Assessment of ASX Clearing and Settlement Facilities – September 2019 Appendix C1. Financial Stability Standards for Central Counterparties

Standard 4: Credit risk

A central counterparty should effectively measure, monitor and manage its credit exposures to participants and those arising from its clearing processes. A central counterparty should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence.

4.1 A central counterparty should establish a robust framework to manage its credit exposures to its participants and the credit risks arising from its clearing processes. Credit exposures may arise from current exposures, potential future exposures, or both.

ASX Clear and ASX Clear (Futures) maintain a comprehensive framework for managing credit exposures to their participants. The core components of this framework comprise: a stress test regime (see CCP Standards 4.5 to 4.7); the use of variation margin to mark positions to market (see CCP Standard 6); and the maintenance of prefunded financial resources. These financial resources comprise initial margin (see CCP Standard 6), other collateral calls based on participants' positions, and a fully prefunded default fund of $250 million at ASX Clear and $650 million at ASX Clear (Futures) (see CCP Standard 4.4). The ASX CCPs also have in place comprehensive arrangements to address any credit losses in excess of their prefunded resources (see CCP Standard 4.8).

Financial resources received in cash from both CCPs are re-invested by ASXCC. To mitigate the credit risk arising from these investments, ASXCC has established an investment policy that includes counterparty limits and minimum credit ratings (see CCP Standard 15).

4.2 A central counterparty should identify sources of credit risk, routinely measure and monitor credit exposures, and use appropriate risk management tools to control these risks. To assist in this process, a central counterparty should ensure it has the capacity to calculate exposures to participants on a timely basis as required, and to receive and review timely and accurate information on participants' credit standing.

The Counterparty Risk Assessment (CRA) team is responsible for monitoring participants' credit standing and ASX's Clearing Risk Oversight team monitors the ASX CCPs' credit exposures to participants. Clearing Risk Oversight monitors day-to-day developments in, among other things, open positions, market price moves and settlement obligations to the CCPs.

Participants' positions are marked to market and the CCPs calculate initial and variation (or mark-to-market) margin requirements at the end of each business day. The CCPs also call margin on an intraday basis when, due to changes in market value and the opening of new positions, uncollateralised exposures exceed predefined limits. Intraday margin calls for both CCPs equal the total shortfall in initial and variation margin if triggered (see CCP Standard 6.4).

Both ASX CCPs identify credit risk factors that have a direct impact on the valuation of participant positions and use these risk factors to construct historical, theoretical and hypothetical credit stress testing scenarios (see CCP Standard 4.6). During the assessment period, ASX Clear (Futures) completed work to more comprehensively define, justify and document its credit risk factors; ASX is conducting further work to justify that its stress testing approach also adequately captures risks posed by indirect credit risk factors such as bid-ask spreads and different trading strategies. Similar work is expected to be completed for ASX Clear during the next assessment period.

To manage the additional credit risk exposure arising from offering real-time novation of OTC products, ASX Clear (Futures) places a limit on the interest rate sensitivity of new transactions (currently set to $500,000 per basis point), conducts frequent portfolio exposure checks and may prevent further novation until an intraday margin call is met. By imposing pre-novation limits on the interest rate sensitivity of each trade (set using the maximum present value of a basis point shift in interest rates), ASX Clear (Futures) minimises the possibility that novating a single large trade results in a significant increase in credit exposure.

ASX Clear and ASX Clear (Futures) conduct daily stress tests to monitor the effects of extreme but plausible scenarios on participants' portfolios. Where stress test results are above a defined limit, AIM is called (see CCP Standard 4.4).

CRA is responsible for ongoing monitoring, assessment and investigation of matters relating to financial requirements (including participants' monthly financial statements). CRA is also responsible for determining an internal credit rating (ICR) for each participant by drawing on information provided by participants in regular financial returns to ASX and other information, including external credit ratings for the participant or its parent, compliance performance and governance arrangements. ASX Clear and ASX Clear (Futures) may call additional margin from a participant with a large portfolio relative to its capital, or where it has other counterparty credit risk concerns (see CCP Standard 4.3).

