2. CLAUSE 2 - NON-MARGINED FINANCIAL INSTRUMENTS METHOD · 2015-11-02 · Capital Liquidity Section 3 Handbook Risk Based Capital Requirements Guidance Annexure 1 (CRR) - Clause 2

Capital Liquidity Section 3 Handbook Risk Based Capital Requirements Guidance

Annexure 1 (CRR) - Clause 2 - Non-Margined Financial Instruments Method

Annexure 1 December 2014March 2016 Page 540

2. CLAUSE 2 - NON-MARGINED FINANCIAL INSTRUMENTS METHOD

(a) RULE

2 NON-MARGINED FINANCIAL INSTRUMENTS METHOD

(a) For unsettled trades in Financial Instruments which are not margined and not covered by one of the other methods in this Annexure, and for unsettled trades in margined Equities, Debt Instruments and warrants, the counterparty risk amount is 3% of the Client Balance, where this balance does not include trades which remain unsettled with the Counterparty for greater than 10 Business Days following the transaction date.

A Participant may reduce the Client Balance by the amount of Financial Instruments held by the Participant on behalf of the Counterparty if they specifically relate to the sale trades pending settlement with the market or by the amount of collateral held by the Participant on behalf of the specific Counterparty if the collateral is Liquid, valued at the mark to market value and the collateral arrangement is evidenced in writing between the Participant and the Counterparty.

(b) For unsettled trades in Financial Instruments which are not margined and not covered by one of the other methods in this Annexure, and for unsettled trades in margined Equities, Debt Instruments and warrants, the counterparty risk amount for trades remaining unsettled for greater than 10 Business Days following the transaction date is at the choice of the Participant:

(i) either:

A. 3% of the contract value; or

B. the excess of:

I. the contract value over the market value of each Financial Instrument in the case of a client purchase; and

II. the market value of each Financial Instrument over the contract value in the case of a client sale,

whichever is the greater; or

(ii) 100% of the contract value for a client purchase or 100% of the market value for a client sale.

A Participant may reduce the contract values and the excesses by the amount of collateral held by the Participant on behalf of the Counterparty if the collateral is Liquid, valued at the mark to market value or another value approved by ASX Clear and the collateral arrangement is evidenced in writing between the Participant and Counterparty.

(c) A Participant need not include credit amounts included in a Client Balance where such amounts represent an amount of cash held in the Participant’s trust and/or segregated account.

(d) This method does not apply to OTC Derivatives but does apply to warrants which also may be covered by the method in clause 6.




(b) FORMULA

( ) { }( )[ ][ ]ccy

n

ccy c

m

cnmfi CRWMTMCVCBcra ∑

∑ ×+×+×=

= =1 1,03.0max03.0

or, at the option of the Participant,

( )[ ][ ]ccy

n

ccy

m

c csp CRWMVCVCBnmficra ∑

∑ ×++×=

= =1 103.0

Where:

cranmfi = counterparty risk amount under the non margined financial instruments method

c = client or counterparty

m = number of clients/counterparties

n = number of currencies

ccy = currency

CB = client balance (T0 to T+10)

CV = contract value (transactions remaining unsettled for more than 10 Business Days following transaction date)

CVp = contract value of client purchase transactions remaining unsettled for more than 10 Business Days following transaction date

MVs = market value of client sale transactions remaining unsettled for more than 10 Business Days following transaction date

MTM = mark to market value

CRW = counterparty risk weighting

(c) GUIDANCE

(i) General

The general principle associated with this method is that a counterparty risk amount must be calculated for those non-margined securities transactions in which a Participant acts as agent for a client or, in certain circumstances, as principal for itself and where a client balance arises as a result of this. A client balance is the net of all outstanding non-margined (and certain margined) securities trades, up to the close of business on T+10 irrespective of whether or not the counterparty is issuer or participant sponsored.




Securities transactions can include both equity and debt instruments.

The following diagram illustrates a typical on market agency arrangement whereby amounts may be owed to a Participant from “normal agency clients” and other participants in the relevant market that have traded as principal through the Participant as “clients”.

The dark lines represent payments/deliveries where a counterparty risk amount is required while dotted lines represent payments/deliveries where a counterparty risk amount is not required.

