Assessment of ASX Clearing and Settlement Facilities 2. Response to COVID-19

An event such as the COVID-19 pandemic has the potential to cause significant operational disruption for operators of systemically important financial market infrastructures (FMIs) such as the ASX CS facilities. For example, it could affect the ability of the FMI, its participants and service providers to continue operating systems or to recover normal operations in the event of an outage. This section discusses how ASX has responded to these challenges, as well as those posed by the significant increases in trading activity and price movements observed during the pandemic.

2.1 Operational Risk

2.1.1 Pandemic response plan

In mid-January, ASX initiated its pandemic response plan in preparation for moving to increasing levels of preventative controls amid reports of elevated risk of spread of infection. The plan aims to maintain continuity of operations while reducing the risk of infection to key staff and responding to broader social isolation measures. In March, ASX responded to the increased risk to continuity of operations from the spread of COVID-19 by requiring critical staff to work across its two operations sites and transitioned the remainder of its workforce to work-from-home arrangements. The transition to remote working was implemented over the weekend of 14—15 March, after a staff member tested positive to COVID-19. While the transition was sudden, ASX had made significant preparations for such a move since initiating its pandemic response plan.

Critical staff working onsite were segregated across distinct teams and operation sites, so that if an infection were to occur at one site, the team at the other site would not be required to isolate. Backups for critical staff were identified, in case any of the onsite teams became infected. To guard against the possibility that operational sites became unavailable, ASX developed plans allowing it to operate critical systems that support the CS facilities on a remote basis. ASX also implemented risk mitigation measures to protect the health and wellbeing of its staff, including the deferral of international travel and increased cleaning of premises.

While these arrangements were necessary to mitigate the health risks associated with the COVID-19 outbreak, they represented a significant change to normal operations that can carry additional operational risks that must be mitigated. For example, the higher-than-usual reliance on technology to support remote working and connectivity to critical systems was mitigated by the frequent review and update of ASX's pandemic response plan and maintaining a limited number of critical staff onsite. ASX also took steps to ensure that cyber security controls continued to operate largely as they did prior to remote working and it monitored key systems for additional vulnerabilities that may arise from the increased use of technology to support remote working.

ASX continues to review and update its pandemic response plan on an ongoing basis to take into account government directives, external developments and lessons learned from its implementation. To date, there have been no service disruptions caused by the transition to remote working arrangements.

2.1.2 CHESS processing delays

On Friday 13 March, CHESS experienced processing delays due to record volumes and a reduction in system performance. Around 7 million cash equities trades were executed across all markets cleared and settled using CHESS. This was more than twice the pre-February peak trading day of 3.3 million trades. ASX deferred end-of-day processing of trades and worked to improve processing times before completing processing on Saturday 14 March. A combination of factors, including ASX's processing delays and a separate operational incident at Chi-X, meant that approximately 119,000 Chi-X trades could not be processed until Sunday 15 March and were excluded from normal netting processes. The fact that the incident occurred on a Friday and ASX was able to continue processing on the weekend, reduced the risk that the delay could impact the opening of markets on the next trading day.

Immediately following this incident, ASIC consulted with the Bank regarding possible responses to manage the risk that CHESS again experienced similar capacity constraints. ASIC then issued a direction capping the trading volumes of the nine largest equity market participants. It revoked this direction in May, instead writing to ask all participants to ensure that the number of trades they place in the market are consistent with their own operational capacity and support the fair and orderly operation of equity markets.[4] In addition, ASX is exploring options to support the fair and orderly operation of markets if a similar increase in volumes were to happen again. The incident in March highlighted the role that global events and extreme volatility can play in driving trading activity in a market with increasing participation from algorithmic and high frequency market traders, and the need for ASX to have a contingency arrangement in place to address extreme increases in volumes that exceed system capacity. ASIC and the Bank are continuing to discuss this situation with ASX.

