Assessment of ASX Clearing and Settlement Facilities 2. Material Developments

This section discusses material developments relevant to the ASX CS facilities that have occurred during 2018/19. Developments between the end of 2018/19 and the finalisation of this report on 27 August are also discussed, where relevant.

To complement this section, background information on activity and participation in the facilities, and governance and risk management in the facilities is set out in Appendix B. A detailed assessment of how the facilities met each of the FSS at the end of 2018/19 is presented in Appendix C.

2.1 Clearing Risk Management

During the assessment period ASX implemented a wide range of enhancements to its management of risks arising from its CCPs' clearing activities. A number of these enhancements were in response to a report issued by the Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO), Resilience of central counterparties (CCPs): Further guidance on the PFMI (CCP Resilience Guidance).[3] These enhancements are set out in Box A below. Other enhancements have been made to the ASX CCPs' management of credit and liquidity risks (see section 2.1.1), margining arrangements (see section 2.1.2), and data and risk systems (see section 2.1.3).

2.1.1 Credit and liquidity risk

Credit stress testing approach in ASX Clear (Futures)

The CCP Resilience Guidance sets out more detailed expectations with respect to the development of extreme but plausible scenarios in credit stress testing. In November 2018, ASX implemented a revised credit stress testing approach for ASX Clear (Futures) intended to address gaps identified against these expectations, as well as to reflect additional areas of improvement identified by ASX. The key changes are summarised below.

  • Comprehensiveness and plausibility. ASX conducted analysis to identify where the existing set of stress scenarios might not fully capture the range of extreme but plausible price movements. Extreme stress events were then added to the set of stress test scenarios to fill identified gaps and enhance the comprehensiveness of credit stress testing. ASX also sought to focus its theoretical and hypothetical scenarios on more plausible points of vulnerability in stress events, placing greater emphasis on aligning its scenarios with observed correlations between products during stressed periods.

Box A: Progress implementing CCP Resilience Guidance

In July 2017, CPMI-IOSCO published the CCP Resilience Guidance, which provides further guidance on the Principles and Key Considerations in the Principles for Financial Market Infrastructure (PFMI) regarding financial risk management by CCPs. At the time the CCP Resilience Guidance was published, the Bank noted that it would take this guidance into account in its interpretation of the FSS. In its 2018 Assessment, the Bank reviewed the ASX CCPs' practices against the CCP Resilience Guidance and concluded that they were either consistent or broadly consistent with that guidance.

To achieve full consistency with the CCP Resilience Guidance, the Bank set a recommendation for the ASX CCPs to implement plans to align certain aspects of their financial risk management and governance practices with those described in the CCP Resilience Guidance. The ASX CCPs have established a multi-year work program to address these recommendations and other minor gaps identified by the Bank in its assessment of the ASX CCPs against the CCP Resilience Guidance. This box summarises the work ASX completed as part of this program during the assessment period.

  • In November, ASX implemented a revised credit stress testing approach for ASX Clear (Futures). The new approach focuses on improving the comprehensiveness and plausibility of scenarios and ensuring that no historical stress periods are excluded purely based on their age (see section 2.1.1). ASX intends to implement similar enhancements to credit stress testing for ASX Clear in the coming assessment period.
  • In order to address gaps in testing of the sufficiency of NZD liquidity resources, liquidity-specific scenarios covering the NZD obligations of ASX Clear (Futures) were implemented in January.
  • In July 2018, ASX removed the assumption that clients in ASX Clear could be ported in the event that their clearing participant defaulted. This change more accurately reflects the extreme but plausible market conditions used in stress testing.
  • ASX updated its Liquidity Stress Testing and Liquidity Requirement Standard to more comprehensively identify potential sources of liquidity risk, including events that could affect the CCPs' ability to make intraday payments. The documentation also more comprehensively sets out the basis and thresholds for classifying risks as material or not for stress testing purposes.
  • In July 2018, ASX set aside a new and separate pool of capital to cover general business risk for the CCPs and restricted its previously combined pool of CCP capital so that it is available solely for the purposes of covering custody and investment risk.
  • In October 2018, ASX increased the margin period of risk (MPOR) from one day to two days for products margined using the Historical Simulation Value at Risk (HSVaR) model and for ASX 200 products margined on a flat-rate basis. These changes were a result of ASX's broader analysis of MPOR assumptions used in initial margin models which was conducted during the previous assessment period and align to the Bank's supplementary interpretation of CCP Standard 6.3 (section 2.5.1). The two- or three-day MPORs used for remaining flat-rate products remained unchanged.

Recommendations. To align financial risk management and governance practices with the CCP Resilience Guidance the ASX CCPs should continue to implement plans to:

  • enhance the comprehensiveness of stress testing to ensure risks are appropriately identified, captured and stressed
  • enhance analysis and justification of assumptions used in stress testing models so that risks are adequately captured
  • remove the assumption made by ASX Clear that excess collateral will not be withdrawn or decreased during periods of stress to more accurately reflect the extreme but plausible conditions appropriate for stress testing
  • ensure that roles and processes in relation to the governance of financial risk management are appropriately formalised and documented in order to ensure that the CS Boards have sufficient information to effectively oversee the CCPs
  • ensure that their arrangements for disclosure to, and soliciting feedback from, stakeholders cover all relevant aspects of the CCPs' risk management frameworks, including margin sensitivity analysis, reverse stress testing and management of procyclicality.
  • Historical scenarios. The CCP Resilience Guidance clarifies that a CCP is expected to include all of the most extreme scenarios observed unless the CCP determines, based on a comprehensive, rigorous analysis, that it is implausible that a particular scenario can reoccur. In light of this clarification, ASX reviewed its historical stress scenarios to ensure that no historical stress periods have been excluded purely because they occurred more than 20 years ago. Historical stress periods are now excluded by ASX only if they have been superseded by more recent market events, or if there are specific reasons to consider the historical event to no longer be plausible.
  • Intraday price changes. In its previous stress testing approach, ASX used the worst intraday/intra-period price return over the close-out period to calibrate its stress testing scenarios. That approach is consistent with requirements set out in the CCP Resilience Guidance; however, ASX considers the approach implausible because it assumes that ASX would close out the entire portfolio of a defaulted participant at the single worst price. In ASX's view, a volume-weighted average price (VWAP) based on observed activity in stressed periods most accurately reflects ASX's preferred close-out strategy and would still incorporate extreme (including intraday) price moves. However, ASX has instead used the worst close-to-close price return over the close-out period, which its analysis indicates is more conservative than VWAP. The Bank has requested that ASX conduct further analysis to demonstrate that the outcome of its chosen approach is consistent with the CCP Resilience Guidance.