CRA also coordinates a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list occurs following actual or potential adverse changes, such as: actual or rumoured financial distress; corporate restructures; operational incidents; risk management controls or significant or repeated compliance or capital issue. Watch list factors are monitored across a number of functions including CRA, Participants Compliance and Operations. Based on an assessment of watch list factors, ASX Clear and ASX Clear (Futures) may decide to place restrictions on a participant's trading, clearing and settlement activities (see CCP Standard 4.3).

ASX's Concentration Risk Standard sets out a risk-based approach to monitoring concentration risks faced by the CCPs. This monitoring is only performed on products for which ASX believes there to be a high or medium risk of concentration occurring, which currently is only futures and ETOs. ASX monitors concentrations in participants' exposures to their clients (see CCP Standard 18), and concentrations of individual participants' positions in particular products for ASX Clear (ETOs and related collateral). The latter type of concentration indicates individual participant exposure to large price movements in a particular product that could challenge its capacity to meet obligations to the CCP. CRPM monitors the concentration of participants' positions in single-name ETOs, by applying a 90 per cent price reduction to the underlying contract and reviewing the resulting exposure against participants' stress test exposure limits (STELs). Further review would be triggered should exposure to a particular product exceed a specified share of a participant's total portfolio, subject to a materiality threshold.

Concentration in futures products at ASX Clear (Futures) is identified and addressed through a margin liquidity add-on, which was introduced during the assessment period (see CCP Standard 6.3).

If a trigger was met under its Concentration Risk Standard, ASX would not automatically take action. In determining whether further investigation or action was warranted, ASX would take into account a number of factors, including the materiality of the breach, and the credit standing and activity profile of the relevant participant (see CCP Standard 4.3).

Under its risk-based approach to monitoring concentration risk, ASX Clear has prioritised formal concentration monitoring for derivatives products over cash market products. This reflects the short term nature of exposures generated by cash market transactions (which settle on a two-day cycle). ASX Clear nevertheless monitors concentration risks in the cash market via its ongoing monitoring of participant credit exposures, investigating whether identified issues are related to concentrated holdings in particular securities.

Likewise, ASX Clear (Futures) has prioritised formal concentration monitoring for exchange-traded products over OTC products, reflecting the currently relatively low level of exposures generated by OTC derivatives transactions. ASX Clear (Futures) nevertheless monitors concentration risks in OTC products via its ongoing monitoring of participant credit exposures.

For details of the ASX CCPs' other participation requirements and participant monitoring arrangements, see CCP Standard 17.

4.3 A central counterparty should have the authority to impose activity restrictions or additional credit risk controls on a participant in situations where the central counterparty determines that the participant's credit standing may be in doubt.

Participants may be subject to conditions and/or restrictions on their admission or additional credit risk controls. For instance, they may be subject to calls for additional margin, higher capital requirements, additional capital reporting requirements, or a reduced STEL (such that additional margin would be called at a lower level of credit stress test exposure (see CCP Standard 4.7)). The application of restrictions, conditions or additional credit controls is at ASX's sole discretion.

ASX Clear and ASX Clear (Futures) will also call capital-based position limit (CBPL) AIM from a participant with a large portfolio (measured by initial margin requirements) relative to its liquid net tangible assets (NTA) or Tier 1 Capital (see Appendix B.3 for a description of this methodology). Participants that are a bank, a subsidiary of a bank, or a bank holding company (where the subsidiary has a minimum $200 million of NTA) are subject to a fixed limit of $1.5 billion for their initial margin liabilities, reflecting the more comprehensive prudential supervision and capital adequacy requirements that these entities are subject to. In order to qualify for this fixed limit, the bank or bank holding company must be subject to prudential supervision by a supervisory authority in a jurisdiction approved by ASX; a bank holding company must also be designated as a Global Systemically Important Bank by the Financial Stability Board. The CBPL for remaining participants at ASX Clear (Futures) and for all participants at ASX Clear is set at three times their level of capital.

The ASX CCPs may also make a call for AIM on the basis of other counterparty credit risk concerns.

