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

Standard 18: Tiered participation arrangements

A central counterparty should identify, monitor and manage the material risks to the central counterparty arising from tiered participation arrangements.

18.1 A central counterparty should ensure that its rules, procedures and agreements allow it to gather basic information about indirect participation in order to identify, monitor and manage any material risks to the central counterparty arising from such tiered participation arrangements.

ASX Clear and ASX Clear (Futures) apply a risk-based approach to the monitoring of tiered participation arrangements. These arrangements are described in further detail below.

ASX Clear

ASX Clear operates an individually segregated account structure for equity derivatives products (see CCP Standard 13.2). While ASX Clear does not have access to data on indirect participants' overall financial position, this account structure means that ASX Clear collects data on their positions in these products, and associated margin requirements and collateral assigned to the account by the participant. During the assessment period, clients of ASX Clear's participants represented 77 per cent of the initial margin held by the CCP to cover its derivatives-related credit exposures to both participants and (indirectly) their clients.

There are, however, practical limitations in the analysis of indirect participation in cash equities clearing. Due to the commingled house/client account structure (see CCP Standard 13.2), ASX Clear is unable to separately identify client positions at either an aggregate or an individual account level. ASX Clear is able to view initial margin and position data of participants, including third-party clearers, which allows it to determine the materiality of third-party clearers' activity in relation to the overall market. In addition, ASX Clear is able to monitor significant changes to indirect participation arrangements in both cash and derivatives markets through its regular discussions with participants, including third-party clearers. Business Development, Participants Compliance, Post Trade Operations and CRPM are each involved in the discussion of changes to participants' exchange-facing business models, including those that relate to tiered participation arrangements.

ASX Clear (Futures)

ASX Clear (Futures) gathers basic information on indirect participation for exchange-traded derivatives in the form of a Daily Beneficial Ownership Report (DBOR) from participants. This report provides details of client positions. These data are aggregated and reviewed using a risk-based approach to identify positions that may be unusual, result in a concentration of risk, or breach position limits set by ASX Clear (Futures) for the expiry period. There are, however, practical limitations to the use of these data for the analysis of tiering; in particular, the account reference of a client or related clients trading through multiple participants may vary from participant to participant. During the assessment period, clients of ASX Clear (Futures)' participants represented 71 per cent of initial margin held by ASX Clear (Futures) to cover its credit exposures to both participants and (indirectly) their clients.

ASX Clear (Futures) offers the option of individually segregated client accounts for both OTC and exchange-traded derivatives (see CCP Standard 13.2). ASX does not currently have a formal framework for directly monitoring indirect participation for OTC derivatives since only one individually segregated client currently uses this service. However, ASX may review indirect participants' positions if it detects large exposures for clearing participants that provide individually segregated client clearing services. If more participants and their clients were to make use of the individually segregated accounts, ASX would be able to gather better information on client positions to support its monitoring of tiered participation risks (see Standard 18.4).

Both CCPs

If required, the ASX CCPs may request more detailed information from participants on any client positions. This information may include further details about the indirect participant's profile or activities, including its intentions regarding future trading activity or proposed action during the expiry period. ASX Clear and ASX Clear (Futures) also have an ongoing program of risk-based thematic participant reviews, covering risk topics of interest or concern. If warranted, these could potentially examine tiering risks if the ASX CCPs were to perceive an increased risk from indirect relationships. ASX Clear currently considers the risks from concentration of indirect participants to be low; ASX Clear (Futures) considers the residual risks from concentration of indirect participants to be very low for OTC products and medium for futures products.

18.2 A central counterparty should identify material dependencies between direct and indirect participants that might affect the central counterparty.

As noted under CCP Standard 18.1, ASX Clear and ASX Clear (Futures) monitor dependencies arising from tiered participation indirectly through a variety of means. These include: discussions with participants on developments in their business and risk management activities; participants' own risk assessments; discussions with new participants as part of the induction process; monitoring of delivery risk (e.g. deliverable futures options expiries at ASX Clear (Futures)) and the CCPs' broader array of risk management data collection (including the DBOR at ASX Clear (Futures)); and monitoring activities (including the weekly risk-based monitoring of client-level data on derivatives-related exposures at ASX Clear). Based on this information, ASX Clear and ASX Clear (Futures) have not identified any material dependencies between direct and indirect participants that are of concern.