Based on data for the 2017/18 financial year, ASX estimated that the changes outlined above reduce ASX Clear (Futures)' average stress test exposures by around 17 per cent. ASX plans to conduct a similar comprehensive review of its stress testing approach for ASX Clear in the second half of 2019.

Annual review of ASX CCPs' default resources

The ASX CCPs are required to set the size of their prefunded financial resources to cover the default of the two participants (and affiliates) that give rise to the largest credit and liquidity exposures in extreme but plausible market conditions (Cover 2 requirement; see Appendix B.3 for further detail). ASX conducts an annual review of the ASX CCPs' prefunded default resources to assess their adequacy, composition and compliance with Cover 2 requirements. The review for the year ending December 2018 concluded that ASX Clear (Futures)' financial resources were adequate but that liquidity resources should be increased from $150 million to $230 million for ASX Clear. This conclusion was driven by two factors. First, in the period covered by the annual review there were five instances in which projected liquidity resources available for cash markets fell below the target minimum allocation of $100 million. Second, ASX's review of the average liquidity requirement for cash markets over the past three years concluded that the target minimum allocation to cash markets should be increased from $100 million to $130 million. ASX implemented the increase to the target minimum allocation to cash markets on 1 July 2019 and expects to implement an additional $80 million liquidity facility later in 2019 to meet its new target level of liquidity resources.

During the assessment period, the ASX CCPs experienced two breaches of their Cover 2 requirements (one each at ASX Clear and ASX Clear (Futures)). There were an additional three breaches immediately before the assessment period (two at ASX Clear and one at ASX Clear (Futures)), in June 2018. The stress test exposure limits (STELs) imposed on participants at each CCP are set conservatively relative to the size of the default fund, with any exposure beyond these limits resulting in a call for stress test AIM. This effectively introduces a buffer for Cover 2 purposes and protection against large positions that are built up gradually. However, all the recent breaches resulted from large intraday changes in the positions held by participants, so the buffers were not sufficient to address movements of the magnitude experienced on these days. While ASX has a process in place to review default fund sizing, including the size of the AIM buffer, it has not established any criteria for the size or frequency of Cover 2 breaches that would trigger an adjustment to the default fund or AIM buffer. ASX is developing supplementary metrics on the frequency and magnitude of Cover 2 breaches to support the Board's existing KRI on default fund adequacy (see section 2.3.1).

Recommendation. ASX Clear and ASX Clear (Futures) should formalise thresholds for the frequency and magnitude of Cover 2 stress test breaches that would result in a recalibration of the overall default fund or AIM buffer.

The annual review also included a review of ASX's approach to the use of offsetting transaction arrangements (OTAs), in light of a recommendation made by the International Monetary Fund (IMF, see Box B). OTAs allow ASX Clear to generate additional liquidity by selling securities that are due to be delivered to a defaulting participant back to the seller of the securities under a rules-based repurchase agreement that reverses at a later date (see Appendix C.1, CCP Standard 7.3). They are used to address the additional liquidity exposures generated by the delay between closing out a securities trade and its settlement on T+2. ASX's review concluded that it was not necessary to increase and diversify qualifying liquid resources to move the use of OTAs to a later stage in the default waterfall because its analysis of hypothetical scenarios showed that usage of OTAs is limited to a small proportion of these. However, ASX will give further consideration to potential alternative sources of liquidity in the coming assessment period since OTAs are more likely to be required for larger defaults and typically comprise around half of projected total liquidity resources used to meet Cover 2.

Box B: Findings from the 2018 Financial Sector Assessment Program

In February 2019, the IMF published a technical note outlining its findings from a 2018 assessment of the supervision, oversight and resolution planning of Australian FMIs under its Financial Sector Assessment Program (FSAP).[4] The assessment included a review of elements of ASX Clear's governance and risk management framework against the CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI). The recommendations are summarised below.