Client Participant (TP & CP)

Exchange/ Clearing House

(ii) Amounts to be Considered

For the purposes of calculating a counterparty risk amount under this method, the following, at a minimum, should be considered:

1. agency or principal4 transactions in non-margined financial instruments (ie, equity securities, debt securities, warrants, ETF units, listed company options, etc) and margined equity, debt instruments or warrants, including brokerage;

2. agency transactions in unlisted securities or through foreign brokers;

3. trades sitting in client suspense accounts;

4. amounts owing as a result of day trading losses, failed transactions fees, interest charged on failed trades;

5. application monies owing, allocation interest units and instalment receipts;

6. other participants of ASX and/or ASX Clear;

7. deferred settlement market and forward transactions;

8. short selling on behalf of clients and margin lending activities; and

9. fund managers.

These are discussed further below.

4 In certain circumstances, principal transactions require a counterparty risk amount to be calculated. See the “Third Party Clearing and Referral Arrangements” section in the guidance for Annexure 1, clause 1.




(A) Agency or Principal Transactions

The following provides guidance in relation to a number of transactions that are normally associated with client business. The guidance is not restricted to transactions executed on the ASX market and, as an example, there is no difference between the treatment for trades executed on the ASX market and trades executed on the Chi-X Australia market.

The focus of the guidance is on the counterparty risk amounts that apply, although any requirement to calculate a position risk amount is also highlighted. Guidance on the position risk requirements for these transactions is provided in the guidance for Annexure 3.

(1) Purchase or Sale as Agent

Where a Participant has entered into a purchase or sale transaction as agent for a client, the Participant will be required to calculate a counterparty risk amount on its exposure to that client from the time that the trade is executed.

(2) Purchase or Sale as Principal by a Trading Only or Referral Participant

Where a Participant has entered into a purchase or sale transaction as principal, no counterparty risk amount is required if the Participant clears its own trades (see the section “Other Participants of ASX and/or ASX Clear” below for an explanation of the reason for this). If this is not the case, the Participant trading as principal will have to calculate a counterparty risk amount on its exposure to its clearing participant.

(3) Purchase or Sale Effected as a Special Crossing5

A purchase or sale may be undertaken either as agent or as principal and the following guidance applies to Clearing Participants only.

1. Where the transaction is done on an agency basis, the Participant will have two clients (the buyer and the seller) and will have to calculate counterparty risk amounts on both clients from the time that the trade is executed.

5 A crossing is a transaction where the Participant acts:

(a) on behalf of both buying and selling clients to that transaction; or (b) on behalf of a buying or selling client on one side of that transaction and as principal on

the other side. All crossings (including special crossings) done on an agency basis will incur counterparty exposure to both the buying client and the selling client (where one side of the crossing is done on a principal basis, there will be exposure to only one counterparty). Crossings are not novated to ASX Clear and hence ASX Clear is never a counterparty to such transactions. Crossings fall into the category of transactions that are accepted by ASX Clear for reporting but not registration.




2. Where one side of the transaction is done as principal, the Participant will have one client only. If the client is buying, the Participant will be selling as principal and if the client is selling, the Participant will be buying as principal. The Participant will have to calculate a counterparty risk amount on its exposure to the client from the time that the trade is executed. A position risk amount will also have to be calculated.

Note: If the Participant is a Trading Participant that uses the services of a third party clearer, the principles previously set out in the “Third Party Clearing and Referral Arrangements” section in the guidance for Annexure 1, clause 1 will apply.

(4) Client Facilitation Effected as a Special Crossing6

Client facilitation involves the Participant agreeing to transact as principal with its client and then seeking to close its principal position by transacting with other clients. The following guidance applies to Clearing Participants only.

Where the client is selling stock, the Participant will be buying the stock as principal. The Participant will be required to calculate a counterparty risk amount on its exposure to that client (seller) from the time that the trade is executed. A position risk amount will also apply from this time.

If the Participant seeks to close the principal position by selling the stock to other clients, the Participant may have any number of counterparties (ie, it may sell the stock to one client or multiple clients). The Participant will have to calculate counterparty risk amounts on its exposures to all buying clients from the time that these trades are executed. A position risk amount will cease to be required from the time that the position is closed out.


