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

Standard 13: Segregation and portability

A central counterparty should have rules and procedures that enable the segregation of positions of a participant's customers and the collateral provided to the central counterparty with respect to those positions.

13.1 A central counterparty should, at a minimum, have segregation and portability arrangements that effectively protect a participant's customers' positions and related collateral from the default or insolvency of that participant. If the central counterparty additionally offers protection of such customer positions and collateral against the concurrent default of the participant and a fellow customer, the central counterparty should take steps to ensure that such protection is effective.

ASX Clear's account structure

ASX Clear maintains a segregated account structure for its options which separates client positions from the participant's proprietary (house) positions. For these products, clients are able to access individually segregated accounts that offer protection against the concurrent default of the participant and a fellow client (see CCP Standard 13.2).

Although ASX Clear utilises a single (commingled) account for each participant's house and client cash market transactions, its arrangements provide clients with protections that ASX considers are materially equivalent to those afforded by segregated house/client omnibus accounts (see CCP Standard 13.2).

ASX Clear (Futures)' account structure

ASX Clear (Futures) enables participants to offer their clients the choice of holding their positions in either a client omnibus account or an individually segregated account. Within the individually segregated account structure, ASX Clear (Futures) offers two options – ‘initial margin value’ and ‘asset attribution’ – which offer different levels of protection for client collateral in the event of a participant default (see CCP Standard 13.2). Under both options, ASX Clear (Futures) maintains a record of positions and the value of initial margin attributable to each client, with the collateral posted by clients to support these positions held in a single commingled collateral account at the participant level. Under each of the omnibus and individually segregated account structures, the positions and collateral of clients are segregated and identifiable from those of clearing participants; accordingly, clients are not directly exposed to losses related to their participant's proprietary (house) activity in the event of that participant's default.

Legal certainty of segregation and portability arrangements

During the assessment period, ASX assessed the legal certainty of the CCPs' segregation and portability arrangements and the protection provided to these under the PSNA.

13.2 A central counterparty should employ an account structure that enables it readily to identify positions of a participant's customers and to segregate related collateral. A central counterparty should maintain customer positions and collateral in individual customer accounts or in omnibus customer accounts, or equivalent.

ASX Clear

ASX Clear offers individual client segregation for options. For these products, client collateral cannot be used to offset losses arising from a participant's proprietary (house) account. Non-cash collateral (including excess collateral) lodged with ASX Clear in respect of options transactions remains registered in the name of the client. Participants can also offer clients the option for clients' excess cash collateral posted against options positions to be held directly with ASX Clear and attributed to an individual client account. Under these arrangements, ASX Clear would transfer or return to the participant's client trust account any excess cash collateral that had been attributed to an individual client account (net of any close-out costs).

ASX Clear currently does not offer segregation of client margin for cash market transactions in individual customer or omnibus accounts. Instead, it has arrangements that provide clients with materially equivalent – but not identical – protections to those offered under house/client omnibus segregation while utilising a commingled house/client structure.^[31] These arrangements aim to ensure that participants employ best practice in processing client trades during the pre-settlement period, namely: client securities due for delivery that are held in the participant's accumulation account remain the beneficial property of the client until they are placed into the participant's settlement account (see Appendix C.2, SSF Standard 10.2); and client monies to fund a purchase must remain in trust accounts until the purchased stock is registered in the client's name.^[32] The ASX Settlement Operating Rules also require daily reconciliation by participants of unsettled stock held beneficially for the client. ASX's proposed replacement for the CHESS system is expected to have functionality that can be configured to support segregation of a participant's clients' positions and collateral from those of the participant during the pre-settlement period.

The settlement processing is also designed to minimise client principal exposure to the participants acting on their behalf. Under these arrangements, participants are required to fund any movements of beneficially held client stock to the settlement account on the day that the movement occurs by placing the required amount into trust for the client concurrent with the CHESS batch settlement process. Participants are able to pre-schedule movements of beneficially held client stock to their settlement account. These ‘pre-positioning’ transactions settle in the first stage of batch processing, with payment providers being notified of a net amount to be transferred between participants' general accounts and client trust accounts. These arrangements aim to ensure that client assets and funds remain in the beneficial ownership of clients for all but a brief window during the settlement period. These arrangements protect clients from principal losses in the event of a participant default but will not protect clients against the cost of replacing trades in such an event.