ASX has commenced a program of work to improve the capacity of its post-trade systems for cash equities. As part of this, it has continued to make further technical improvements to improve the processing speed of CHESS and is planning to implement a number of other upgrades in the second half of 2020. These are expected to add sufficient additional capacity for CHESS to be able to process on a repeatable basis a volume of cash equities trades similar to that observed on 13 March. ASX is also considering further upgrades in 2021 that would significantly increase the capacity of the current system.

This incident highlights the limitations of the CHESS system in quickly responding to extreme increases in the number of trades. While the identified enhancements will improve capacity in the current system, CHESS is built on technology developed in the 1990s that is not easily scalable. In the medium term, ASX plans to implement a replacement system that is expected to be able to process 15 million trades per day at launch and is designed to be more flexible so that capacity can be increased in the future if needed.

Recommendation. ASX should implement the new clearing and settlement system for cash market transactions as soon as this can be safely achieved by ASX and users of CHESS. In the short term, ASX should carry out plans to increase the capacity of the current CHESS system and develop contingency arrangements to address future extreme increases in volumes that exceed current processing capacity.

2.1.3 Reprioritisation

Addressing the operational risk management challenges presented by COVID-19 placed additional demands on the ASX CS facilities. In response, ASX prioritised work to maintain operations and address risks associated with COVID-19, while delaying some work on longer-term projects. In response to market volatility, ASX also prioritised additional analysis and enhancements to key financial risk models (see section 2.2) and re-planned its longer-term roadmap to enhance its clearing risk management systems (see section 3.3.2). ASX will be consulting with its participants on further extending the timelines for its CHESS replacement project (see section 3.3.1).

2.2 Financial Risk

The COVID-19 pandemic presented significant financial risk management challenges for the ASX CCPs. The uncertainty and rapidly evolving information associated with COVID-19 resulted in heightened volatility in financial markets (Graph 1). The 9.5 per cent fall in the All Ordinaries index on 16 March was the highest single-day decline since the index fell 25 per cent on 20 October 1987. Australian dollar interest rate markets have also experienced historically large movements. This extreme market volatility has highlighted the importance of CCPs' financial risk management arrangements (Box B).

Graph 1
Graph 1 Equity and Bond Market Volatility

During this time of heightened volatility, the ASX CCPs' financial risk management frameworks generally performed well. The ASX CCPs, both of which have equities as their largest risk exposures, demonstrated resilience and throughout this period of volatility additional steps were taken to strengthen their risk management arrangements. These enhancements were managed successfully by ASX despite the very significant operational challenges presented by remote working; in particular, the very large fall in equities on 16 March occurred on the first day following ASX's transition to work-from-home arrangements. However, some vulnerabilities emerged during the period, including in relation to the CCPs' ability to collect margin in response to late-in-day market price movements, the possible procyclical effects of margin setting changes, and the adequacy of stress test scenarios. These issues are discussed further below.

Box A: CCP financial risk management

In the absence of a participant default, a CCP has no direct exposure to price movements in the products it clears. However, in the event of a default, the CCP would assume the obligations of the defaulting participant – and therefore the risk exposures of its portfolio – until the CCP is able to close out those positions. Heightened market volatility would exacerbate the credit and liquidity risks faced by the CCP in this scenario.

A CCP's first line of defence in managing these risks is to reduce the likelihood of a participant default via stringent participation requirements and ongoing monitoring of capital and liquidity positions.

A second line of defence comes from the collection of margin from clearing participants.

  • Variation margin is collected to prevent the build-up of exposures as prices move. It is directly linked to current volatility since it reflects changes in the market values of participants' positions.
  • Initial margin is calibrated to cover possible adverse price changes between the time of a default and when a position could be closed out. Initial margin models are usually calculated using a historical sample of price movements; depending on how this sample is constructed, margin levels may be more or less responsive to the most recent levels of volatility.

Both types of margin are collected either daily or several times per day, depending on the product, either at fixed intervals or in response to significant market movements.