  • Increase and diversify qualifying liquid resources to move the use of OTAs to a later stage in the waterfall. The IMF recommended that ASX Clear should consider increasing its liquidity resources other than OTAs, for example via additional commercial bank liquidity facilities, in order to delay the point at which the CCP relies on OTAs to meet its liquidity obligations in a default. The IMF noted that fixed liquidity facilities provide greater upfront transparency to liquidity providers and participants regarding the size of their potential liabilities than is possible for OTAs, which depend on the size and composition of the defaulter's portfolio. ASX has considered this recommendation as part of the 2019 annual review of the ASX CCP's default resources (see section 2.1.1).
  • Expansion of eligible collateral and application of concentration limits to collateral. The IMF recommended that ASX Clear should consider allowing participants to provide government and semi-government bonds as non-cash collateral for their margin obligations. ASX considered this recommendation but concluded that there is insufficient demand from participants to post bonds as collateral and that the operational costs of accepting these bonds outweighed the benefits. The IMF also recommended that ASX applies concentration limits to equity collateral to ensure that it can be liquidated without significant adverse price effects during stressed conditions. ASX does not plan to address this recommendation given that its monthly monitoring of clearing risk does not demonstrate significant or persistent concentration risk in equity collateral and that the large number of individual client accounts makes it difficult to implement concentration limits at the participant level.
  • Procyclicality of margin models and collateral haircuts. The IMF recommended that ASX's annual model validation process include consideration of the procyclicality of its margin models. ASX plans to assess the procyclicality of its margin models as part of its work plan to address gaps against the CCP Resilience Guidance (see Box A).
  • Replace the CHESS system. The IMF noted the age of the CHESS system and recommended that it be replaced with modern technology to increase operational reliability and support compliance with financial risk management requirements. ASX had commenced a project to replace the CHESS system prior to the IMF review (see section 2.4.1). Since CHESS does not support segregation of house and client cash equity positions, the IMF recommended that the replacement system support operationally segregated accounts at ASX Clear. ASX has included this in the Day 1 business requirements for the CHESS replacement system. The Bank has raised a similar recommendation in the context of the Legal Basis special topic (see section 3.5).
  • Point of settlement finality. The IMF recommended that ASX clarify the point at which settlement is final in the ASX Clear and ASX Settlement operating rules. ASX has concluded that the rules are sufficiently clear on this point but, following discussion with the Bank, has agreed to improve the way in which the point of settlement finality is described on its website.
  • Group interdependencies. The IMF recommended that ASX Clear's recovery plan should more fully address interdependencies with other entities in the ASX Group. ASX will consider interdependencies that are not already addressed in its next annual review of its recovery plan.
  • Group structure. The IMF recommended that ASX consider ring-fencing the CS facilities within its overall group structure through a dedicated risk management framework, committees, staff and risk management systems. ASX considers that splitting its risk management function in this way could reduce its effectiveness in managing enterprise-wide risks. The Bank will further consider this recommendation in the context of the proposed resolution regime for CS facilities.

Liquidity lines for G4 currencies in ASX Clear (Futures)

Participants in ASX Clear (Futures) are able to post cash collateral in any of the G4 currencies (USD, EUR, GBP, JPY) in addition to AUD. ASX Clear (Futures) has in place a requirement that all collateral in G4 currencies must be held in highly liquid investments so that it can cover all intended day-to-day liquidity requirements, such as the return of cash collateral to participants. In order to meet this requirement, collateral is invested as cash (at call) or in reverse repos secured by G4 government securities. During the assessment period, ASX Clear (Futures) established intraday liquidity facilities with two commercial banks of $200 million each to facilitate same-day repayment of G4 cash collateral. In the absence of a default, ASX Clear (Futures) may use these facilities to repay collateral to participants before receiving the proceeds from the investments in which the collateral is held, a process which might otherwise be delayed by currency cut-off times in international payment systems. In the event of a default, ASX Clear (Futures) may also use the facilities to fund the G4 currency leg of a foreign exchange swap, which could be used to raise AUD cash ahead of the same-day receipt of investment proceeds from the corresponding collateral.

2.1.2 Margin

Overnight margining and real-time risk monitoring

To address the potential for participant exposures to build up during the ASX 24 Night Session, ASX Clear (Futures) runs a 2.00 am intra-day margin call for participants that are most active in the Night Session. Since the systems used for payment of AUD margin (Austraclear and the Reserve Bank Information and Transfer System (RITS)) are closed overnight, these margin calls are made in USD and settled via the US banking system. To avoid the risk of calling variation margin in USD overnight then having to fund a matching outgoing variation margin payment in AUD the following day, ASX does not typically include variation margin obligations as part of this call. Instead, participants are required to maintain a margin buffer to cover potential variation margin obligations arising from overnight price moves.

The 2018 Assessment included a recommendation for ASX Clear (Futures) to introduce a process for ongoing review and resizing of its margin buffer. During the assessment period ASX completed a review which concluded the current buffers are generally more than sufficient and indeed could be reduced. The review also found increased initial margin levels might be more effective than the buffer for protecting against exposures. In order to demonstrate the sufficiency of initial margin, ASX plans to enhance its backtesting approach to recognise intraday margin collections and identify the most conservative point of default assumption. Once this enhanced backtesting approach is implemented ASX plans to reassess the need for overnight buffers.

The 2018 Assessment also recommended that, by 30 June 2020, ASX Clear (Futures) should put in place arrangements to be able to monitor and manage intraday exposures created during ASX 24's Night Session on a near real-time basis. ASX implemented a risk-visualisation tool in December 2018 which calculates intraday exposures at 10-minute intervals. For the Day Session, ASX has implemented a prototype checklist prompting staff to measure exposure and erosion of resources against internal thresholds several times a day. For the Night Session, ASX plans to implement automated alerts to escalate potential issues for further review. ASX expects to formalise and document this approach later this year.

Recommendation. By 30 June 2020, ASX Clear (Futures) should embed, review and refine its arrangements to monitor and manage intraday exposures created during ASX 24's Night Session on a near real-time basis, or take other steps to ensure comprehensive management of intraday exposures created during ASX 24's Night Session.

Changes to ASX Clear (Futures) margining approach

In November 2018 ASX implemented a number of changes it made to its Margin Policy in the previous assessment period. ASX increased the frequency with which it recalibrates margin parameters from quarterly to monthly, and extended the historical sample period used to calibrate margin parameters for exchange-traded derivatives at ASX Clear (Futures) from one year to five years. ASX considers that these changes, together with extensions to the MPOR for less liquid products made in the last assessment period and the introduction of a liquidity add-on at ASX Clear (Futures) (see below), will provide a more robust estimate of potential future exposure. As a result, ASX was comfortable reducing the target level of initial margin coverage at ASX Clear (Futures) to a confidence level of 99.5 per cent from 99.7 per cent.