4.4 A central counterparty should cover its current and potential future exposures to each participant fully with a high degree of confidence using margin and other prefunded financial resources (see CCP Standard 5 on collateral and CCP Standard 6 on margin). In addition, a central counterparty that is involved in activities with a more complex risk profile or that is systemically important in multiple jurisdictions should maintain additional financial resources to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. All other central counterparties should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. In all cases, a central counterparty should document its supporting rationale for, and should have appropriate governance arrangements relating to, the amount of total financial resources it maintains.

ASX Clear's $250 million default fund currently consists entirely of its own equity. ASX Clear (Futures)' $650 million default fund consists of $450 million in ASX capital (across three tranches), and $200 million in participant contributions (across two tranches). The order of application in the event of a futures participant default would be as follows: $120 million of own equity; $100 million from futures participants; $150 million of own equity; $100 million from OTC participants; and $180 million of own equity. The ordering of OTC and futures participant contributions would be reversed in the event of an OTC participant default (see CCP Standard 12.1).

ASX Clear and ASX Clear (Futures) conduct daily stress tests to determine whether the level of each CCP's prefunded financial resources would be sufficient to cover the default of the two participants and their affiliates that would potentially cause the largest aggregate credit exposure to the CCP under a wide range of scenarios (see CCP Standards 4.5 to 4.7).

Since ASX Clear clears only transactions in cash securities and equity futures and options and ASX Clear (Futures) clears primarily transactions in exchange-traded futures and OTC IRD, the Bank does not consider that ASX Clear and ASX Clear (Futures) are involved in activities with a complex risk profile. Nonetheless, the Bank has concluded that both CCPs are systemically important in multiple jurisdictions and are therefore subject to higher financial resource requirements (i.e. Cover 2). This conclusion reflects that ASX Clear and ASX Clear (Futures) are recognised as foreign CCPs in the EU by ESMA and the Bank's supplementary interpretation of the FSS identifies the need for a CCP to seek recognition in other jurisdictions as one possible indicator of systemic importance in multiple jurisdictions.^[15],[16]

Under the ASX CCPs' AIM methodology, a participant is required to post additional collateral should stress test outcomes reveal that the potential loss arising from its positions (as at the close of the previous day) exceeds a predetermined STEL (see CCP Standard 4.7). The objective of this regime is to provide additional participant-specific cover against non-systematic spikes in individual participants' exposures. This mitigates the risk that the default of a participant with a large exposure, in more extreme market conditions than are contemplated by regular initial margin, may deplete or even exhaust the CCPs' default funds. By upholding the ‘defaulter pays’ principle, the AIM regime also provides an incentive for participants to manage the risk they bring to the CCPs.

4.5 A central counterparty should, through rigorous stress testing, determine the amount and regularly test the sufficiency of its total financial resources available in the event of a default or multiple defaults in extreme but plausible market conditions. Stress tests should be performed daily using standard and predetermined parameters and assumptions. On at least a monthly basis, a central counterparty should perform a comprehensive and thorough analysis of stress-testing scenarios, models and underlying parameters and assumptions used to ensure they are appropriate for determining the central counterparty's required level of default protection in light of current and evolving market conditions. A central counterparty should perform this analysis of stress testing more frequently when the products cleared or markets served display high volatility, become less liquid, or when the size or concentration of positions held by a central counterparty's participants increases significantly. A full validation of a central counterparty's risk management model should be performed at least annually.

ASX Clear and ASX Clear (Futures) use daily credit stress tests to monitor risk exposures to individual participants and the adequacy of their financial resources. The CCPs apply some common underlying parameters and assumptions in performing credit stress tests, including:

• profits in client accounts cannot be used to offset house losses, or losses on other client accounts (although client profits and losses may offset within the same client omnibus account)
• positions in client accounts will be closed out rather than transferred to another participant, with any losses crystallised as a result
• the point of default is assumed to occur after initial and variation margin obligations from the previous day's settlement cycle have been met by the participant, but before AIM obligations from the previous settlement cycle have been met by the participant.