A CCP's third line of defence is its prefunded default fund, which consists of pooled resources contributed by clearing participants and/or the CCP itself. Each CCP operating in Australia seeks to maintain a default fund large enough to cover a default of the two participants (and their affiliates) to which the CCP has the largest exposures in extreme but plausible market conditions – a requirement known as ‘Cover 2’. If a CCP's stress tests show that its exposures could breach this requirement then it may collect additional margin as an alternative to increasing its default fund. The Cover 2 requirement is not usually affected by recent levels of market volatility because it is calculated using predefined stress scenarios. However, the scenarios themselves may require adjustment if recent volatility has exceeded these extreme levels.

CCPs may also supplement their prefunded financial resources with other margin requirements – for example, by collecting overnight ‘buffer’ margin from participants to cover potential overnight price movements if the CCP does not collect variation margin during this period.

If a CCP's losses were to exhaust all of its prefunded resources, the CCP's last line of defence would be to turn to additional recovery tools, which could include allocating residual credit losses and liquidity shortfalls to the CCP's surviving participants.

For specific details on the ASX CCPs' risk management arrangements, see Appendix B.

2.2.1 Initial margin

ASX responded to heightened volatility in financial markets by increasing initial margin settings so that the CCPs had additional resources to protect themselves against higher expected future volatility. The largest adjustments were to equities products, with initial margin rates on equity index futures and options increasing from 4.5 per cent to 10 per cent in two stages over March. This was the largest single-month increase ASX has made to equity margin requirements under its current margining approach. The increase was larger than that required by its statistical model, reflecting ASX's judgement that equity market volatility could remain elevated for some time. In May, ASX made further increases to margin rates for single-stock equity derivatives and to the flat rate applied to less liquid cash equities to reflect the volatility observed over March. In addition, adjustments to the margin settings on over-the-counter (OTC) derivatives resulted in a doubling of margin collected on these products. No changes were made to margin rates for exchange-traded interest rate products following the outbreak of COVID-19. These had already been increased significantly in November to address a low-rate bias in ASX's stress tests (see section 2.2.4) and, unlike equities, yields stabilised quickly after the Bank announced its interventions in the bond market on 19 March.[5]

In aggregate, initial margin collected by ASX Clear (Futures) rose over March from $7.7 to $9.4 billion, while initial margin at ASX Clear rose from $1.3 to $1.9 billion (Graph 2). Nearly all of this increase was due to changes in margin rates for equity derivatives. Despite elevated trading volumes, net participant exposures remained constant or declined across most products. Initial margin subsequently declined to $8.9 billion at ASX Clear (Futures) and $1.5 billion at ASX Clear as at the end of the assessment period.

Graph 2
Graph 2 ASX: Initial Margin by Product

2.2.2 Procyclicality

Increasing margin requirements during periods of market stress can create liquidity challenges for a CCP's participants. Such increases can be considered ‘procyclical’ if they tend to occur during downturns in the business or credit cycle and may either cause or exacerbate market instability. This risk has been an area of focus among regulators in recent years, and international guidance has encouraged CCPs to put in place measures to maintain higher initial margin requirements ‘through the cycle’ in order to avoid sudden increases in times of stress. These measures can involve CCPs placing a floor on margin requirements or ensuring – even during periods of low volatility – that their margin calculations always take into account earlier episodes of particular stress.

ASX calculates initial margin requirements for equity index derivatives using a five-year historical sample of price movements; it uses a range of sample periods between 12 months and 12 years for other products. The margin model ASX uses for exchange-traded derivatives requires ASX to regularly review and manually adjust key margin parameters. ASX targets a confidence level of at least 99.5 per cent for these parameters. While ASX can choose to keep margin rates at a higher level than the statistical recommendation, it does not have a systematic approach to doing so.

Margin rates for equity derivatives are likely to remain elevated while the latest period of volatility remains in the historical sample and ASX continues to apply a discretionary floor to margin requirements. However, under ASX's current margining approach, margin requirements could again decline following an extended period of low volatility, creating the potential for another sudden increase at the onset of the next period of heightened market volatility. The 2018 Assessment identified ASX's lack of a systematic approach to assessing and mitigating the potential for procyclical changes as a weakness in ASX's risk management framework. ASX has plans in place to implement enhancements to its procyclicality framework in the coming assessment period.