Liquidity add-ons

The 2018 Assessment included a recommendation that ASX Clear and ASX Clear (Futures) should complete the implementation of add-ons to manage liquidity risk for cash market products and products margined using the CME Standard Portfolio Analysis of Risk (SPAN) model. In November 2018, ASX Clear (Futures) introduced a liquidity add-on for exchange-traded derivatives margined using CME SPAN (see CCP Standard 6.3). This add-on is based on the size of a participant's portfolio relative to a ‘base’ portfolio in a product. The base portfolio is set at a size that would allow it to be liquidated within the product's MPOR with minimal market impact, based on historical trading volumes. ASX is continuing work to develop its approach to liquidity add-ons at ASX Clear.

Recommendation. ASX Clear should complete the implementation of add-ons to manage liquidity risk for cash market products and products margined using the CME SPAN model.

Electricity product inter-commodity spread concession

In November 2018, ASX reduced the range of ICCs for electricity contracts in ASX Clear (Futures). ICCs allow for a reduction in initial margin requirements where offsetting positions are held in correlated contracts. ASX removed ICCs for peak, cap and options contracts; ASX Clear (Futures) now only offers ICCs for electricity contracts for base contracts. ASX estimated the impact of these changes was an approximately 20 per cent increase in margin requirements for electricity products. Margin offsets on electricity products played a role in losses sustained in the default of a clearing participant at Nasdaq Clearing AB in September 2018 (see Box C).

Box C: Nasdaq Clearing AB Member Default

In September 2018, a private trader clearing as a direct participant defaulted at Scandinavia-based CCP Nasdaq Clearing AB. The participant defaulted because he could not meet a margin call related to a spread position on German and Nordic power futures contracts. Nasdaq Clearing conducted a closed auction to return the CCP to a matched book. The resulting losses consumed all of the participant's collateral and a large share of the mutualised default fund. This default attracted considerable attention from other CCPs, their participants and regulators because of the large impact a single trader had on Nasdaq Clearing's financial resources. In contrast, when Lehman Brothers defaulted in 2008, CCPs were able to return to a matched book without exhausting the collateral Lehman had provided (with one exception).[5]

Following the default, Nasdaq Clearing announced plans to enhance its risk management framework.[6] In broad terms, these plans included: increasing initial margin requirements; improving the auction process used to manage defaults; enhancing participant eligibility requirements; and increasing the amount of its own capital at risk in a default. Nasdaq Clearing has also highlighted focusing on improving market liquidity.

During the assessment period ASX conducted a review of its risk management framework against the key lessons learned from the Nasdaq Clear default. For each of the issues identified, ASX concluded it already had measures in place or is working to implement measures to address them.

  • ASX Clear (Futures) had already increased its MPOR for electricity products from two to three days, and in November 2018 implemented a liquidity add-on and reduced the number of offsets available for electricity products (section 2.1.2).
  • On 1 July 2019, ASX implemented a market-making scheme to improve liquidity for electricity derivatives. ASX is also exploring introducing auctions for electricity derivatives as an alternative default-management tool (see section 2.2.1).
  • Participants in the ASX CCPs must be corporations that hold an Australian Financial Services Licence; individual traders may not participate directly.
  • ASX contributions make up the majority of each ASX CCP's default fund.

ASX Clear (Futures) expects to complete a broader review of its methodology for calibrating ICCs in the coming assessment period. Regular monthly reviews of ICCs have been suspended until that review is completed.

Recommendation. ASX Clear (Futures) should review its methodology for calibrating ICCs used in its margining model and resume reviews of ICCs on a regular basis.

2.1.3 Data and risk systems

Data issues

CCP Standard 21.2 requires that the ASX CCPs provide detailed information on margining and stress testing to the Bank on at least a quarterly basis. At the end of the previous assessment period, ASX identified errors in the data it provides to the Bank, leading to the revision of a number of data series related to core measures of financial risk management, including credit and liquidity stress testing. Investigations into the underlying causes of the data issues revealed that there were no errors in the underlying data. However, there were issues related to the querying and manipulation of data, inconsistency of ASX's practices with its approved liquidity stress testing model and documentation, and incorrect reporting of liquidity stress testing results to relevant governance committees. In response to these issues, ASX initiated a series of remedial actions to improve the integrity of its data, internal controls and governance processes. The key changes were an increase in the transparency of reporting in internal clearing risk management reports and the development of a Risk Verification Engine that verifies that raw data from production systems is consistent with data reported to internal and external stakeholders.

During 2018/19, a further issue was identified relating to the methodology used to determine the selection of Cover 2 participants in credit stress testing. The methodology used by ASX selected Cover 2 participants based on their stress test exposures before accounting for AIM held. However, this approach did not always result in the correct identification of the two clearing participants that would lead to the maximum Cover 2 exposure after taking into account collateral posted to meet AIM requirements, potentially understating the CCP's exposure in the event of default. The flaw in methodology was corrected in November 2018. No additional breaches in Cover 2 were identified during the assessment period, however an additional historical breach was identified in the 2017/18 assessment period. In response to this issue, and in light of the issues noted above, ASX commissioned an independent professional services firm to validate all credit and liquidity stress test reporting to provide assurance that there were no additional issues.

Enhancements to risk management systems

During the assessment period, ASX Clear (Futures) implemented a risk-visualisation tool that facilitates a near real-time view of risks (see section 2.1.2). It has also implemented enhancements to its credit stress testing system (see section 2.1.1) and liquidity add-ons (see section 2.1.2) for ASX Clear (Futures). Further system changes are planned to implement other changes to support ASX's plans to align its risk management practices with those described in the CCP Resilience Guidance (see Box A).

In order to support timely implementation of risk management system enhancements, such as those outlined above, ASX has implemented a number of its risk management enhancements in ad hoc systems that sit outside of its core systems. This has been done because in some cases ASX's core systems lack the capability to implement more sophisticated risk management techniques. ASX has a longer-term aspiration to ensure that all its risk management functionality operates in core systems, but does not yet have a defined plan to achieve this.