As discussed under CCP Standard 18.4, the use of individually segregated accounts allows ASX Clear to monitor the proportion of a participant's derivatives business attributable to a particular client and set triggers for further action based on the proportion of initial margin attributable to that client. This is also the case for individually segregated accounts in ASX Clear (Futures), although use of these accounts is limited.

Another important potential source of tiered participation risks in ASX Clear arises in the context of the third-party clearing market. There are a small number of participants offering third-party clearing services in the derivatives and cash markets. While there is a greater dispersion of third-party clearing activity for derivatives than cash equities, the largest third-party clearer in the cash market represented a relatively small proportion of total positions held at ASX Clear during the assessment period.

18.3 A central counterparty should identify indirect participants responsible for a significant proportion of transactions processed by the central counterparty and indirect participants whose transaction volumes or values are large relative to the capacity of the direct participants through which they access the central counterparty in order to manage the risks arising from these transactions.

The ASX CCPs encourage participants to develop appropriate risk control measures in managing their relationships with indirect participants. ASX does not set thresholds, either formal or informal, at which it would encourage direct participation by an indirect participant. ASX's general approach to managing risks associated with participants' business activities is based on a framework that can flexibly detect and respond to new risks as they arise, rather than setting firm ex ante activity limits (see CCP Standard 18.1). However, ASX does monitor indirect participants to identify when their positions in futures contracts exceed expiry position limits set for certain products traded on ASX 24.

18.4 A central counterparty should regularly review risks arising from tiered participation arrangements and should take mitigating action when appropriate.

ASX maintains a formal Concentration Risk Standard, which sets out a risk-based approach to monitoring concentration risks in a number of areas (see CCP Standard 4.2), including tiered participation.

ASX Clear

On the basis of the relatively low exposures generated by cash market transactions, ASX has concluded that the residual risks to ASX Clear from tiered participation arrangements in the cash market are low. ASX Clear therefore monitors tiering risks for the cash market as part of its ongoing monitoring of participant credit exposures, investigating whether identified issues are due to client positions (see CCP Standard 4.2).

ASX has, however, identified two main sources of tiering risk in the clearing of derivatives products in ASX Clear.

• For low strike price options, the potential for large mark-to-market margin requirements following exercise may be a particular issue where there is a concentration of positions in individual client accounts.
• For ETOs more generally, clients of participants may execute strategies, such as selling deep out-of-the-money put options for premium income, that have the potential to trigger significant margin obligations in the event of large price movements.

ASX Clear therefore monitors indirect participation in the derivatives market on a weekly basis, using concentration indicators based on initial margin. Further investigation is triggered if a client's ETO initial margin is greater than $10 million and accounts for over 25 per cent of its clearing participant's total ETO initial margin, or if the client holds more than 40 per cent of the gross market position in a security (subject to a minimum contract size). The Concentration Risk Standard notes that a number of factors will be considered when determining the appropriate response to any breaches of triggers, including the materiality of the breach and the credit standing and activity profile of the participant involved.

ASX Clear (Futures)

Exposures arising from OTC derivatives clearing, including from client clearing, remain low relative to exchange-traded derivatives exposures. Accordingly, ASX Clear (Futures) has focused on the residual risks from tiered participation arrangements in its exchange-traded derivatives clearing activities.

ASX Clear (Futures) reviews risks arising from tiered participation in exchange-traded derivatives on a periodic basis using the DBOR client-level data. A number of predefined triggers are applied to these data to identify positions that may be unusual, result in a concentration of risk, or breach position limits set by the facility for the expiry period. The triggers are defined at the contract level, taking into account factors such as the nature of the contract, the market liquidity, whether the contract has position limits for expiry, and whether it is deliverable. Monitoring of the DBOR data, including the DBOR triggers, is conducted by ASX Participants Compliance.

If client use of individually segregated client accounts reaches a material level (see CCP Standard 13), ASX Clear (Futures) would consider whether enhancements to its monitoring of indirect participation in the exchange-traded and OTC derivatives market are required. The Concentration Risk Standard notes that a number of factors will be considered when determining the appropriate response to any breaches of triggers, including the materiality of the breach and the credit standing and activity profile of the relevant participant. Clients that continue to clear via an omnibus client account will continue to be monitored using the DBOR data.

ASX does not have a formal process to monitor tiered participation risks for OTC derivatives in view of the small number of indirect participants to date.