ASX Clear (Futures)

ASX Clear (Futures) enables participants to offer clients the choice of holding their positions in either an individually segregated account or a client omnibus account. Clearing participants are not obliged to offer both individually segregated and omnibus client accounts, but must provide their clients with a client fact sheet, developed by ASX, which explains the types of accounts that are available, and the advantages and disadvantages of each option (see CCP Standard 13.4). Initial margin is calculated separately for positions held in each individual or omnibus client account. Portfolio margining of interest rate futures against OTC positions (see CCP Standard 6.5) is only permitted for clients that have individual client accounts for both types of products with the same participant.

Under the initial margin value individually segregated account structure, only positions are segregated at the individual client account level. Operationally, collateral is not segregated: gross collateral requirements are aggregated across all client accounts and managed by the participant within a single commingled client collateral account. In the event of a default, the value of the initial margin applied to the client's position in an individual client account would either be transferred to another participant or returned to the client (net of any close-out costs). Under these arrangements, any excess collateral would be returned to the administrator of the defaulted participant. That is, ASX Clear (Futures) guarantees only the transfer or return of the value of each client's initial margin requirement, not the individual collateral securities or any excess collateral that may have been posted. This approach is similar to the ‘Legally Segregated Operationally Commingled’ segregation model mandated in the US by the CFTC.

Under the asset attribution account structure, cash and securities lodged as margin or excess collateral are attributed to individual client accounts. While all client collateral is operationally managed in a single commingled account under these arrangements, ASX Clear (Futures) would transfer or return the collateral value (including excess collateral) for an individual client account (that is, the greater of the initial margin requirement or the value of attributed assets, net of any close-out costs). Subject to exceptions set out in the rules, ASX Clear (Futures) would transfer or return to the client equivalent (in specie) securities to those that had been attributed. Participants that offer individually segregated accounts are not obliged to offer the asset attribution option.

Under both individually segregated account structures, variation margin payments (and other cash flows) to and from clearing participants are netted. Accordingly, there is a risk that a participant could default before passing on to each client the gross flows underlying the net payment. Despite this, ASX's individually segregated account structures each provide significant protections for client collateral posted to the CCP relative to the omnibus segregation structure.

In establishing this account structure, ASX took into account stakeholders' views via a public consultation, which sought feedback on the level of segregation, basis for margin collection and the appropriate level of client protection benefits. The consultation covered legal, regulatory and operational aspects of the proposed account structure, outlined the implications of different account structures used by ASX Clear (Futures) and identified operational constraints to portability.

13.3 To the extent reasonably practicable under prevailing law, a central counterparty should structure its portability arrangements in a way that makes it highly likely that the positions and collateral of a defaulting participant's customers will be transferred to one or more other participants.

Both ASX Clear and ASX Clear (Futures) have the capacity to transfer (port) participants' clients' positions and collateral under their Operating Rules (see CCP Standard 13.3). Part 5 of the PSNA provides legal protections to facilitate the transfer of a defaulted participant's client positions and collateral (as provided for by its Operating Rules) without the need to seek approval from the participant's external administrator. ASX maintains an internal policy governing the segregation and portability arrangements at ASX Clear and ASX Clear (Futures), which formally aligns with the requirements of this standard.

The likelihood that positions and collateral of a defaulting participant's customers will be transferred to one or more other participants depends, in part, on the account structure (see below). In addition, during the assessment period it was identified that there may be practical impediments to achieving portability due to the requirement under the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 that the applicable customer identification procedure must be carried out prior to a participant receiving a transfer. ASX is seeking relief from AUSTRAC in respect of this requirement.

Individually segregated client accounts – OTC and exchange-traded derivatives

The segregation of accounts for each individual client supports the transfer of client positions and collateral to another participant in the event of a clearing participant default. Under individually segregated structures, margin requirements are calculated on a gross basis (i.e. individually for the positions held by each client). Accordingly, there should be sufficient collateral available to support the transfer of each client's positions to another clearing participant. In ASX Clear, all client derivatives accounts are individually segregated. In ASX Clear (Futures), individually segregated accounts are available for both OTC and exchange-traded derivatives.