Recommendation. ASX should establish a long-term plan to ensure that its core systems have the functionality to fully support its risk management approach, including by migrating risk management systems currently operated on non-core systems to core systems.

2.2 Default Management and Recovery

2.2.1 Enhancements to fire drills

Electricity auctions

During the previous assessment period, as part of its work to conduct and document analysis of MPOR assumptions used in initial margin models, ASX found that electricity derivatives were less liquid than previously understood. In response, ASX increased the MPOR from two to three days for all energy derivative contracts at ASX Clear (Futures) and adjusted its margin methodology to remove the assumption of a normal distribution of price returns. ASX has taken further steps to improve its ability to manage positions in electricity derivatives in the event of default. In July 2019, ASX implemented new market-making arrangements for Australian electricity futures to encourage greater liquidity in these products. ASX is also encouraging end users to put in place secondary clearing arrangements to support the porting of client positions in the event of a default and therefore mitigate the risks associated with the concentration of clearers. Lastly, ASX has been developing a framework for conducting auctions of electricity derivatives, including end users as bidders, to broaden the range of options available in its default management process.

ASX is conducting a two-stage default management fire drill to test these new arrangements. In the first stage, completed in June 2019, ASX conducted a liquidity polling exercise, involving both clearing participants and end users. The purpose of this stage was to identify the extent to which participants are able and willing to provide liquidity in the event of a clearing participant default that originates in electricity markets. It also tested the capacity of each end user to fund replacement initial margin with a second clearer if its primary clearer is in default. The next stage of the fire drill, expected to be carried out in the second half of 2019, will test the operational processes of conducting a default management auction, including processes for transmitting information to bidders.

OTC auction testing

During the assessment period, ASX implemented a series of enhancements to default management fire drill exercises in respect of its OTC derivatives service. To comprehensively test the default management process from end to end, the coverage and scope of OTC fire drill exercises was expanded to include the default event, a review by ASX's internal default management committee of the hedge recommended by the participant Default Management Group, and the transfer of the auctioned portfolio in a test system environment. ASX also introduced a biannual auction fire drill that tests participants' operational readiness to take part in the auction phase of default management (e.g. to quickly and accurately price an auction portfolio).

2.2.2 Termination of BBY's participation

In March, ASX Clear, Austraclear and ASX Settlement formally terminated the participation of BBY Limited (BBY). BBY was a broker participant that entered external administration in May 2015, and was suspended by ASX Clear and, subsequently, Austraclear and ASX Settlement, during the process of default management and its later insolvency proceedings. BBY's default is described in the 2015 Assessment, with additional lessons learned in the Default Management special topic in the 2016 Assessment.

2.3 Building Stronger Foundations

During the previous assessment period, ASX commenced a three-year program (Building Stronger Foundations) to address the findings of an independent external review of ASX's technology governance, operational risk and control frameworks (the Review). The program also incorporates ASX initiatives and projects to improve enterprise risk management and governance practices that had been identified by ASX prior to the Review. The Review was conducted by KPMG at the instigation of the Bank and ASIC, identifying 36 recommendations to address gaps identified in ASX's risk management, technology governance, enterprise architecture and incident management. The 2018 Assessment acknowledged that ASX had engaged constructively with the Review process and accepted all of the recommendations set out in the report. These recommendations were also incorporated into ASX's three-year enterprise risk management (ERM) plan that had been developed in late 2017 to address gaps (covering many of the areas later identified in the Review) in ASX's ERM approach identified in a January 2016 review commissioned by ASX Internal Audit.[7] During the assessment period, ASX also conducted a self-assessment of its governance and risk management practices against the findings of the Australian Prudential Regulation Authority's (APRA's) 2018 Prudential Inquiry into the Commonwealth Bank of Australia (CBA), concluding that the gaps identified would be addressed by the implementation of the Building Stronger Foundations program and the ERM plan (Box D).

The 2018 Assessment recommended that the ASX CS facilities complete a number of the actions planned as part of the Building Stronger Foundations program in order to fully observe requirements of the FSS relating to Governance (CCP and SSF Standard 2) and Operational Risk (CCP Standard 16 and SSF Standard 14) (see section 1.1, Table 1). Sections 2.3.1 to 2.3.4 summarise the progress made by ASX in addressing the Bank's recommendations, and its broader progress in each of the four work streams in the Building Stronger Foundations program. At the end of the assessment period ASX had closed 28 of the Review's 36 recommendations and addressed 95 per cent of the underlying deliverables in the Building Stronger Foundations program.[8]

Box D: Self-assessment against Findings of APRA's Prudential Inquiry into the Commonwealth Bank of Australia

In April 2018, APRA released the final report on its Prudential Inquiry to examine the frameworks and practices in relation to the governance, culture and accountability within the CBA group. The report identified weaknesses in the framework for managing non-financial risks (operational, compliance and conduct risks), a lack of clear understanding or ownership of these risks, and that senior leadership was slow to recognise and address emerging threats to CBA's reputation. The report made a series of recommendations grouped around the following themes:

  • more rigorous Board and Executive Committee level governance of non-financial risks
  • exacting accountability standards reinforced by remuneration practices
  • a substantial upgrading of the authority and capability of the operational risk management and compliance functions
  • injection of the ‘should we’ question in relation to all dealings with and decisions on customers
  • cultural change from reactive and complacent to empowered, challenging and striving for best practice in risk identification and remediation.

