Assessment of ASX Clearing and Settlement Facilities – September 2019 Appendix C2. Financial Stability Standards for Securities Settlement Facilities

Standard 12: General business risk

A securities settlement facility should identify, monitor and manage its general business risk and hold, or demonstrate that it has legally certain access to, sufficient liquid net assets funded by equity to cover potential general business losses so that it can continue operations and services as a going concern if those losses materialise. Further, liquid net assets should at all times be sufficient to ensure a recovery or orderly wind-down of critical operations and services.

12.1 A securities settlement facility should have robust management and control systems to identify, monitor and manage general business risks, including losses from poor execution of business strategy, negative cash flows or unexpected and excessively large operating expenses.

ASX's approach to business risk is consistent with its overall Enterprise Risk Management Policy and Framework (see SSF Standard 3). Under the framework, formal policies are in place for individual risk categories such as accounting, authorisations, business continuity, technology, fraud control and procurement.

ASX monitors a variety of financial business risks, including market risk, credit risk, liquidity risk and capital risk.

• Group funds may be exposed to market risk due to changes in market variables such as interest rates and foreign exchange rates. Mitigants for market risk include hedging of foreign exchange and limits with respect to weighted average maturity of investments, with appropriate capital allocation.
• Credit risk for the group's general business activities arises in the collection of receivables, which principally comprise fees from market participants, issuers, users of market data and other customers. Mitigants include active collection procedures on trade receivables and review of the ‘ageing’ of receivable amounts, as well as ceasing to provide services where receivables remain unpaid. The ASX SSFs novate the income from receivables to a related entity that bears the responsibility for collecting receivables.
• Liquidity risk arises from the group's time-critical payables. This is mitigated by ASX's liquidity management arrangements, including forward planning and forecasting of liquidity requirements and holding sufficient liquid net assets to meet payable obligations.
• ASX may be exposed to capital risk if equity in its group entities falls below prudent or regulatory minimum levels. ASX manages its capital at a group level, with an objective of maintaining a prudent level of surplus net tangible equity above its capital allocation. Ongoing monitoring of cash flows and capital adequacy is conducted via quarterly meetings of the Risk Committee.

ASX undertakes periodic strategic risk assessments in the context of its overall business plans. Through this process, ASX identifies new strategic business initiatives. These are subject to financial analysis, including a sensitivity analysis of cash flows. Impacts on capital are also determined and analysed.

ASX conducts risk assessments when undertaking any expansion of its activities or in the event of material changes to its business. Risk assessments are built into ASX's project management framework (see SSF Standard 14.2). Under this framework an initial high-level complexity indication is defined at the project concept stage. This is followed by a formal project risk assessment covering both project delivery risks and impacts to business activities. ASX typically conducts a series of workshops involving a range of stakeholders to discuss risks associated with any planned new service. Prior to the approval of a project for launch/production, ASX prepares an operational readiness summary and conducts a final workshop to discuss possible risks associated with initial launch. This includes consideration of potential failure scenarios and workarounds, procedures for escalation of issues, customer readiness and help desk and key staff availability.

Following launch, the risks of a new activity are captured in risk profiles that are prepared by relevant management every six months. The Risk Committee also monitors actual and forecast capital and liquidity requirements on a quarterly basis, including requirements related to new projects.

During the assessment period, ASX established KRIs for each of the risk categories set out in its revised Risk Appetite Statement, including for financial and strategic risks (see SSF Standard 2.6). These indicators are reported to the ASX's Audit and Risk Committee on a quarterly basis.

12.2 A securities settlement facility should hold, or demonstrate that it has legally certain access to, liquid net assets funded by equity (such as common stock, disclosed reserves or other retained earnings) so that it can continue operations and services as a going concern if it incurs general business losses. The amount of liquid net assets funded by equity a securities settlement facility should hold, or have access to, should be determined by its general business risk profile and the length of time required to achieve a recovery or orderly wind-down, as appropriate, of its critical operations and services if such action is taken.

ASX has set aside $188 million (as at 30 June 2019) for operational and business risks across both Austraclear and ASX Settlement. Since ASX has identified constraints to making business risk capital bankruptcy remote within the SSFs, this capital is held at the ASX Group level. Each CS facility has a separate allocation for business risk capital that is explicitly recognised within group-wide capital holdings. These holdings include an additional buffer against potential losses sustained elsewhere in the group. The ASX Group Support Agreement places an obligation on ASX to maintain sufficient capital to support the ASX SSFs' continued operations in the event of general business losses, supporting the legal certainty of the ASX SSFs' access to business risk capital as required. However, the agreement does not guarantee SSF access to business risk capital if the ASX Group entity holding the capital is nearing insolvency or external administration, and in certain non-insolvency circumstances the agreement provides ASX Limited with the right to terminate the agreement without transferring this capital to the SSF. ASX plans to address these gaps later in 2019

The calibration of the $188 million in operational and business risk capital set aside for ASX Settlement and Austraclear involves the following:

• Risk calculations at the level of the individual SSF. ASX first calculates risk amounts for the individual SSFs. This is based on a methodology that applies a capital charge for operational and business risk to the value of securities held in the facility. The correlation between asset values and associated risks is modelled on a percentage basis, with the percentage of required business risk capital resources declining as the level of assets increases – recognising that a significant part of the business risk capital resources required represent a fixed cost. ASX's application of this methodology results in a charge of 0.66 basis points on $2 trillion of securities held in ASX Settlement and a charge of 0.69 basis points on just under $2 trillion securities held in Austraclear, giving a required value of risk resources of around $132.6 million and $128.8 million for ASX Settlement and Austraclear, respectively. ASX reviews the methodology periodically and compares it to similar methodologies applied by other SSFs, fund managers and custodians. Any proposed amendments are approved by the Settlement Boards.
• Assumptions regarding correlated risks. ASX assumes that the two facilities will not both require their full risk funds at the same time. This reflects that the custodial and operational risks that this capital is calibrated to cover are unlikely to result in simultaneous peak losses in both SSFs. ASX has applied a ‘square root of the sum of squares’ formula to arrive at the figure of $188 million to cover the operational and business risk exposure of the two settlement facilities. The business risk capital held across the two SSFs is calibrated to be sufficient to ensure that, even if one SSF were to utilise the full value of its required risk resources, sufficient funds would be available to fund the other SSF's recovery plan and meet the single largest uninsured business loss event for that facility. In addition, ASX's general capital buffer is calibrated to be sufficient to ensure that it would remain able to provide to the second SSF the full value of its required risk resources in the event that this was required.

ASX Settlement and Austraclear also undertake periodic loss scenario analysis in order to validate whether the business risk capital is sufficient to meet the potential single largest uninsured business loss event for the SSFs. ASX has in place a number of insurance policies to reduce its exposure to a broad range of risks, including professional indemnity, fraud, and operational risks such as computer manipulation and equipment failure. However, this insurance provides limited direct cover for the SSFs due to the nature of ASX's intragroup arrangements and the type of losses that the SSFs could be directly exposed to. The other factors driving ASX's business risk capital calculation limit the extent to which the level of ASX's insurance cover could reduce the level of capital that it holds.

12.3 A securities settlement facility should maintain a viable recovery or orderly wind-down plan and should hold, or have legally certain access to, sufficient liquid net assets funded by equity to implement this plan. At a minimum, a securities settlement facility should hold, or have legally certain access to, liquid net assets funded by equity equal to at least six months of current operating expenses. These assets are in addition to resources held to cover participant defaults or other risks covered under SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk. However, equity held under international risk-based capital standards can be included where relevant and appropriate to avoid duplicate capital requirements.

ASX Settlement's and Austraclear's recovery planning arrangements have been developed with reference to the CPMI-IOSCO guidance on recovery planning (see SSF Standard 3.5). In calculating the quantum of business risk capital described under SSF Standard 12.2, ASX has sought to ensure access to sufficient liquid net assets to fund operations during the execution of the ASX SSFs' recovery plan or to cover a minimum of six months of current operating expenses.

The ASX SSFs' enhanced recovery approach establishes arrangements such that losses arising from a range of general business risks would be absorbed by ASX through application of general business risk capital held for the SSFs at the ASX Group level (see SSF Standard 12.2). This recovery approach takes into account that ASX has in place a number of insurance policies to reduce its exposure to a broad range of risks, including professional indemnity, fraud, and operational risks such as computer manipulation and equipment failure.

Austraclear would apply a similar approach to address losses on its treasury investment portfolio since the amount invested is not material.

ASX Limited has also committed to maintaining adequate levels of business risk capital for the CCPs and SSFs, recapitalising these funds as required (SSF Standard 12.5).

12.4 Assets held to cover general business risk should be of high quality and sufficiently liquid in order to allow the securities settlement facility to meet its current and projected operating expenses under a range of scenarios, including in adverse market conditions.

During the assessment period, the risk capital for ASX's CS facilities was predominantly invested in accordance with the ASX Limited and ASX Operations Pty Limited Investment Mandate. The Investment Mandate specifies investment objectives, responsibilities, approved products and counterparties, and audit and maintenance of the mandate. Approved products are generally highly rated and liquid products such as: cash deposits; bank bills, negotiable certificates of deposit and floating rate notes issued by APRA-approved ADIs; foreign exchange in specified currencies; Australian Government securities; and selected semi-government securities. Limits are applied against counterparty, liquidity and market risks. Liquidity limits are specified for maximum instrument maturity and weighted average maturity. Earlier in the assessment period a portion of the SSFs' operational and business risk capital was held in the form of ASX's investment in ASX200 companies; as of 30 June the entirety of this capital was required to be invested as per the ASX Limited and ASX Operations Pty Limited Investment Mandate.

12.5 A securities settlement facility should maintain a viable plan for raising additional equity should its equity fall close to or below the amount needed. This plan should be approved by the board of directors and updated regularly.

As noted, ASX Limited manages its operational and business risk capital at the group level. The ASX Limited Board monitors the ongoing capital adequacy of the ASX Group as part of its regular capital planning activities. The Board determines the most appropriate means of raising additional capital when needed, giving due consideration to prevailing market conditions and available alternative financing mechanisms. This was most recently reviewed and approved by the Board in June 2018.

The ASX SSFs' recovery approach depends on timely and reliable recapitalisation processes to address general business losses. Accordingly, the SSFs have established an intragroup service agreement which commits ASX Limited to maintaining adequate levels of business risk capital for the SSFs, recapitalising these funds as required. ASX Limited maintains a plan that sets out how it would fulfil its obligations to recapitalise ASX Settlement and Austraclear. The elements of this plan include the use of existing group cash reserves and raising additional capital through an equity issuance by ASX Limited.