Recommendation. Consistent with the CCP Resilience Guidance, the ASX CCPs should develop a systematic procyclicality framework designed to avoid destabilising increases in margin and other financial risk requirements during periods of heightened market volatility.

2.2.3 Liquidity risk management

Variation margin calls rose significantly at both ASX CCPs over March and early April due to the elevated market volatility over this period (see Graphs 3 and 4). Daily variation margin calls at ASX Clear (Futures) exceeded the previous historical high of $1.4 billion on 11 occasions, with a maximum of $2.5 billion being called on 16 March. Daily premium margin called from ASX Clear members exceeded the previous historical high of $1.5 billion on four occasions, with a maximum of $1.9 billion called held on 23 March.[6]

While ASX Clear (Futures) calls for margin at a number of points during the day, it does not typically call variation margin between 1.30 pm and 8.05 am the next day.[7] ASX Clear usually only calculates initial and variation margin at 5.00 pm, after market close, for collection at 10.30 am the next day. However, in response to the extreme intraday price moves seen in March, both ASX CCPs made frequent use of an additional, ad hoc intraday margin call at around 2.30 pm. However, the CCPs cannot initiate a margin call that is able to be collected on the same day much later than this; this reflects the time required for ASX to calculate margin requirements and for participants to meet their margin obligations before the closure of Austraclear's day session at 4.28 pm. ASX Clear (Futures) participants that are active during the overnight session are required to post additional collateral to cover potential adverse price movements overnight, in the absence of a variation margin call during this period.

Graph 3
Graph 3 ASX Clear (Futures) Variation Margin
Graph 4
Graph 4 ASX Clear Derivatives Variation Margin

Rapid price movements after the last intraday margin run can result in a significant build-up of exposures. In March, ASX Clear (Futures) twice breached its Cover 2 liquidity requirement following large upward movements in equity futures prices between 2.30 pm and 5.00 pm, when ASX calculates its stress test exposures. These price increases generated large variation margin obligations for two participants with sizeable short positions that the CCP would be required to fund if the participants had defaulted prior to the settlement of variation margin the next morning. In addition, ASX's stress test scenarios assume that the CCP would then have experienced further losses from rising equities prices before it could close out the short positions.

Two Cover 2 breaches within a 12-month period exceeds the ASX Board's risk tolerance for the frequency of stress test breaches (see section 3.4.1). ASX's immediate response was to require the two participants that caused the Cover 2 breaches to each post additional overnight liquidity buffer margin of $150 million; this was reduced in early April after increases in initial margin requirements for all participants reduced the likelihood of a further breach. The size of the overnight buffer as applied to all participants was also recalibrated in April with a shorter lookback period to place more weight on the heightened volatility of March and April.

While ASX Clear did not have any Cover 2 breaches, it did have three breaches of its internal cash market liquidity buffer over the assessment period. A breach of this buffer does not indicate an overall shortfall of liquid resources, but it implies that in the event of a Cover 2 scenario there would be a greater reliance on offsetting transaction arrangements (OTAs) as a source of liquidity.[8] The first breach occurred in December, a few days before ASX executed an $80 million committed liquidity facility that would otherwise have prevented the breach. ASX Clear had two subsequent breaches of its internal liquidity buffer in March. In response, ASX Clear initially increased AIM requirements for select participants before introducing a permanent liquidity buffer requirement for participants with large liquidity exposures on derivatives in July.[9]

The 2019 Assessment included a recommendation that ASX Clear (Futures) should embed, review and refine its arrangements to monitor and manage intraday exposures during ASX 24's Night Session on a near real-time basis. During the assessment period, ASX implemented an alert at 2 am to identify participants with an initial margin exposure of greater than $100 million. The alert triggers an investigation by ASX to manually validate the size of the initial margin call before it is made on the participant. This complements actions in earlier assessment periods, including the development of a risk-visualisation tool to monitor intraday exposures on a near real-time basis, the implementation of an overnight margin buffer and the introduction of the 2 am overnight margin call.