(5) Underwritten Placement of Existing Shares Via a Book Build

An underwritten placement of existing shares differs from client facilitation because the Participant is not obliged to buy the stock from the selling clients as principal but rather is obliged to pick up any shortfall that it has not been able to sell to other clients. The following guidance applies to Clearing Participants only.

When the underwritten placement of existing shares via a book build agreement is signed, the Participant will incur a counterparty risk requirement to the seller of the stock. As the final sale price of the stock is not known at this time, the Participant should initially use the guaranteed minimum price specified in the agreement to

6 Refer to the previous footnote for information on crossings.




calculate the counterparty risk amount. This price will have to be revised when the final price is known.

Subsequent to the signing of the agreement, the Participant will incur further counterparty risk exposures as it “sells” the stock to its other clients (ie, the buying clients). In practical terms, however, where a book build is used to determine the final price of the stock, it will not be possible to calculate a counterparty risk amount for individual buying clients as neither the final price nor the number of units that they will be allocated will be known until the finalisation of the book build. Accordingly, the counterparty risk amount for the individual buying clients should be calculated when these two details are finalised. The Participant should, however, know approximately the total of the counterparty risk amounts for the buying clients prior to this time and have adequate capital allocated to cover it when required.

When the deadline for the placement is reached, whatever stock has not been sold to buying clients must be treated as a principal position by the Participant and a position risk amount will need to be calculated from this time. At or before this time the final price will be known and this is the price that should be used to calculate both the revised counterparty risk amount for the selling client and the final position risk amount.


(6) Underwriting of Initial Public Offering (IPO)

Where a Participant acts as underwriter of an IPO, the Participant is not required to calculate a counterparty risk amount on the issuer.

As applications are received from buying clients, the Participant will incur counterparty exposure to the buying clients. The Participant will be required to calculate counterparty risk amounts on its exposure to each buying client from the time that the Participant pays the issuer until such time as the buying client has paid the Participant. For the purposes of the counterparty risk calculation, the market value of the securities prior to their listing and trading is the “cost” or “subscription” price.

When the closing date for applications is reached, any shortfall in applications must be treated as a principal position by the Participant and a position risk amount will need to be calculated from this time.

An underwriting risk requirement has not yet been implemented (refer to the guidance for Annexure 4).




(7) Underwritten Placement of New Shares

The placement of new shares differs from an IPO in that an IPO is the first sale of securities when a company lists on the sharemarket whereas the placement of new shares is the issue of new securities by a company that is already listed and has previously issued other securities.

The treatment of an underwritten placement of new shares is identical to that for an underwriting of an IPO.

(B) Agency Transactions in Unlisted Securities or Through Foreign Brokers

Where a Participant executes an agency transaction in unlisted securities or through foreign brokers, the Participant will have two counterparties and hence two client balances.

(C) Trades Sitting in Client Suspense Accounts

For these types of trades, each individual transaction should be treated as a client balance until the trade is actually booked to a client.

(D) Day Trading Losses, Failed Transactions Fees, Interest Charged on Failed Trades

These amounts may be included in the client balance. If the amount remains unsettled after 10 Business Days the counterparty risk amount will be 100% of the amount owing.

(E) Application Monies Owing, Allocation Interest Units and Instalment Receipts

If a Participant has applied and paid for stock, allocation interest units or instalment receipts on behalf of clients, the Participant will be required to calculate a counterparty risk amount for clients that are yet to pay. This applies from the time that the Participant outlays the funds to the issuer or issuer’s agent.

If any part of the amount paid by the Participant is for stock or units for which clients have not yet been found, this is to be treated as an “other current asset” (as long as the time until the stock commences trading is less than 30 days) and is not subject to any risk requirement until the public offer closes. If the time until the stock commences trading is greater than 30 days, the amount paid must be treated as an excluded asset on the basis that it does not meet the definition of liquid.




If the stock, allocation interest units or instalment receipts are registered in the Participant’s nominee account (and hence remain under the Participant’s control), the amount owing from the client is to be treated under the non-margined financial instruments method. For the purposes of the counterparty risk calculation, the market value of these instruments prior to their listing and trading is the “cost” or “subscription” price.

