2015/16 Assessment of ASX Clearing and Settlement Facilities A2.2 Austraclear Standard 12: General business risk

A securities settlement facility should identify, monitor and manage its general business risk and hold, or demonstrate that it has legally certain access to, sufficient liquid net assets funded by equity to cover potential general business losses so that it can continue operations and services as a going concern if those losses materialise. Further, liquid net assets should at all times be sufficient to ensure a recovery or orderly wind-down of critical operations and services.

Austraclear identifies, monitors and manages its general business risks in the context of its overall Enterprise Risk Management Policy (SSF Standard 12.1). It has access to funds held at group level calibrated to support continued operations as a going concern if it incurs general business losses. These funds are backed by equity and invested in liquid assets. The legal basis of Austraclear's access to funds held at group level is set out in the ASX Group Support Agreement (SSF Standards 12.2, 12.3, 12.4). During the Assessment period, Austraclear enhanced its recovery arrangements in line with the CPMI-IOSCO guidance on recovery planning (SSF Standard 12.3). ASX maintains viable arrangements to raise additional equity for its CS facilities as required (SSF Standard 12.5).

Austraclear's management of general business risk is described in further detail under the following sub-standards.

12.1 A securities settlement facility should have robust management and control systems to identify, monitor and manage general business risks, including losses from poor execution of business strategy, negative cash flows or unexpected and excessively large operating expenses.

ASX's approach to business risk is consistent with its overall Enterprise Risk Management Policy and Framework (see SSF Standard 3). Under the framework, formal policies are in place for individual risk categories such as accounting, authorisations, business continuity, technology, fraud control and procurement.

ASX monitors a variety of financial business risks, including market risk, credit risk, liquidity risk and capital risk.

• Group funds (as distinct from collateral lodged by participants) may be exposed to market risk arising from changes in market variables such as interest rates and foreign exchange rates. Mitigants for market risk include hedging of foreign exchange and interest rate risks, with appropriate capital allocation.
• Credit risk for the Group's general business activities arises in the collection of receivables, which principally comprise fees from market participants, issuers, users of market data and other customers. Mitigants include active collection procedures on trade receivables and ‘ageing’ of receivable amounts.
• Liquidity risk arises from the Group's time-critical payables. This is mitigated by ASX's liquidity management arrangements, including forward planning and forecasting of liquidity requirements.
• ASX may be exposed to capital risk if equity in its group entities falls below prudent or regulatory minimum levels. ASX manages its capital at a group level, with an objective of maintaining a prudent level of surplus net tangible equity. Ongoing monitoring of cash flows and capital adequacy is conducted via quarterly meetings of CALCO.

ASX undertakes periodic strategic risk assessments in the context of its overall business plans. Through this process, ASX identifies new strategic business initiatives, such as the group-wide technology transformation project and enhancements to the OTC derivatives clearing service. These are subject to financial analysis, which includes high, low and base case revenue assumptions and forecasts. Impacts on capital are also determined and analysed.

ASX undertakes risk assessments when undertaking any expansion of its activities or in the event of material changes to its business. Risk assessments are built into ASX's project management framework (see SSF Standard 14.4). Under this framework an initial high-level risk indication is defined at the project concept stage. This is followed by a formal project risk assessment covering both project delivery risks and impacts to business activities. ASX typically conducts a series of workshops involving project staff to discuss risks associated with any planned new service. Prior to the approval of a project for launch/production, ASX prepares an operational readiness summary and conducts a final workshop to discuss possible risks associated with initial launch. This includes consideration of potential failure scenarios and workarounds, procedures for escalation of issues, and help desk and key staff availability.

Following launch, the risks of a new activity are captured in risk profiles that are prepared by relevant management every six months. CALCO also monitors actual and forecast capital and liquidity requirements on a quarterly basis, including requirements related to new projects.

12.2 A securities settlement facility should hold, or demonstrate that it has legally certain access to, liquid net assets funded by equity (such as common stock, disclosed reserves or other retained earnings) so that it can continue operations and services as a going concern if it incurs general business losses. The amount of liquid net assets funded by equity a securities settlement facility should hold, or have access to, should be determined by its general business risk profile and the length of time required to achieve a recovery or orderly wind-down, as appropriate, of its critical operations and services if such action is taken.

ASX has set aside $245.6 million for operational and business risk across the four ASX Group CS facilities, $170.6 million of which has been attributed specifically to operational and business risks across both Austraclear and ASX Settlement. Since ASX has identified constraints to making business risk capital bankruptcy remote within the SSFs, this capital is held at the ASX Group level. Each CS facility has a separate allocation for business risk capital that is explicitly recognised within group-wide capital holdings. These holdings include an additional buffer against potential losses sustained elsewhere in the group. The ASX Group Support Agreement places an obligation on ASX to maintain sufficient capital to support Austraclear's continued operations in the event of general business losses, supporting the legal certainty of Austraclear's access to business risk capital as required.