ASX plans to introduce further enhancements to its management of intraday exposures. These include a project to rebuild its credit stress testing model to enable intraday stress testing and to enhance margin backtesting so that its prefunded resources better capture risks from the potential for rapid price movements late in the day. While these enhancements would reduce the risk that late-in-day or overnight price movements leave the CCPs with an uncovered exposure, the impact of recent market volatility on both CCPs highlights that prefunded resources may not be sufficient if market moves are sufficiently large. ASX does not yet have a developed framework for monitoring variation margin liabilities overnight or to address margin exposures that exceed those covered by initial margin and the overnight margin buffer.

Recommendation. The ASX CCPs should put in place arrangements that allow them to monitor and manage exposures arising from large late-in-day price movements, including movements that exceed the coverage provided by initial and additional margin. For ASX Clear (Futures), this also applies to price movements during the overnight trading session.

2.2.4 Stress tests

The results of a CCP's stress tests directly determine the level of prefunded resources it must hold. Consistent with the FSS, ASX seeks to maintain prefunded resources that would be sufficient to cover its losses from the default of any two clearing participants using a range of ‘extreme but plausible’ stress test scenarios. It is therefore critical that these scenarios reflect up-to-date information on what may be plausible risks to the CCPs. These scenarios may be based on historical events (e.g. the Lehman Brothers default), hypothetical events (e.g. geopolitical conflict), or theoretical scenarios extrapolated from historical price movements using statistical techniques.

During the assessment period, ASX's historical stress test scenarios for equity index derivatives were calibrated using observed changes in prices at market close over a three-day period.[10] However, this approach does not take into account losses that could arise from more extreme intraday price movements that could occur while a defaulted participant's portfolio is being closed out. In light of this issue, on 6 July ASX revised its calibration of historical stress test scenarios for some key futures contracts so that estimated losses take intraday prices into account.[11]

In response to the volatility observed in March, ASX also reassessed whether the magnitudes of its stress tests remain appropriate. On 6 July, ASX introduced 17 new historical and theoretical stress test scenarios across both CCPs based on price movements observed in March. Several of these scenarios extend the boundary of what ASX had previously considered ‘extreme but plausible’, including by significantly increasing the largest ‘yield-down’ shock for 10-year bond futures, increasing the largest upward shock for equity index futures, and introducing more severe combinations of both equity and rates shocks than were previously considered. The Bank is in the process of discussing with ASX how it defines the boundary of ‘extreme but plausible’, including the governance processes that underpin the determination of this boundary. While ASX has a clear approach to the inclusion of historical scenarios in its suite of stress tests, its approach to formulating hypothetical and theoretical scenarios that are extreme but plausible is less well defined.

The changes outlined above come in addition to a major update to the stress testing methodology for ASX Clear (Futures)' rates products that was implemented in April. The enhancements introduce absolute shocks to interest rates (i.e. assuming interest rates fall by a fixed number of basis points, rather than by a percentage of the current yield). This update was intended to address the low-rate bias in the previous methodology, which implied that the shocks used in stress tests became smaller as rates fell. ASX had planned to make these changes prior to the COVID-19 outbreak and accelerated implementation in light of the decline in yields in early March.

2.3 Participant Risks

ASX did not experience a participant or client default at either CCP during the assessment period. ASX's monitoring of participants across both CCPs indicated that most maintained strong capital positions and adequate liquidity. Most of the risk at ASX Clear (Futures) is concentrated in the large domestic and international banks, while ASX Clear has a greater number of participants (including smaller brokers) and the risk is slightly less concentrated. During the period of market stress brought on by COVID-19, ASX Clear received capital returns from all non-bank participants to check compliance with its capital requirements and received daily liquidity returns from smaller participants to assess their capacity to meet margin calls. ASX Clear (Futures) has also been collecting more frequent data on the liquidity position of some of its larger members, in order to gain more timely insight into the potential build-up of liquidity pressures at those participants.

Participants in the ASX CCPs did not experience any significant operational issues from working-from-home arrangements or fail to make any margin payments.