If, however, the stock, allocation interest units or instalment receipts are registered into the client’s issuer or participant sponsored account prior to the client paying, this would be considered a free delivery and hence a counterparty risk amount would have to be calculated under the free delivery method.

If the Participant has been given a Firm Allocation and there is a shortfall once the public offer closes, then the shortfall will become a principal position for the Participant and this will require the calculation of a position risk amount under Annexure 3. This will generally need to be calculated from the date that the Participant has outlaid the funds or the date that the public offer closes, whichever is later, but this may vary depending on the individual offer.

(F) Other Participants of ASX and/or ASX Clear

(1) As Clients

If a Participant executes a transaction on behalf of another participant of ASX and/or ASX Clear which is trading as principal (that is, taking a proprietary position), then the executing participant will need to establish the entity that is trading as principal as a client and, therefore, a client balance will exist for that entity.

Similarly, the entity that is trading as principal will need to treat the executing participant as a counterparty as it is exposed to the executing participant for settlement of the trade. The entity trading as principal will need to establish a client balance for the executing participant.

(2) As Market Counterparties

(A) NOVATED TRADES

A client balance does not, however, need to be established between participants with respect to normal market settlement obligations for trades conducted on market in the ASX or Chi-X Australia markets. When a trade has been novated to ASX Clear, the trade between the buyer and seller is discharged and replaced with two new trades – one between the buyer and ASX Clear and the other between the seller and ASX Clear, ie, ASX Clear becomes the central counterparty to the trade.

A counterparty risk amount is not required to be calculated for amounts which are owing to or from ASX Clear. Therefore, for trades which have been novated to ASX Clear there will be no client balance for ASX Clear or the other participant that was




the original counterparty to the trade. There will, of course, be counterparty risk to the client if the trade was done on an agency basis. The “novated” amounts should be readily identifiable in the settlement reports produced by each Participant’s back office systems supplier.

This treatment also applies if the two participants have requested that the trade be excluded from set off (ie, the netting of delivery obligations and payment obligations). This is because the trade continues to be novated and so ASX Clear is still the legal counterparty to each participant.

(B) NON-NOVATED TRADES

It should be noted that if a trade is removed from novation7, then a counterparty risk amount would have to be calculated for the other participant (or other clearing house if applicable). This is because when a trade is removed from novation, the two participants are taken to be in direct contractual relationship with each other on the terms of, and from the time of, the original transaction. ASX Clear has no obligation in relation to transactions which have been removed from novation. Therefore, the other participant or clearing house is the counterparty to the transaction, not ASX Clear.

Similarly, some trades are accepted by ASX Clear for reporting but not registration and hence are not novated to ASX Clear. Each of the participants that are counterparty to such a trade must calculate a counterparty risk amount on the other participant and/or client. Examples of such trades are crossings and information only or booking purpose trades.

(G) Deferred Settlement Market and Forward Transactions

On occasions, the ASX markets may operate on a deferred settlement basis. In general terms, a deferred settlement market exists where the normal settlement period (ie, T+32) is extended by ASX for a particular security and the extension applies to all market transactions in that security and all participants of ASX and/or ASX Clear.

A forward transaction is one where the two parties to a transaction have agreed to a time for settlement that is later than the normal settlement period for that type of transaction.

The counterparty risk amount for a transaction executed in a deferred settlement market or a forward transaction should be calculated in accordance with the requirements of the non-margined financial instruments method. This applies even if the time until settlement date is greater than 30 days (ie, such a transaction is not treated as an excluded asset).

7 The two participants may choose to have a trade removed from novation so that they can settle the trade directly or in another clearing house.




(H) Short Selling on Behalf of Clients

If a Participant executes a short sale on behalf of a client, this should be treated the same as a standard client share sale transaction. The counterparty risk amount for a client short sale should be calculated in accordance with the requirements of the non-margined financial instruments method.

If a Participant borrows stock to meet its obligations on the short selling arrangement, the Participant will also have an exposure to the lender of the stock. This will be subject to a counterparty risk amount under the securities lending and borrowing method in Rule S1, Annexure 1, clause 4.