The calibration of the $170.6 million in operational and business risk capital set aside for Austraclear and ASX Settlement, involves the following:

• Risk calculations at the level of the individual SSF. ASX first calculates risk amounts for the individual SSFs. This is based on a methodology applied by other SSFs, fund managers and custodians that applies a capital charge for operational and business risk to the value of securities held in the facility. The correlation between asset values and associated risks is modelled on a percentage basis, with the percentage of required risk resources declining as the level of assets increases – recognising that a significant part of the risk resources required will represent a fixed cost. ASX's application of this methodology results in a charge of 0.67 basis points on $1.90 trillion of securities held in Austraclear and a charge of 0.71 basis points on $1.60 trillion securities held in ASX Settlement, giving a required value of risk resources of around $127 million and $114 million for Austraclear and ASX Settlement, respectively.
• Assumptions regarding correlated risks. ASX assumes that the two facilities will not both require their full risk funds at the same time. This reflects that the custodial and operational risks that this capital is calibrated to cover are unlikely to result in simultaneous peak losses in both SSFs. ASX has applied a ‘square root of the sum of squares’ formula to arrive at the figure of $170.6 million to cover the operational and business risk exposure of the two settlement facilities. The business risk capital held across the two SSFs is calibrated to be sufficient to ensure that even if one SSF were to utilise the full value of its required risk resources, sufficient funds would be available to fund the other SSF's recovery plan and meet the single largest uninsured business loss event for that facility. In addition, ASX's general capital buffer is calibrated to be sufficient to ensure that it would remain able to provide to the second SSF the full value of its required risk resources in the event that this was required.

12.3 A securities settlement facility should maintain a viable recovery or orderly wind-down plan and should hold, or have legally certain access to, sufficient liquid net assets funded by equity to implement this plan. At a minimum, a securities settlement facility should hold, or have legally certain access to, liquid net assets funded by equity equal to at least six months of current operating expenses. These assets are in addition to resources held to cover participant defaults or other risks covered under SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk. However, equity held under international risk-based capital standards can be included where relevant and appropriate to avoid duplicate capital requirements.

In October 2015, Austraclear implemented enhanced recovery planning arrangements, developed with reference to the CPMI-IOSCO guidance on recovery planning (see SSF Standard 3.5). ASX updated the documentation of its recovery and orderly wind-down plans to reflect these new arrangements during the Assessment period. In calculating the quantum of business risk capital described under SSF Standard 12.2, ASX has sought to ensure access to sufficient liquid net assets to fund operations during the execution of Austraclear's recovery plan or to cover a minimum of six months of current operating expenses.

Austraclear's enhanced recovery approach establishes arrangements to address losses that arise from a range of general business risks. These general business losses to Austraclear would be absorbed by ASX, including through application of general business risk capital held for the SSFs by ASX Limited (see SSF Standard 12.2). This recovery approach takes into account that ASX has in place a number of insurance policies to reduce its exposure to a broad range of risks, including professional indemnity, fraud, and operational risks such as computer manipulation and equipment failure. Austraclear undertakes periodic loss scenario analysis which aim to ensure that the level of operational and business risk capital is sufficient to meet the single largest uninsured business loss event for the SSF. In calculating the required quantum of operational and business risk capital, the loss scenario exposures are reduced by the level of insurance coverage. Austraclear's approach assumes full reliability and timeliness of payout under these insurance policies.

Austraclear would apply a similar approach to address losses on its treasury investment portfolio since the amount invested is not material.

12.4 Assets held to cover general business risk should be of high quality and sufficiently liquid in order to allow the securities settlement facility to meet its current and projected operating expenses under a range of scenarios, including in adverse market conditions.

The risk capital for ASX's CS facilities is invested in accordance with the ASX Limited and ASX Operations Pty Limited Investment Mandate. The Investment Mandate specifies investment objectives, responsibilities, approved products and counterparties, and audit and maintenance of the mandate. Approved products are generally highly rated and liquid products such as: cash deposits; bank bills, negotiable certificates of deposit and floating rate notes issued by APRA-approved ADIs; foreign exchange in specified currencies; Australian Government securities; and selected semi-government securities. Limits are applied against counterparty, liquidity and market risks. Liquidity limits are specified for maximum instrument maturity and weighted average maturity.

12.5 A securities settlement facility should maintain a viable plan for raising additional equity should its equity fall close to or below the amount needed. This plan should be approved by the board of directors and updated regularly.

As noted, ASX Limited manages its operational and business risk capital at the group level. The ASX Limited Board monitors the ongoing capital adequacy of the ASX Group as part of its regular capital planning activities. The Board determines the most appropriate means of raising additional capital when needed, giving due consideration to prevailing market conditions and available alternative financing mechanisms. For example, in June 2013, ASX Limited conducted a capital raising by way of a $553 million share entitlement offer, with the bulk of the funds being used to increase the business risk capital of the CS facilities and their pooled financial resources to deal with participant default.

Austraclear's enhanced recovery approach depends on timely and reliable recapitalisation processes to address general business and investment losses. Austraclear reviewed its recapitalisation arrangements during 2015/16 to ensure consistency with its enhanced recovery arrangements. This plan is supported by an intragroup service agreement which commits ASX Limited to maintaining adequate levels of business risk capital for the SSFs, recapitalising these funds as required. ASX's plans to fulfil its obligations to recapitalise Austraclear include the use of existing group cash reserves and raising additional capital through an equity issuance by ASX Limited.