2.4 Default Management

The risks of a participant default have been heightened during the COVID-19 pandemic: participants have been exposed to additional credit and liquidity stresses arising from volatility in financial markets, and in the medium term may be exposed to the economic impact of a prolonged shutdown. There have also been potential operational complexities arising from the ASX CS facilities and their participants working remotely or operating under business continuity arrangements. These complexities could make it more difficult to liquidate a defaulting participant's portfolio and contain losses if any participants of the ASX CS facilities were to default.

ASX reviewed its preparedness to manage the default of a participant in response to the COVID-19 pandemic, including by testing that key default management systems could be accessed remotely. In addition, ASX tested its arrangements and established that all external dependencies for default management were unaffected even though a number of default brokers and financial institutions had also activated their business continuity plans. As a result, ASX is confident of its ability to manage a default with all staff working remotely, notwithstanding that such an arrangement would be less efficient in some circumstances and it would therefore seek to bring some additional staff in its office where it could.

A default involving an OTC derivatives portfolio would create an additional challenge. It may not be possible for ASX to follow its standard default management approach, which requires an in-person meeting of its participant Default Management Group (DMG) within two hours. ASX has therefore developed contingency plans allowing it to hedge the defaulter's portfolio and proceed directly to an auction without input from the DMG.

Further information on ASX's default management arrangements is provided in chapter 4.

2.5 Conclusions

The COVID-19 pandemic presented significant operational and financial risk management challenges for the ASX CS facilities, including disruptions to their normal working arrangements, large increases in transaction volumes and heightened volatility on financial markets. Each of these issues in isolation would have represented serious risk management challenges. The combination of these issues and the protracted nature of the crisis further exacerbated the challenge.

Within this context, the ASX CS facilities performed very well in most respects. ASX successfully activated pandemic plans and transitioned to remote working arrangements within a short period of time, without any interruption to its critical operations. The CCPs also demonstrated resilience during a time of heightened volatility, particularly in equity markets, managing the risks associated with the largest single-day decline in equities for over 30 years on the first day following the transition to remote working. The post-GFC regulatory reforms also ensured that CCPs and their participants entered the current crisis better capitalised and with greater liquidity buffers than was the case in 2008. Nevertheless, developments surrounding COVID-19 highlighted some areas of vulnerability for the ASX CS facilities that will inform the Bank's supervisory engagement over 2020/2021.

The Bank will continue to engage closely with ASX on other matters related to the COVID-19 crisis over the coming assessment period. This will include monitoring the arrangements that ASX has in place to address a possible escalation of the situation, its preparations for incident or default management, and the steps it is taking to monitor the credit and liquidity position of its participants.


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‘Premium margin’ is the term given to margin collected to cover mark-to-market changes in the close-out price of exchange-traded options (ETOs) [6]

ASX Clear (Futures) usually makes three intraday margin calls per day for initial and variation margin at 8.05 am, 11.30 am and 1.30 pm. It also makes an end-of-day call for initial and variation margin at 5.00 pm, which is settled the following morning at 11.00 am. In addition, ASX Clear (Futures) makes an initial margin-only intraday call during the overnight session at 2.00 am and calls AIM between 5.00 and 8.00 am. [7]

An OTA enables ASX Clear to settle its payment obligations on the intended settlement date with participants due to deliver securities, through an arrangement to offset the underlying settlement obligations to and from those participants via a repurchase agreement with the participants. It provides temporary liquidity until ASX Clear is able to sell the securities subject to the OTA and use these funds to unwind the transaction. [8]

ASX Clear's liquidity buffer is calibrated to cover the 75th percentile of changes in the CCP's liquidity exposures from participants' equity derivative positions over a three-month lookback period. It includes a minimum threshold such that it only affects participants with relatively large exposures. [9]

Three days is the maximum amount of time ASX expects it could need to close out a defaulted participant's portfolio in stressed conditions. [10]

Under ASX's revised methodology, stress test losses for relevant futures contracts are calculated using the change in price between the worst point of entry (i.e. either the highest or lowest price observed during the day, depending on the direction of the position) and the volume weighted average price observed over either the next two or three days (whichever produces a higher loss). [11]