(I) Margin Lending Activities

The counterparty exposures arising from margin lending, where the Participant is the financier (ie, if the Participant is not the financier, the agency transactions for the client should be included as a normal agency trade), have been identified as exposures not specifically covered by a method within the Risk Based Capital Requirements. Accordingly they have been treated as non-standard exposures and an explanation of the capital treatment for these has been included in the guidance for Rule S1.2.9 earlier in this Handbook.

(J) Fund Managers

Information on how to treat agency equity orders placed by a fund manager has been provided elsewhere in this Handbook. Guidance on who a Participant’s counterparty is for the purposes of calculating a client balance is provided in the guidance for clause 1. Guidance on how to apply counterparty risk weightings for dealings with fund managers is provided in the guidance for clause 8.

(iii) Method

(A) Timing

There are two basic components to the calculation of the counterparty risk amount for non-margined financial instruments. The first component is based on transactions that remain unsettled with the client or counterparty up to and including 10 Business Days following transaction date (ie, from T0 to T+10) and which are included in the client balance. The second component is based on transactions that remain unsettled with the client or counterparty for a period greater than 10 Business Days from execution (ie, from close of business on T+10).

(1) From T0 to T+10

The counterparty risk amount for transactions that remain unsettled with a client or counterparty for up to 10 Business Days following transaction date is calculated as 3%




of the client balance which is the net of unsettled buy and sell transactions with that client or counterparty.

(2) Past T+10

The counterparty risk amount for transactions that remain unsettled with a client or counterparty for a period greater than 10 Business Days following transaction date is calculated in one of two ways at the option of the Participant. Under both approaches, however, the calculation is based on individual transactions as opposed to the client balance. The calculation applies from close of business on T+10.

As both approaches adequately address the risk and liquidity issues associated with the outstanding transaction, it is not necessary to treat or disclose any amounts calculated as excluded assets.

(A) APPROACH 1

The first approach equates the counterparty risk amount to the greater of 3% of the contract value and the positive credit exposure (mark to market loss) created by the mark to market of the transaction.

It is important to note that the calculation of the mark to market amount is dependent on whether the transaction is a purchase or sale from the perspective of the client or counterparty (not from the Participant’s own perspective). For a client or counterparty purchase, the mark to market loss is the excess of the contract value over the market value. For a client or counterparty sale, the mark to market loss is the excess of the market value over the contract value.

(B) APPROACH 2

The second approach, which is the easiest but usually the most capital intensive, is to take 100% of the contract value for a client purchase or 100% of the market value for a client sale as the counterparty risk amount.

The contract value is the maximum loss for a Participant if a client fails to settle a purchase transaction. While technically the maximum loss for a client sale is the excess of the market value over the contract value, the market value is deemed as the counterparty risk amount because the point of Approach 2 is to provide a simple methodology for Participants that do not choose to use Approach 1.

(B) Securities Subject to Trading Halts or Suspension

For transactions outstanding greater than 10 Business Days following transaction date where the security underlying the transaction becomes subject to a trading halt, the last market value is acceptable in calculating the counterparty risk amount. This is because trading halts are only placed on securities for two days.




If, however, the security underlying the transaction is subject to suspension, the market value should be taken as nil on the basis that the security is not liquid.

(iv) Reducing the Counterparty Risk Amount

(A) General

At the option of the Participant, the counterparty risk amounts calculated in accordance with the non-margined financial instruments method as explained above can be reduced. This can be achieved through:

1. client settlement upon execution;

2. application of ASX Clear Operating Rule 7.2;

3. collateralistion; and

4. counterparty risk weighting.

(B) Client Settlement upon Execution

(1) General

The client balance for a particular client or counterparty can be adjusted by the amount of cash received or held from that client or counterparty with respect to a specific buy transaction or by the value of scrip delivered to the Participant with respect to a specific sell transaction.

The client balance is adjusted by removing from the client balance that portion of the contract value that is covered by cash or scrip. If the transaction is fully covered, the full contract value is removed from the client balance. However, if the Participant controls cash or scrip in excess of the contract value, only the contract value can be removed from the client balance.