In June 2018, APRA wrote to the boards of 36 of its larger regulated institutions asking them to gauge whether the weaknesses uncovered by the CBA Prudential Inquiry also existed in their own companies. APRA published a summary of its findings from these self-assessments in May 2019, noting that, while the quality of the self-assessments varied, some consistent findings included that:

  • non-financial risk management requires improvement
  • accountabilities are not always clear, cascaded and effectively enforced
  • acknowledged weaknesses are well known and some have been long-standing
  • risk culture is not well understood, and therefore may not be reinforcing desired behaviours.

While there are no APRA-regulated entities within the ASX Group, ASX carried out a self-assessment against the CBA Prudential Inquiry findings on a voluntary basis in order to benchmark its risk management practices and culture against industry better practice. The self-assessment was carried out by ASX Internal Audit and presented to the ASX Limited Audit and Risk Committee in November 2018.

In carrying out the review, ASX Internal Audit interviewed ASX employees and ASX's external auditor, and reviewed the results of previous staff and customer surveys, as well as materials from relevant ASX meetings. The self-assessment identified a number of gaps, but concluded that the most significant of these were already being addressed via the Building Stronger Foundations program or other initiatives already in progress.

2.3.1 Risk management

Defining and embedding risk appetite

The Review found that ASX's risk appetite statement required additional detail on risk tolerance levels in order for management to effectively implement consideration of the risk appetite into day-to-day operations. In response, the ASX Limited Board has endorsed a revised risk appetite statement that divides the risks faced by ASX into seven categories (from the previous two): operational; technology; financial; counterparty; legal/regulatory; reputation; and strategic risk. The revised risk appetite statement is accompanied by a set of 30 Board-level KRIs that quantify the Board's risk tolerance for a range of key metrics across each of the seven risk categories. The relevant KRIs are monitored by business unit management on a monthly basis and reported quarterly to the executive-level Risk Committee, the CS Boards and the ASX Limited Board Audit and Risk Committee. In order to ensure a consistent adoption of the Board-defined risk appetite across the organisation, ASX is developing business unit level KRIs that provide a more detailed breakdown of the Board-level KRIs and define comparable tolerances for other related risks. The first such set of business unit level KRIs have been developed in respect of ASX's technology risks. ASX will review its risk appetite statement annually in light of future changes to its business strategy and lessons learned from embedding the use of KRIs in its day-to-day operations.

Strengthening the three lines of defence and risk culture

The Review found that ASX's three-lines-of-defence model for risk management and, in particular, the risk management and compliance functions for operations and technology had been under-resourced and lacked clarity regarding roles and responsibilities for risk activities across the organisation.[9] ASX has progressed work, also identified in its three-year ERM plan, to strengthen and mature its first- and second-line risk management. This includes the recruitment of additional headcount into first-line risk management for operations and technology, and across the second-line risk management function. In addition, ASX updated its ERM policy to clarify the roles and responsibilities of its second-line risk function, and describe the role of the Risk Committee.

The work to strengthen ASX's three-lines-of-defence model is linked to other work streams designed to more thoroughly embed improvements in risk management into ASX's culture. For example, ASX has introduced more explicit risk management goals into its review of senior executive performance, and plans to extend this approach to other staff in future years. Another work stream has been the implementation of a ‘Risk Champion’ initiative, under which individuals across the range of ASX's business units have been nominated to promote group-wide risk initiatives (including the roll-out of new risk systems described below) and support senior management in their risk and compliance responsibilities. Among other aims, these work streams are intended to promote stronger first-line risk ownership and consistent standards of risk management across the organisation.

Operational risk measurement and monitoring

The Review indicated that one of the reasons for the previously limited analysis of information provided to executive and board forums was the limitations of ASX's systems to measure and monitor operational risks. A key part of ASX's response to this finding is the implementation of an Enterprise Risk, Internal Audit & Compliance Application (ERICA) that will allow ASX to capture, consolidate and analyse risk, compliance and audit data more effectively and support more effective risk reporting. By the end of the assessment period ASX had completed the first phase of implementation of ERICA, but many of the benefits of the system are expected to be delivered in subsequent phases that utilise features such as risk dashboards reporting on business unit level KRIs, and with the development of a richer history of risk and compliance data as the system is used over a longer time horizon. Upgrades to ASX's IT service management tool are also expected to improve the quality and coverage of incident data across the organisation over time (see section 2.3.4).

While ASX's work to improve its systems to measure and monitor operational risks remains ongoing, it has taken steps to improve the reporting of risk data that are available in its current systems. This includes the development of standardised risk dashboards to report key risk metrics, such as performance against the Board-level KRIs. These risk metrics and other risk and operational performance reporting is included in quarterly reports from the first and second lines to the executive-level Risk Committee and Technology, Operations and Security Committee, as well as the Board Audit and Risk Committee.

2.3.2 Technology governance

The Review identified that ASX's IT strategy had historically focused on individual projects rather than an overarching vision of the IT function, and therefore recommended that ASX define a technology strategy and roadmap that provide this vision. In response, ASX has refreshed its technology strategy and developed a new technology operating model. The model includes nine ‘domains’ that cover both functional (e.g. trading, or derivatives and OTC markets) and cross-functional (e.g. cyber, digital) aspects of ASX's operations. Four of these domains had been established by the end of the assessment period, including the domains relating to cyber, digital, trading, and derivatives and OTC markets. These domains define ASX's current technology capabilities along with an implementation plan to reach ASX's target state.

2.3.3 Enterprise architecture

The Review identified that a contributing factor to ASX's absence of an overarching IT strategy was that ASX lacked a true end-to-end view of its IT architecture (i.e. its enterprise architecture). The Review recommended that ASX clarify the role of enterprise architecture within its strategic planning for technology. In response, ASX has established an enterprise-level ‘Design Authority’ intended to ensure that governance and decision-making over IT projects takes into account the broader system architecture. ASX has also completed a capability review of the existing enterprise architecture function and recruited additional resource to that team. ASX engaged an external consultant to assist in developing a comprehensive view of ASX's critical systems and documenting ‘blueprints’ of the target state for ASX's enterprise architecture.

