to the defaulted participant.

In the first instance, ASX Clear (Futures) would meet obligations arising from a participant default using collateral lodged by that participant. Collateral may be in the form of cash or eligible securities (see CCP Standard 5.1). In the event that the defaulted participant's contributions were insufficient, ASX Clear (Futures) could draw upon its default fund (see CCP Standard 4). These resources are commingled across futures and OTC products. While not essential, the commingled default fund adopted by ASX Clear (Futures) simplifies the default management process when the defaulter's portfolio contains both OTC derivatives and portfolio-margined futures positions. 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. The order in which survivors' default fund contributions would be used (i.e. the default waterfall) would, however, be proportional to the scope of the defaulter's activities. The proportion of futures and OTC participant contributions that would be used after each tranche of ASX capital will be based on the defaulter's share of initial margin for exchange-traded compared with OTC derivatives products (including portfolio-margined futures) over the previous 90 days. ASX conducted the annual review of commingling arrangements in May 2015, which was presented to the Risk Consultative Committee and CS Boards. The review concluded that the arrangements remained appropriate, particularly as exposures generated by OTC derivatives remain small relative to futures.

In the event that its $650 million of prefunded resources were exhausted, ASX Clear (Futures) would have the power under its enhanced recovery approach to call up to a further $200 million in Recovery Assessments from participants for a single default, or up to $600 million if multiple participants were to default (see CCP Standard 4.8). Beyond this, ASX Clear (Futures) would be able to apply a haircut to a range of its outgoing payment obligations to participants to allocate remaining losses stemming from the default. As a last resort, ASX would have a power in recovery to allocate losses by reductions to settlement payments in the context of complete termination of all open contracts.

During the Assessment period, ASX Clear (Futures) implemented an enhanced approach for replenishing its default fund in the event that these were drawn upon during the management of a participant default (see CCP Standard 4.8 and Box A). As soon as practicable following the conclusion of the default management process, ASX Clear (Futures) would make an ‘initial interim replenishment’ contribution to restore its default fund up to at least the Minimum Fund Size of $100 million. At the end of a 22-business-day ‘cooling-off period’, the default fund would be fully replenished to $400 million.[17] In order to maintain the required level of financial cover during this period, ASX would supplement its interim contribution with AIM called from participants. ASX would also have the discretion to call an interim replenishment contribution from participants during the cooling-off period; this would be capped at the level of the Minimum Fund Size. If further increases to the default fund were required following full replenishment, these would be met 50/50 by ASX and participant contributions as part of the quarterly recalibration of the default fund.

The appropriate strategy for replenishing any CCP resources utilised during the default would be determined by the ASX Clear (Futures) Board, in consultation with the ASX Limited Board.

ASX Clear (Futures)' plans for recapitalisation include the use of existing group cash reserves and raising additional capital through an equity issuance by ASX Limited. To support the credibility of its new replenishment arrangements, ASX established an intragroup Replenishment Deed, which governs the provision of funds for ASX Clear (Futures)' replenishment obligations by ASX Limited.

12.2 A central counterparty should be well prepared to implement its default rules and procedures, including any appropriate discretionary procedures provided for in its rules. This requires that the central counterparty should:

  1. require its participants to inform it immediately if they:
    1. become subject to, or aware of the likelihood of external administration, or have reasonable grounds for suspecting that they will become subject to external administration; or
    2. have breached, or are likely to breach, a risk-control requirement of the central counterparty; and
  2. have the ability to close out, hedge or transfer, a participant's open contracts in order to appropriately control risk of a participant that:
    1. becomes subject to external administration; or
    2. breaches a risk-control requirement of the central counterparty.

To facilitate early identification of a default event, the ASX Clear (Futures) Operating Rules and Procedures require that a participant inform ASX Clear (Futures) immediately in the event of a default, or if there is a reasonable expectation of such an event occurring. This requirement is legally binding, including in the event that an external administrator was appointed to the clearing participant. The Operating Rules and Procedures envisage a number of possible events of default. These include scenarios in which the clearing participant becomes subject to external administration, is unable to meet obligations relating to open contracts, defaults at another CCP or exchange, or breaches the CCP's risk-control requirements, such as by failing to fulfil margin or other payment obligations to the CCP.