(2) Cash Management Accounts, Trust Accounts and Participant Sponsored Holdings

(A) CASH MANAGEMENT ACCOUNTS

Client funds in cash management accounts can also be used to adjust the client balance with respect to a specific buy as long as the Participant has sole and unconditional control over those funds. A Participant that has the ability to sweep a client’s account to pay for purchases may only reduce the counterparty risk amount prior to the settlement date if this ability means that the funds are “locked” in favour of the Participant or if the funds are actually removed from the cash management account.




(B) TRUST ACCOUNTS

Amounts held in a Participant’s trust account would generally be reflected in a client balance in accordance with the above treatment. If that trust money is in relation to unsettled transactions, it may be used to reduce the client balance for the purposes of calculating the counterparty risk amount as long as that money in the trust account is in respect of the relevant transactions or as otherwise agreed by the client.

Further, if the client balance relates solely to trust money (ie, the client does not have any unsettled transactions and has left the money in trust pending future transactions), there is no requirement to calculate a counterparty risk amount on that client balance (ie, it does not represent a positive credit exposure).

(C) PARTICIPANT SPONSORED HOLDINGS

Where a selling client has the scrip which is the subject of the sale transaction in a participant sponsored account and the Participant has either locked that scrip from the client or has strong internal controls to prevent that client recalling the scrip prior to settlement, the value of the scrip may be removed from the client balance.

The following table summarises the above three counterparty risk amount reduction methods.

Table 1 – counterparty risk amount reduction methods – client has settled

Settlement Upon Execution

Period Post Execution

Client

Balance / Transaction

Cash in Trust or

Cash Management Account 1

Scrip Under the

Participant’s Control2

CHESS Participant Sponsored Holding3

T0 - T+23 Net Buy purchases deducted from client balance

N/A N/A

Net Sell sales deducted from client balance

sales deducted from client balance

1 - assumes all purchase orders are only taken if there are sufficient cleared funds in the cash management account to cover the transactions and that those funds are “locked” at the time of placing the orders such that they cannot be accessed by the client.

2 - assumes that the client has delivered sufficient scrip to cover the full amount of the sale orders.

3 - assumes that the client has sufficient underlying stock in their participant sponsored CHESS holding to cover the full amount of the sale order and that the holding is “locked” at the time of placing the order such that it cannot be removed by the client.

(D) OPTIMISATION

In certain instances, the removal from the client balance of a contract value in the manner noted above may result in an increased counterparty risk amount. The reason for this is that the method set out for the T0 to T+10 period is not strictly risk based. In recognition of this, Participants may optimise, that is, choose the minimum counterparty risk amount where a strict interpretation of the Rule may cause




dichotomous results. However, for a Participant to do this, it requires a system capable of recognising these anomalies and of applying optimisation in a manner that is consistent with the spirit of the Rule.

The following two examples seek to clarify how optimisation is meant to work.

(i) EXAMPLE 1

Assume a Participant has undertaken a $30,000 buy transaction and $20,000 sell transaction for a single client where the stock being sold is participant sponsored and both trades are in the T0 to T+10 period.

The client balance without applying client settlement upon execution is $10,000. If the Participant applies client settlement upon execution and removes the value of the stock from the client balance this gives an adjusted client balance of $30,000.

As the removal of the sell transaction from the client balance results in a larger counterparty risk amount, the Participant could choose to optimise and not remove the $20,000 sell transaction from the client balance.

(ii) EXAMPLE 2

Assume that a Participant has undertaken four buy transactions for $10,000 each and six sell transactions for $10,000 each for a single client.

If all of the securities being sold are participant sponsored, the Participant could use optimisation to selectively eliminate two of the $10,000 sell transactions and arrive at a $0 client balance.

If, however, there was a mix of participant sponsored and issuer sponsored securities being sold, selective elimination of two of the $10,000 sells would not be allowed as this type of cherry picking would not be within the spirit of the Rule. The client balance would be $20,000 in this case.

(3) Chess 101 Dual Entry Settlement Notification (101 Message)

It should be noted that if a settlement has been scheduled via a 101 message this cannot be used to reduce a counterparty risk amount. The reason for this is that this 101 message does not guarantee settlement by the other party and the Participant will still have the responsibility to settle the transaction should the other party fail to do so. The 101 message is a promise only, it does not guarantee settlement.