During the assessment period, ASX determined and documented its approach to incorporating a more conservative point of default assumption in stress testing for both CCPs. This new approach involves conducting ‘point-in-time’ stress testing, which would compare stress test exposures against margin held at the same point in time, rather than at the time of settlement of end-of-day margin. ASX plans to incorporate this more conservative assumption in its stress testing over the next assessment period.

Each CCP also applies assumptions that are specific to its own credit stress tests. At ASX Clear, these assumptions include:

• for equity derivatives, excess collateral posted by participants and their clients is available to cover stress test exposures. ASX plans to remove excess collateral as a source of assumed default resources during the next assessment period
• prices may rebound following a large fall (a rebound scenario); price and volatility move independently in this scenario
• the time taken to liquidate the portfolio, or stressed period of risk (SPOR), is three days.

At ASX Clear (Futures) these assumptions include:

• excess collateral posted by participants and their clients is not available to cover stress test exposures
• the assumed SPOR is three days for liquid exchange-traded derivatives and five days for all other exchange-traded products and OTC derivatives.

The stress test regimes aim to provide coverage for 99.98 per cent of observed price and volatility movements (i.e. extreme market moves that have a probability of occurring once in 20 years). At ASX Clear, credit stress tests are based on a range of scenarios covering extreme price moves and volatility shifts at the market-wide, sector and individual stock levels (see CCP Standard 4.6). ASX Clear's stress test framework incorporates intraday price movements; that is, price changes are based on the most extreme close-to-high or close-to-low price movements observed over the relevant holding period.

At ASX Clear (Futures), credit stress tests are based on a range of scenarios covering extreme price moves and volatility shifts in equity, interest rate and electricity contracts (see CCP Standard 4.6). ASX Clear (Futures) stress testing approach is based on the most extreme close-to-close price movements observed over the relevant holding period. During the assessment period, ASX Clear (Futures) completed work to define, justify and document its SPOR assumptions. Similar work is expected to be conducted for ASX Clear during the next assessment period.

On a monthly basis, the RQWG reviews daily price and implied volatility changes for the month to determine whether there is any evidence of stress that would support a change to scenarios. Any observed changes in price or volatility at both CCPs, or interest rate curves at ASX Clear (Futures) in excess of the stress test scenarios would constitute an event beyond what was previously considered to be extreme but plausible. Accordingly, it is likely that a revision to the relevant stress test scenario would be presented for consideration by the Clearing Boards.

ASX's Model Validation Standard requires that models used at the ASX CCPs in their credit, collateral, margining and liquidity risk management systems must undergo a full independent annual validation (see CCP Standard 2.6). Under this framework, the credit stress test model must be validated annually by an independent expert.

4.6 In conducting stress testing, a central counterparty should consider the effect of a wide range of relevant stress scenarios in terms of both defaulters' positions and possible price changes in liquidation periods. Scenarios should include relevant peak historic price volatilities, shifts in other market factors such as price determinants and yield curves, multiple defaults over various time horizons, simultaneous pressures in funding and asset markets, and a spectrum of forward-looking stress scenarios in a variety of extreme but plausible market conditions.

ASX Clear and ASX Clear (Futures) use their credit stress tests to establish the overall adequacy of prefunded financial resources and to determine whether a participant is required to post STEL AIM (see CCP Standard 4.4). Prefunded financial resources are sized to cover projected Cover 2 losses under the active scenarios, and only active scenarios may trigger a STEL AIM call.

Active stress test scenarios in ASX Clear

ASX Clear's stress test regime is based on a range of both single and multi-factor scenarios based on either historical observations or forward-looking hypothetical scenarios. To meet the target level of coverage, ASX Clear calibrates historical market-wide and sector-specific stress test scenarios to cover the most extreme movement observed over a lookback period of 20 years of price and volatility data. Currently, ASX Clear does not have a formal process to ensure that historical periods of stress that fall beyond the 20-year lookback period remain incorporated within stress testing scenarios unless explicitly excluded. Scenarios for individual stocks are calibrated to ensure that the assumed price movements always provide at least the targeted level of cover, verified by back-testing based on 20 years of price history where available. The following suite of scenarios is currently active in ASX Clear:

• Six market-wide scenarios that cover price movements ranging from a 15.5 per cent decrease to an increase of either 9.8 per cent or 13.0 per cent (depending on recent market conditions), increases in volatility of up to 170 per cent, and scenarios that combine changes in price and increases in volatility.
• Other scenarios that cover 10 broad market sectors (including consumer staples, electricity, financials, consumer discretionary, utilities and information technology), applying hypothetical extreme increases and decreases in price across these sectors, and increases in volatility of up to 170 per cent.
• Scenarios for 25 individual stocks, chosen based on total open derivatives positions; one set of scenarios cover price movements of 30 per cent with a 170 per cent movement in volatility, and another set cover a 250 per cent increase in volatility with no change in price.

Currently, ASX Clear's active stress test scenarios apply sector-specific shocks in isolation, assuming that prices remain stable in all other sectors and the market as a whole. However, in addition to its suite of active scenarios, ASX Clear reviews on a monthly basis the daily results from four forward-looking hypothetical macroeconomic events such as an inflation or commodity price shock. These monthly reviews may trigger ad hoc calls for AIM. ASX Clear is intending to make these forward-looking scenarios active through longer-term enhancements to its credit stress test system.

In practice, the largest stress test exposures are commonly generated by market-wide price movements, i.e. the market down or market up scenarios. However, small or medium-sized participants that have less diversified/more concentrated positions often record their largest stress test results against single-stock stress test scenarios.

Active stress test scenarios at ASX Clear (Futures)

ASX Clear (Futures) implemented new stress scenarios in November that reflect changes to its stress testing approach earlier in the assessment period. ASX Clear (Futures)' new stress test approach comprises a suite of historical, theoretical and hypothetical (forward-looking) scenarios that apply to exchange-traded derivatives and OTC products.

Historical scenarios are based on the largest observed price movements over the SPOR, using the entire price history available for the product. Observed periods of stress are excluded by ASX Clear (Futures) only if their reoccurrence is considered implausible based on the contemporary structure and functioning of the market, or if they have been superseded by more recent market events.

Theoretical scenarios are based on statistical inference from 20 years of historical price and volatility data, to capture extreme but plausible (1-in-20-year) events that have not been observed. This statistical analysis takes into account correlations between contracts and uses a Student's t-distribution to allow for more extreme events than a normal distribution. These include a range of scenarios that model a range of shifts, tilts, twists and bends of the yield curve, as represented by different yield shocks across the 30 day, 90-day, 3-year, 10-year and 20-year interest rate futures contracts as well as scenarios that apply model shocks to equities and state-specific electricity markets.

Hypothetical scenarios are forward-looking scenarios largely based on expert judgement that reflect scenarios that are could result in extreme market stress but are not based on historical precedent. The hypothetical scenarios used by ASX Clear (Futures) represent macroeconomic or market-wide events such as a commodity price collapse, domestic housing collapse or a sovereign default.

In total, ASX Clear (Futures) uses 174 stress scenarios for participants that clear exchange-traded derivatives. These scenarios involve movements of price and volatility across the SPI 200 equity index futures, and the five AUD interest rate futures contracts (20-year bond, 10-year bond, 3-year bond, 90-day bank accepted bill and 30-day interbank cash); these movements are combined with price and volatility stresses to base quarter, base strip quarter and peak quarter electricity contracts for New South Wales, Queensland, South Australia and Victoria. This approach is considered conservative given the lack of observed correlation in movements between these products historically. Together, equity, interest-rate and electricity contracts cover greater than 98 per cent of ASX Clear (Futures)' potential future risk exposure (measured by initial margin requirements).

All scenarios for exchange-traded derivatives apply relative (i.e. percentage) price shocks.