Although the ASX Clear (Futures) Operating Rules set out specific events of default, declaration of a default would never be automatic. Instead, ASX Clear (Futures) maintains the right to investigate a potential default fully, taking into account any extenuating circumstances. The process of investigating, and the subsequent handling of, a potential default would generally depend on its nature. Specifically, ASX distinguishes between ‘financial’, ‘operational’ and other ‘compliance’ defaults. This differentiation appropriately reflects the severity of the breach and potential ramifications of a declaration of default. The PIRC, which is chaired by the GE, Operations and made up of senior staff from operational, risk management, compliance and legal departments, is responsible for monitoring and managing clearing participant incidents and the escalation of potential default events to the DMC (see Appendix A2.1, SSF Standard 3.1 for further detail on the PIRC). Ultimately, the declaration of any default is the responsibility of the Managing Director and CEO of ASX (or relevant delegates), under delegated responsibility from the CS Boards.

The Operating Rules and Procedures allow ASX Clear (Futures) to employ a variety of methods to close out or otherwise manage the positions of a defaulted participant. These include hedging, transfer, on- or off-market liquidation, expiry and exercise. As a last resort, partial or complete termination powers would be available to ASX Clear (Futures) under its enhanced recovery arrangements (see CCP Standard 12.1). For the OTC derivatives clearing service, ASX Clear (Futures) may conduct an auction of the defaulted participant's OTC derivatives positions.

There are advantages and disadvantages to each method for managing the defaulted participant's exposures. The specific method used in practice may depend on a number of factors, including market conditions and the composition of the defaulted participant's portfolio. For example, subject to other legal and practical impediments, the account structure used by the defaulted participant would be a relevant factor in determining whether client positions could be transferred following a default event. ASX Clear (Futures) offers individual client accounts for both OTC derivatives and exchange-traded derivatives, which are more likely to be able to support the transfer of client positions following a default (see CCP Standard 13). However, both OTC and exchange-traded derivatives clients can opt to clear via an omnibus account with net margining, which may make the transfer of individual client positions in a default event difficult due to possible under-collateralisation of individual positions. ASX Clear (Futures) provides a window of up to 24 or 48 hours for a defaulted participant's futures or OTC clients with individually segregated accounts to transfer their positions to another participant, although it retains the flexibility to either extend or shorten this window, depending on the prevailing circumstances. As described under CCP Standard 12.1, ASX policy establishes a preference for controlling the risk associated with a defaulted participant's OTC derivatives positions through a process of hedging then auction.

12.3 A central counterparty should publicly disclose key aspects of its default rules and procedures.

ASX Clear (Futures)' Operating Rules and Procedures and the OTC Rules and OTC Handbook are available on the ASX public website. These rules outline when ASX Clear (Futures) may take action against a participant and the powers of ASX Clear (Futures) in the event of a default, including its ability to transfer clients' positions to other participants. ASX Clear (Futures)' Operating Rules set out the treatment of proprietary and customer positions. In addition, ASX has published a high-level overview of its approach to managing a clearing participant default on its website, as well as a client fact sheet that outlines the segregation and portability arrangements in ASX Clear (Futures) and the rights of clients in the event of their clearing participant's default. The OTC Handbook provides a description of the default management auction process for OTC derivatives, including numerical examples of the juniorisation process.

In addition to the default management information provided on its website, ASX provides detailed responses to any targeted requests for information by clearing participants. Clearing participants have the ability to provide feedback and seek further information on default processes through this mechanism.

12.4 A central counterparty should involve its participants and other stakeholders in the testing and review of the central counterparty's default procedures, including any close out procedures. Such testing and review should be conducted at least annually and following material changes to the rules and procedures to ensure that they are practical and effective.