2.3.4 Incident management

The Review observed limitations in ASX's analysis of incident data, as well as the lack of a defined system for managing identified incidents and issues. It also observed a heavy reliance on subject matter knowledge experts within ASX, in part resulting from the lack of a centralised knowledge repository that could provide an end-to-end view of system operations. On 1 July 2019, ASX implemented the first phase of an IT service management tool to support the management of incidents and problems, and provide centralised knowledge management functionality. In future phases ASX will develop the tool's functionalities for change management and include additional technology capabilities to improve the quality of incident data over time. ASX also reviewed and identified key business processes in technology and operations that require documentation to provide an end-to-end view of ASX's operations.

To complement the incident management functionality of the IT service management tool, ASX has implemented a crisis communication tool to support more timely delivery of updates and instructions to ASX's crisis management team and other key stakeholders while managing incidents with extreme or widespread impact.

2.3.5 Conclusions and recommendations

The actions described in sections 2.3.1 to 2.3.4 represent significant progress towards addressing the recommendations relating to the Review and implementation of the Building Stronger Foundations program in the 2018 Assessment. Taking this progress into account, the Bank's assessment is that each of the ASX CS facilities broadly observes the standards on Governance (CCP and SSF Standard 2) and Operational Risk (CCP Standard 16 and SSF Standard 14).

Recommendation. The ASX CS facilities should continue to implement plans under ASX's Building Stronger Foundations program to:

  • embed their risk appetite in business processes and decision-making throughout the organisation
  • improve first-line risk ownership
  • consolidate and develop a consistent enterprise-wide view of systems, policies, procedures and controls to identify, monitor and manage operational risks
  • improve systems and processes supporting change management and incident management
  • enhance knowledge management in order to reduce reliance on key individuals.

2.4 Operations and Technology

2.4.1 CHESS replacement

During the assessment period, ASX continued its work on replacing CHESS, its core system for clearing, settlement and other post-trade services for the Australian cash equity market. ASX is working with Digital Asset (DA), a New York-based technology company to develop the system that will replace CHESS.

In September 2018, ASX released its response to an earlier consultation on the proposed functionality of the CHESS replacement system. Its response also clarified what functionality ASX expects to make available from Day 1 and set out a draft implementation timeline. This included an extension of the earliest commencement date for the new system by six months to the first half of 2021.

The new system will be built incorporating elements of distributed-ledger technology (DLT). However, ASX's application of DLT in the CHESS replacement system differs significantly from the arrangements of other systems such as Bitcoin and other cryptocurrencies that also use DLT. ASX will use a private, permissioned network application of DLT. Under this approach, ASX will operate, and control access to, the network according to ASX rules, creating a trusted network of nodes. The distributed ledger will provide the single source of truth regarding transactions on the market, with ASX providing access to users allowing each to see elements of the ledger relevant to them. Participants will be able to connect to the system either by taking a node via a ‘Ledger Application Programming Interface’, or by using a message-based protocol. ASX is developing messages utilising the international ISO 20022 message protocol for users who choose to connect to the system via messages.

User engagement

ASX and DA are currently developing the software for the CHESS replacement system. This work is expected to be completed by June 2020, ahead of a period of industry-wide testing. ASX has been progressively releasing portions of the software into a Customer Development Environment, allowing users to test new functionality as it is developed. These releases have been accompanied by technical information on the functionality of the new system, connectivity and messaging specifications, testing information and support details. ASX has also released information on the costs to access the replacement system for clearing and settlement participants once the new system commences.

The replacement of the core post-trading system for the Australian equities market will have a significant impact on a range of users across the market, including clearing and settlement participants and their service providers, investors, issuers, registries and market operators. Consistent with the Regulatory Expectations for Conduct in Operating Cash Equity Clearing and Settlement Services in Australia (Regulatory Expectations) set out by the Council of Financial Regulators (CFR) and Australian Competition and Consumer Commission (ACCC), ASX has therefore established a number of forums through which users can provide input and feedback on the CHESS replacement project.[10] One such forum for stakeholder input is the ASX Business Committee, which meets on a quarterly basis. During the assessment period, ASX expanded the membership of this committee to include representatives from share registries along with the Governance Institute of Australia, Australasian Investor Relations Association and the Australian Shareholder Association. ASX has also convened a Technical Committee focused on the adoption of ISO 20022 messaging, a Connectivity and Integration Working Group, and an Implementation and Transition Working Group to seek stakeholder input on the technical requirements of the replacement system, as well as its transition strategy. Smaller focus group meetings have been arranged to discuss specific functionality. During the assessment period ASX convened nine meetings of the Technical Committee, 11 meetings of the Connectivity and Integration Working Group, 12 focus group meetings and established the Implementation and Transition Working Group.

Also consistent with the Regulatory Expectations, ASX has committed to providing access to its clearing and settlement infrastructure on transparent and non-discriminatory terms. ASX currently provides several non-ASX markets with access to its clearing and/or settlement services and will continue providing this access. ASX has specifically committed to ensure that its new platforms and technology will not be designed in such a way as to raise barriers to access to operators of other markets, or to any competing CS facilities that might emerge in the future.

In recognition of the challenges associated with delivering a large-scale technical project at the same time as effectively engaging users and other stakeholders (including regulators), ASX has increased the resourcing dedicated to project management in recent months. This includes complementing its project management team with the appointment of a new Project Director with the responsibility for delivering the agreed scope of the project.

Regulatory engagement

The Bank has continued to engage with ASX on its progress in building the new system together with members of a CFR and ACCC working group focused on the implications for competition in cash equities clearing and settlement (including how the Regulatory Expectations are being met). The Bank will continue to focus its engagement on the operational resiliency of the new system, and understanding how the new business requirements align with the requirements in the FSS and can support ASX's risk management capabilities. This includes engagement on planned functionality to support segregation between a participant's clients' positions and collateral from the participant's own positions and collateral (see section 3.4).