For participants that clear OTC derivatives, ASX Clear (Futures) applies 146 historical, theoretical and hypothetical scenarios. These scenarios capture movements in AUD and NZD swap rates (BBSW, AONIA, BKBM and NZONIA), and apply simultaneous shocks to the five AUD interest rate futures contracts in the case of futures that are allocated for OTC portfolio margining. Scenarios also include shocks to the correlation between AUD and NZD rates. The BBSW, BKBM, AONIA and NZONIA curves are split into segments based on differences in participation and activity in the underlying market. Currently, the price shocks are calibrated using 20 years of data history for the Australian IRD market, and take into account the assumed five-day holding period for OTC derivatives transactions. Similar to the scenarios applied to exchange-traded derivatives, OTC scenarios are sized to be equivalent to once-in-20-year events and apply relative shocks to yields.

For-information scenarios at both CCPs

ASX also has a number of ‘for-information’ stress test scenarios (5 in ASX Clear and 24 in ASX Clear (Futures)). These are scenarios that are considered by ASX to go beyond the level of ‘extreme but plausible’; accordingly, the results from these scenarios are not reported and AIM is not called based on the results of these scenarios.

The CCPs' for-information scenarios include hypothetical event-based scenarios representing macroeconomic or market-wide events – such as a cyber attack on the ASX exchange – and other scenarios based in full or in part on historical market movements. This includes events that have been excluded from historical scenarios because their reoccurrence is considered implausible.

In addition to the scenarios discussed above, ASX Clear (Futures) also runs for-information scenarios that model shocks affecting a single tenor, the effect of assuming an increased holding period and the impact of an absolute interest rate shock.

Reverse stress testing at both CCPs

The ASX CCPs both perform monthly reverse stress testing. This involves scaling up a selection of existing stress test scenarios that typically result in the largest stress test losses for each CCP; the aim is to determine the magnitude of shock that would be required to exhaust prefunded financial resources. ASX also considers the impact of the simultaneous default of its largest three and four participants (and affiliates).

4.7 A central counterparty should have clearly documented and effective rules and procedures to report stress-test information to appropriate decision-makers and ensure that additional financial resources are obtained on a timely basis in the event that projected stress-test losses exceed available financial resources. Where projected stress-test losses of a single or only a few participants exceed available financial resources, it may be appropriate to increase non-pooled financial resources; otherwise, where projected stress-test losses are frequent and consistently widely dispersed across participants, clear processes should be in place to augment pooled financial resources.

Credit stress test exposures are routinely reported to ASX management, the Clearing Boards and the Bank. Participant stress test losses are used to gauge the adequacy of ASX Clear's and ASX Clear (Futures)' prefunded financial resources, with widespread and/or large STEL breaches and Cover 2 capital breaches an indicator that resources may need to be increased. In addition to being reported to ASX management, all Cover 2 capital breaches are escalated in the first instance to the CRO and the Risk Committee, and are further reported to the CEO and CS Boards. The CS Boards, in consultation with the ASX Limited Board, are responsible for approving any increase to the default fund where this is considered necessary (see below). Approval by the ASX Limited Board is also required where any changes impact ASX Limited's contributions to the default fund or default liquidity resources.

Each participant in ASX Clear or ASX Clear (Futures) is allocated a STEL based on its ICR. Each CCP has determined a buffer that it uses to set the maximum STEL for any participant. The maximum STEL is set at half of the total default fund of the relevant CCP less the buffer. This reflects the fact that the ASX CCPs hold prefunded financial resources to cover two participant defaults (and the default of their affiliates), while allowing AIMs calls to be triggered before Cover 2 stressed losses exceed the level of these resources. This reduces the potential for prefunded financial resources to be breached as a result of a rapid increase in exposures (see below). At ASX Clear, where a group of participants are affiliated (i.e. part of the same corporate group), and the sum of affiliated participants' STELs that would apply if based solely on ICRs exceeds the maximum STEL, an adjustment is applied to the STELs of the affiliated participants. The adjustment ensures that ASX Clear's combined exposure to affiliated participants cannot increase above the assigned group-wide STEL without triggering an AIM call (see below). Since there are only a limited number of affiliated participant groups with combined ICR-based STELs that would exceed ASX Clear's default fund, ASX Clear allows input from these groups as to how the required reduction in STELs is distributed across the group. Currently, no ASX Clear (Futures) participants are affiliates.