The DMF is reviewed on an annual basis, or more frequently as needed, and is regularly tested by in-house default management ‘fire drills’. The fire drills assist in ensuring that relevant ASX personnel are familiar with the default management process and identify areas where the DMF should be updated. Findings, including any recommended enhancements to the DMF, are reported to the DMSG after each fire drill. The Bank observed both the exchange-traded and the OTC derivatives fire drill exercises conducted in mid 2016, and will continue to observe future fire drills. In recent years, the DMF has been updated on several occasions[18]:

  • during the 2011/12 Assessment period, to incorporate experience gained from the default of MF Global
  • in the 2012/13 Assessment period in anticipation of the launch of the OTC derivatives clearing service
  • in 2014, to account for the use of offsetting transaction arrangements in ASX Clear, changes to client segregation arrangements, and the implementation of the ‘juniorisation’ mechanism
  • in 2016, to reflect ASX's new recovery planning arrangements, the experiences gained from the BBY Limited default, and learnings from the 2016 ASX Clear (Futures) and ASX Clear fire drills.

A further update to the DMF is expected in due course to reflect the introduction of the proposed FMI resolution regime, after the regime is finalised.

Currently, participants are not directly involved in default management fire drills that test ASX Clear (Futures)' default management procedures for exchange-traded products. This allows ASX to more freely incorporate scenarios based on actual participants and portfolios into its fire drills, involving the use of confidential information that cannot be shared with other participants. Nevertheless, after each fire drill a sample order file is sent to each of the default brokers that would be used by ASX to execute close-out trades, in order to test the compatibility of the file with their systems.

Separate fire drills for the OTC clearing service are conducted by the DMG, the most recent of which took place in July 2016. This fire drill utilised upgraded risk systems designed to better identify potential hedges for a defaulted participant's OTC portfolio. The DMG comprises representatives of all OTC clearing participants, who are tasked with periodically convening to review the default management process and recommend amendments. Each OTC derivatives clearing member is involved directly in simulations of the hedging and auction stages of the default management process.

ASX Clear (Futures)' default arrangements take into account, as far as possible, the implementation of any resolution regime that governs the CCP's participants. ASX has undertaken analysis on the impact of resolution proceedings for ADIs and banks in several other jurisdictions on a CCP's default management processes. While acknowledging that bank resolution authorities may have broad powers to intervene in the arrangements of an insolvent bank participant, the analysis suggests that, in general, resolution proceedings should not impede a CCP's default management processes. ASX will be conducting further analysis on the interaction between ADI and FMI resolution once the proposed framework for FMI resolution has been finalised.

12.5 A central counterparty should demonstrate that its default management procedures take appropriate account of interests in relevant jurisdictions and, in particular, any implications for pricing, liquidity and stability in relevant financial markets.

The DMF identifies that the key aim in handling a default is to minimise the impact of the event on ASX Clear (Futures), its participants and the market. Since close-out decisions by the DMC are complex and involve careful consideration of the specific circumstances surrounding the default, documented default management procedures are not prescriptive. Rather, ASX Clear (Futures) would consider a range of high-level factors in a default situation, including: any systemic risk implications; potential contagion and implications for wider market liquidity; interdependencies with other entities; the impact on the CCP's risk profile and financial standing; additional risks that could be incurred by participants; and market conditions and default portfolio complexity.

Futures participants are predominantly large foreign banks or subsidiaries of these banks that have a significant domestic presence. However, in 2014/15, a futures participant commenced clearing remotely from the United Kingdom. All OTC participants are Australian banks, Australian branches of foreign banks or Australian incorporated subsidiaries of foreign banks. In addition, products cleared by ASX Clear (Futures) are AUD-denominated, with the exception of NZD contracts (which make up around 3 per cent of initial margin requirements). Accordingly, default management actions would be taken during the local time zone for all but one participant (taking into consideration the extended trading hours of the ASX 24 market). ASX has not identified any impediments to carrying out its default management processes in the event of the default of a remote clearing participant, although ASX would consider additional factors such as the potential impact of time zone differences, as well as interactions with foreign CCPs and external administrators.


The cooling-off period concludes 22 business days after the conclusion of the final default management process initiated during the period. [17]

No fire drill was held in 2015 for exchange-traded derivatives, since default management arrangements more broadly were tested in the context of the default of BBY Limited in ASX Clear. [18]