Clients may nominate in advance an alternative (backup) clearing participant to which it would seek to port its positions (and any associated collateral value) in the event of default of its clearing participant. Advance nomination of a backup clearing participant is optional and, even if nominated, a backup clearing participant may in the event be unwilling or unable to take on the positions. However, given the short timeframe for decisions in the event of a default, ASX's client fact sheet discloses to clients that they should have a back-up broker in place at all times if they want to increase the likelihood that a successful transfer can be achieved.

Omnibus client accounts – ASX Clear (Futures) OTC derivatives and futures

Participants of ASX Clear (Futures) have the option of operating an omnibus client account structure for OTC derivatives and futures. A fully collateralised transfer of an individual client's positions within an omnibus account is unlikely, since these positions are margined on a net basis. ASX would therefore expect to manage a defaulted participant's client omnibus account as a single client account – that is, no individual client within an omnibus account would be transferred separately from the others. Since porting requires the consent of the receiving participant and each individual client, the simultaneous transfer of all clients within an omnibus account would be challenging.

Comingled house and client accounts – Cash market transactions

The commingled account structure used for cash market transactions creates practical difficulties for portability. The commingled account structure makes it difficult to identify client positions and, even if positions could be identified, since house and client positions are margined on a net basis across the commingled account, there is unlikely to be sufficient collateral at the CCP to achieve the fully collateralised transfer of individual client positions to alternative clearing participants. Accordingly, ASX would expect to manage a defaulted participant's commingled account as a single client account – that is, no individual client would be transferred separately from the others. Since porting requires the consent of the receiving participant and each individual client, the simultaneous transfer of a large number of clients would be challenging. However, even under a segregated account structure the scope for transfer of cash market positions would be limited due to the short (two-day) equity settlement cycle.

13.4 A central counterparty should disclose its rules, policies and procedures relating to the segregation of a participant's customers' positions and related collateral. In particular, the central counterparty should disclose whether customer collateral is segregated on an individual or omnibus basis. In addition, a central counterparty should disclose any constraints, such as legal or operational constraints, that may impair its ability to segregate or port a participant's customers' positions and related collateral.

Current arrangements for segregation and portability are defined in the ASX Clear and ASX Clear (Futures) Operating Rules and Procedures (including ASX Clear (Futures)' OTC Rulebook and Handbook). ASX has also published a public overview of clearing participant default arrangements, which outlines the current operational constraints to portability and the implications of different account structures.^[33]

ASX has published a client fact sheet and a brochure on its client protection model, which outline segregation and portability arrangements in ASX Clear (Futures), the rights of clients in the event of a default, and protection available for excess client collateral. ASX Clear (Futures) participants are required to make the fact sheet available to all of their direct clients. The fact sheet and brochure are also available on ASX's public website.^[34]

Footnotes

In particular, ASX's alternative arrangements do not provide a client with protection against replacement cost risk if its clearing participant defaulted. [31]

Participants maintain ‘accumulation’ and ‘settlement’ accounts to manage the processing of securities for settlement. Client securities due for delivery are typically initially placed in accumulation accounts prior to transfer to the participant's settlement account, at which point the participant takes effective control over the use of securities. Securities are delivered to and from settlement accounts as part of ASX Settlement's batch settlement process. [32]

Available at <http://www.asx.com.au/documents/clearing/131001_Default_Management_-_Public_Information _Document_v2.pdf>. [33]

The client fact sheet is available at <http://www.asx.com.au/documents/clearing/ ASXClientClearingClientFactSheet22January2016.pdf>; the brochure on the client protection model is available at <https://www.asx.com.au/documents/clearing/ASX_CPM_Brochure.pdf>. A related fact sheet describing the legal model used in ASX Clear (Futures)' client clearing arrangements is available at <http://www.asx.com.au/documents/clearing/ClientProtectionModelFactSheet_31August2015.pdf>. [34]