2.4.2 Secondary data centre

During the assessment period, ASX progressed work to replace its current secondary data centre with a new site, including completion of the detailed design of the data centre and specification of hardware requirements. ASX plans to commence a phased migration of its back-up systems to the new site from late 2019 and expects to complete the migration of ASX systems by mid 2020.

2.4.3 Cyber enhancements

During the previous assessment period the Bank assessed ASX against the CPMI-IOSCO Guidance on Cyber Resilience for Financial Market Infrastructures (the Cyber Resilience Guidance), concluding that ASX's practices are consistent or broadly consistent with the guidance, apart from in relation to the expectation that ASX is able to recover critical operations safely within two hours following an extreme cyber attack.[11] The Cyber Resilience Guidance recognises that it may take time for FMIs to meet this expectation. During the assessment period, ASX has made further enhancements to its cyber security practices in line with actions identified in its Cyber Strategy roadmap and is obtaining independent expert reviews to confirm the effectiveness of key elements of these enhancements.

2.5 Other Developments

2.5.1 Cross-border regulatory developments

United Kingdom

In October 2018, the Bank of England (BoE) wrote to non-UK CCPs, including ASX Clear and ASX Clear (Futures), that provide services in the UK, providing information on the process for applying for recognition in the UK if the UK withdraws from the EU.[12] The letter also explains that CCPs applying for UK recognition that were already recognised within the EU at the date of exit would be subject to a temporary recognition regime allowing them to continue to provide clearing services in the UK for up to three years while the CCP's application is being assessed. ASX submitted applications for recognition for both ASX CCPs in March, making them eligible for the temporary recognition regime on account of their existing EU recognition.

European Union

The EU is also updating its approach to the supervision of recognised non-EU CCPs, including the ASX CCPs. The proposed changes will result in non-EU CCPs being placed in one of two tiers depending on their degree of systemic importance to the EU. CCPs determined to be systemically important by the European Securities and Markets Authority (ESMA) will be subject to additional requirements and a greater degree of supervision than CCPs that are judged not to be systemically important to the EU. The proposed changes are due to take effect later in 2019, after which a decision will be taken by EU authorities as to which tier of systemic importance the ASX CCPs will be allocated to.

ASX Clear increased its minimum MPOR for cash equities from one to two days in October in order to align with the Bank's supplementary interpretation of CCP Standard 6.3 for domestically licensed derivatives CCPs that provide services to participants that are either established in the EU or subject to EU bank capital regulations. This supplementary interpretation was issued in the context of ESMA's assessment of the equivalence of the Australian regime for regulation of CCPs with that established in the EU.

New Zealand

ASX Clear (Futures) has submitted an application for designation as a Designated Settlement System in New Zealand. If successful, designation would provide additional protection for the finality of ASX Clear (Futures)' settlements in New Zealand, addressing risks to the finality of settlements identified in respect of participants that operate a New Zealand branch (see section 3.2). ASX Clear (Futures) would also be subject to oversight by the Reserve Bank of New Zealand (RBNZ) and the New Zealand Financial Markets Authority (NZFMA). The New Zealand Government is currently consulting on proposals to enhance the oversight regime for FMIs which, if legislated, would provide the RBNZ and NZFMA with additional regulatory powers that apply to designated FMIs. These powers include the ability to set regulatory standards for designated FMIs, powers to oversee their rules, investigative and enforcement powers, and crisis management powers.

2.5.2 Money settlements

NZD payment arrangements

ASX Clear (Futures) settles its NZD obligations, including variation margin for NZD OTC and exchange-traded derivatives, via an arrangement with ASX Clearing Corporation Limited (ASXCC). Under new arrangements introduced during the assessment period, ASX Clear (Futures) now uses Payments NZ's High Value Clearing System to facilitate the settlement of NZD margin payments through the RBNZ's Exchange Settlement Account System (ESAS). The payments are settled between ASXCC's RBNZ ESAS account and the RBNZ ESAS accounts of ASX Clear (Futures) participants or their Participating ESAS account holders. Previously, ASXCC settled these obligations across its exchange settlement account with the RBNZ, with payments initiated in ESAS via the RBNZ's central securities depository, NZClear. The change in arrangements follows the decommissioning of the cash payment functionality in NZClear.

USD settlement in Austraclear

Austraclear's foreign currency settlement service allows participants to make RMB payments in commercial bank money, across the books of Bank of China. In November, Austraclear extended its foreign currency offering to include the settlement of cash transactions in USD. Similar to Austraclear's arrangements for RMB, settlement of the USD payment occurs in commercial bank money across the books of JP Morgan, which was approved as a foreign currency settlement bank for the purposes of USD cash payments in Austraclear.


The CCP Resilience Guidance is available at <> [3]

The IMF report is available at: <> [4]

See BIS (2018) Two defaults at CCPs, 10 years apart at <> [5]

See Nasdaq Commodities: Strategic Initiatives for 2019, available at <>. [6]

For more information on the ERM plan, see section 2.3.2 of the September 2018 Assessment. [7]

The closure of these recommendations was approved by an ASX executive steering group. KPMG reviewed these closure decisions at 30 June, confirming that the necessary conditions had been met for closure. [8]

Under the three-lines-of-defence model, the first line is risk management within the business functions themselves; the second line is an independent risk management and compliance function that develops risk management policy and oversees risk management in the first line; and the third line is independent assurance (i.e. internal and external audit). [9]

Available at: <>. [10]

The CPMI-IOSCO Guidance on Cyber Resilience for Financial Market Infrastructures is available at <>. [11]

The BoE's letter to non-UK CCPs is available at <>. [12]