2015/16 Assessment of ASX Clearing and Settlement Facilities A1.1 ASX Clear 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 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 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 (CCP Standards 12.1, 12.2). ASX Clear 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 (CCP Standard 12.3). Default management procedures are tested and reviewed on at least an annual basis (CCP Standard 12.4). ASX Clear's default management arrangements are designed for the particular characteristics of its activities, and take into account potential impacts on Australian 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 with the authority and flexibility to deal with a participant default using a variety of methods to manage its exposure. For cash market transactions, ASX Clear may carry the defaulted participant's outstanding cash equity transactions through to settlement, enter into market transactions to sell or purchase securities to facilitate the settlement of novated transactions, and enter into an OTA in respect of any settlements involving the failed participant or those affected by its failure (see CCP Standard 7.3). For derivatives, ASX Clear has the ability to close out any open positions, exercise or terminate open contracts, or seek to transfer (port) client positions. The specific method for managing ASX Clear's 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 existing 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.

Default management

Under its Operating Rules and Procedures, ASX Clear may employ a variety of methods to close out or otherwise manage the positions of a defaulted participant. These include settlement of outstanding cash equity trades, 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 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 would have the power to completely terminate all open contracts in order to restore its matched book.

Use and sequencing of financial resources

Following a declaration of default, ASX Clear 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 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 could draw upon its $250 million default fund (see CCP Standard 4). In the event that these resources were exhausted, ASX Clear would have the power to call a further $300 million in Recovery Assessments from participants under its new recovery arrangements (see CCP Standard 4.8). As a last resort, ASX would have the power in recovery to allocate losses by reducing settlement payments in the context of complete termination of all open contracts.

In 2015/16, ASX Clear 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 would make an ‘initial interim replenishment’ contribution to restore its default fund up to at least the Minimum Fund Size of $37.5 million. At the end of a 22-business-day ‘cooling-off period’, the default fund would be fully replenished to $150 million.[15] In order to maintain the required level of financial cover during the cooling-off 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 Board, in consultation with the ASX Limited Board. ASX Clear's 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's 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.

The ASX Clear Operating Rules and Procedures envisage a number of possible events of default, including scenarios in which a clearing participant:

  • becomes subject to external administration
  • is unable to meet obligations relating to its open contracts
  • defaults at another CCP or exchange
  • 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 Operating Rules set out specific events of default, declaration of a default would never be automatic. Instead, ASX Clear 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 to employ a variety of methods to close out or otherwise manage the positions of a defaulted participant. These include settlement of the defaulted participant's outstanding cash equity trades, 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 under its enhanced recovery arrangements (see CCP Standard 12.1). 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 CCP would be a relevant factor in determining whether client positions could be transferred following a default event. The individually segregated client account structure for derivative positions at ASX Clear makes it more likely that transfer of these positions could be achieved than in the case of cash securities, for which client positions and house positions are commingled. In practice, it is likely that the scope for transfer of cash market positions would be limited under any account structure due to the short (two-day) equity settlement cycle (see CCP Standard 13).

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

ASX Clear's Operating Rules and Procedures are available on the ASX public website. These rules outline when ASX Clear may take action against a participant and the powers of ASX Clear in the event of a default, including the ability of ASX to transfer client derivative positions to other participants. ASX Clear's 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 participant default on its website.

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 the ASX fire drill exercise conducted in mid 2016 and will continue to observe future fire drills. In recent years, the DMF has been updated on several occasions[16]:

  • during the 2011/12 Assessment period to incorporate experiences 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 OTAs, changes to client segregation arrangements, and the implementation of the ‘juniorisation’ mechanism in ASX Clear (Futures)
  • 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 for ASX Clear. 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.

ASX Clear's 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, 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 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.

Participants include both Australian and overseas brokers with a significant domestic presence, including subsidiaries of Australian and overseas banks. Products cleared by ASX Clear are traded on Australian markets and denominated in AUD. Accordingly, default management actions would be taken during the local time zone for all participants.


The cooling-off period concludes 22 business days after the conclusion of the final default management process initiated during the period. [15]

No fire drill was held in 2014/15 since default management arrangements were tested in the context of the default of BBY Limited. [16]