Where a participant's projected stress test losses exceed its STEL, ASX will call for STEL AIM. At both CCPs, STEL AIM is calculated overnight. At ASX Clear, AIM calls are typically made by 8.15 am and must be met within two hours. At ASX Clear (Futures), AIM calls are notified to participants between 5.00 am and 8.00 am, and must be met by 11.00 am. Participants may meet AIM calls using AUD cash at both CCPs or also with certain highly rated securities at ASX Clear (Futures) (see CCP Standard 5.1).

The CS Boards review the characteristics and continued adequacy of the ASX CCPs' prefunded pooled resources on at least an annual basis. Material changes to these resources must be approved by the CS Boards. In deciding whether ASX Clear and ASX Clear (Futures) have sufficient prefunded pooled financial resources, ASX considers the size, frequency, duration and distribution of AIM calls across participants. ASX Clear and ASX Clear (Futures) would consider increasing these resources if stress test results in excess of prefunded pooled resources were persistent, significant and widespread. In other cases, the CCPs would generally rely on additional collateral collected under the AIM regime.

4.8 A central counterparty should establish explicit rules and procedures that address fully any credit losses it may face as a result of any individual or combined default among its participants with respect to any of their obligations to the central counterparty. These rules and procedures should address how potentially uncovered credit losses would be allocated, including the repayment of any funds a central counterparty may borrow from liquidity providers. These rules and procedures should also indicate the central counterparty's process to replenish any financial resources that the central counterparty may employ during a stress event, so that the central counterparty can continue to operate in a safe and sound manner.

ASX Clear and ASX Clear (Futures) have loss allocation arrangements to fully address any uncovered credit losses that they may face (see CCP Standard 3.5). Further, ASX Clear (Futures) has the power to reduce (i.e. haircut) outgoing payments to participants. The ASX CCPs' also have put in place arrangements to allow for replenishment of their default funds following a draw-down of the funds in the event of a participant default.

Allocation of credit losses

Uncovered credit losses would initially be addressed via Recovery Assessments called from surviving participants.

• At ASX Clear, this would be capped at $300 million across all participants and distributed in proportion to each participant's average daily initial margin in the quarter prior to the default triggering the loss. A variable cap on individual participant assessments is set based on the participant's average daily initial margin for the quarter prior to the default (see CCP Standard 3.2).
• At ASX Clear (Futures), Recovery Assessments would be capped at the level of participants' default fund contributions, if assessments were called in relation to a single default (a maximum of $200 million in aggregate); or at three times the level of participants' default fund contributions (a maximum of $600 million in aggregate), if assessments were called in relation to multiple participants defaulting within a defined default period.^[17]

If there was a reasonable expectation that Recovery Assessments could be insufficient to address an uncovered loss, ASX Clear (Futures) would have the power to reduce (haircut) outgoing payments to participants in order to allocate losses suffered on the defaulting participant's portfolio. For example, a haircut could be applied to variation margin payments due to participants with net in-the-money positions in the event of mark-to-market loss on the defaulter's portfolio. Payment haircuts could be applied to a broad range of ASX Clear (Futures)' payment obligations, excluding the return of initial margin. There is no cap on the use of payment haircutting to allocate uncovered losses, although ASX Clear (Futures) would consult with the RCC in determining whether to continue payment haircutting if losses allocated via this tool exceed $650 million or where haircutting continued for a period of more than seven business days.

Any residual losses that could not be addressed via Recovery Assessments or payment haircutting could be allocated to participants via a power available to both CCPs to completely terminate all open contracts. Complete termination would be reserved as a last resort tool if there were no other means of addressing an uncovered loss. Under complete termination, all open contracts at the CCPs would be settled with participants at their current market value, with any residual losses of the CCPs allocated by haircutting settlement payments to participants. Recovery Assessments at ASX Clear are set at a level that seeks to minimise the potential for reliance on complete termination as a loss allocation tool. Reliance on complete termination is also considered extremely unlikely at ASX Clear (Futures), since payment haircutting provides an uncapped mechanism to allocate losses associated with market risk on the defaulter's portfolio. ASX Clear also has a limited capacity to haircut payments, but this only applies to settlement payments in the context of complete termination (see below).

Replenishment

ASX has established a staged process for replenishment of the CCP default funds in the event that these were exhausted or partially drawn down following a participant default. At the end of a 22 business-day ‘cooling-off period’, the ASX Clear and ASX Clear (Futures) default funds would be fully replenished to up to $150 million and $400 million, respectively.^[18]

The enhanced arrangements comprise three key stages: Initial Interim Replenishment, Further Interim Replenishment, and Final Replenishment.

• Initial Interim Replenishment. As soon as practicable following the conclusion of the default management process, ASX would contribute an Initial Interim Replenishment amount to restore the default fund up to at least the Minimum Fund Size. In order to reach full financial cover during the cooling-off period, ASX would expect to supplement this contribution with AIM called from participants. The Minimum Fund Sizes for ASX Clear and ASX Clear (Futures) are set at $37.5 million and $100 million, respectively. In determining these amounts, ASX sought to balance the liquidity impact of relying on non-pooled resources (i.e. AIM) with the risk of the interim contribution being used to absorb further losses from a subsequent default. ASX expects to review these amounts during the next assessment period.

• Further Interim Replenishment. At any time during the cooling-off period, ASX would have the discretion to call for a Further Interim Replenishment amount from clearing participants. This amount would be capped at the level of the Minimum Fund Size for each CCP. Individual clearing participant contributions would be determined in proportion to the risk associated with positions held by the participant prior to the default, and capped at the level of the participant's maximum Recovery Assessment. Participants would not be required to contribute to Further Interim Replenishment if they satisfied all conditions for resignation prior to the call being made. Participants would be given at least five business days' notice of their obligations so as to provide sufficient time for approval processes to be completed and funding to be arranged.^[19] ASX would consult with the relevant RCC in determining whether to call for Further Interim Replenishment (including the amount and timing of the call).

  Irrespective of the number of defaults within a cooling-off period, the maximum required amount of interim replenishment would be capped at $75 million for ASX Clear and $200 million for ASX Clear (Futures), split 50/50 between ASX and its clearing participants. ASX also reserves the right to make additional contributions to the default fund beyond this amount, if it determined this to be appropriate. In the event of a subsequent default during the cooling-off period, ASX's interim contribution and any funds remaining from the existing waterfall would be used prior to participants' interim contributions.

• Final Replenishment. At the end of the cooling-off period, the CCP default funds would be fully replenished to up to $150 million for ASX Clear and $400 million for ASX Clear (Futures), with contributions split 50/50 between the CCP and its participants. ASX would retain the capacity to call additional clearing participant and ASX contributions to restore the default funds to pre-recovery levels as part of a recalibration at the end of the quarter, should stress tests reveal that post-recovery exposures were not being adequately covered.

Footnotes

For more information, see ‘Supplementary interpretation of CCP Standards’ in Appendix C. [15]

The RBNZ has also stated that ASX Clear (Futures) may be of systemic importance in New Zealand and may therefore be designated for oversight as an offshore FMI under the RBNZ's proposed new oversight regime for FMIs. For more information, see ‘An Enhanced Oversight Framework for Financial Market Infrastructures’, available at <http://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervision/financial-market-infrastructure-oversight/regulatory%20developments/FMIs-Cabinet-paper.pdf?la=en>. [16]

The cap on assessments for multiple defaults remains in place until the expiry of a ‘default period’ that commences with the default of the first participant and concludes 22 business days after completion of the default management process for the final defaulting participant, where each default is separated from completion of the default management process for the preceding one by 22 business days or less. [17]

The cooling-off period concludes 22 business days after the conclusion of the final default management process initiated during the period. The default funds may be replenished to a level below the pre-default size, subject to the CCP still meeting the cover 2 requirement (see CCP Standard 4.4). [18]

If a subsequent default during the cooling-off period depleted the default fund below the Minimum Fund Size, participants could be required to make the contribution as soon as reasonably practicable following completion of that default management process, and potentially as soon as the next day. [19]