(C) Application of ASX Clear Operating Rule 7.2

Under ASX Clear Operating Rule 7.2, if a client fails to settle a trade with a Participant, the Participant may exercise any rights it has, including any rights under the ASX Clear Operating Rules or the client agreement.

For the purposes of the Risk Based Capital Requirements, ASX Clear Operating Rule 7.2 may be applied to reduce the client balance but only if the Participant’s client agreement gives the Participant the right to close out the trade if a client has not honoured its contractual obligation to settle. This applies regardless of whether or not the Participant has made a demand on a client and may only be applied from settlement date, only up to and including T+10 and only in the manner detailed below. Where a client fails to complete a specific contract whether it be a purchase or a sale, the contract value included in the client balance may be reduced by the market value of the security underlying that contract8 but the reduction cannot exceed the contract value9.

Thus, for a client purchase, if the market value of the stock underlying the purchase is less than the contract value, there will be a portion of the contract value remaining in the client balance. If the market value of the stock underlying the purchase is greater than the contract value, the transaction is effectively removed from the client balance.

If the Participant has registered the stock into the client’s account (either issuer or participant sponsored account) prior to the client paying, this would be a free delivery and a counterparty risk amount would have to be calculated under the free delivery method. ASX Clear Operating Rule 7.2 cannot be applied in this instance because the Participant has lost control over the stock and will not be able to liquidate it to recover the amount owing from the client.

With respect to a client sale, where the market value of the security underlying the sale is less than the contract value, the sale is effectively removed from the client balance. Where the market value of the securities underlying the sale is greater than the contract value, the market value should be deducted from the contract value. That is, the “credit” entry in the client balance will be the loss that the Participant would suffer if it were to close the position out in the market in accordance with ASX Clear Operating Rule 7.2.

8 If the security underlying the contract is subject to a trading halt, the last market value may be used since a trading halt is only placed on a security for two days. If, however, the security is subject to suspension, the market value should be taken as nil on the basis that the security is not liquid. 9 While ASX Settlement Rule 7.2.2(f) gives the right to a Sponsoring Participant to refuse to comply with a client’s withdrawal instructions and to retain securities equal to 120% of the current value claimed, as it does not permit the Sponsoring Participant to actually deal with the securities held, it may not be used to reduce any counterparty risk amounts for the purposes of the Risk Based Capital Requirements (see further comment on this in the next section (D) “Collateral Arrangements”).




Unlike client settlement upon execution, optimisation is not permitted when applying ASX Clear Operating Rule 7.2 to reduce the client balance. This is because ASX Clear Operating Rule 7.2 can only be applied after the client has already failed to honour its obligation to settle with the Participant and it is not appropriate to allow a further reduction in the counterparty risk amount for such a client.

Table 2 – counterparty risk reduction method – client has not settled

Period Post

Execution

Client Balance /

Transaction

Underlying Stock1 (ASX Clear Operating Rule 7.2)

T0 - T+32 Net Buy N/A

Net Sell

T+43 - T+10

Buy

client balance includes the specific contract value less the market value of the securities underlying the contract

Sell client balance includes the market value of the securities underlying the contract less the contract value

> T+10

Buy 2

contract value less market value of the underlying securities (ie, negative mark to market)2

Sell 2 market value of securities underlying the contract less the contract value

1 Recognises the Participant’s right under ASX Clear Operating Rule 7.2. See previous commentary for full details.

2 Note: The contract value less the market value of the underlying securities (negative mark to market) that the Participant now holds pending client settlement is the amount calculated in accordance with clause 2(b)(i)(B). Therefore, the underlying securities cannot be treated as “additional” collateral. The counterparty risk amount will be the greater of this amount and 3% of the contract value. In addition, if the Participant liquidates the client position (in accordance with ASX Clear Operating Rule 7.2) and realises a loss, the counterparty risk amount with respect to that position will be the realised loss and not 3% of the contract value or 3% of the loss.

(D) Collateral Arrangements

(1) Criteria

Under some circumstances the counterparty risk amount can be reduced by the amount of collateral held by the Participant as long as the following conditions are met:

1. the collateral must satisfy the definition of liquid (ie, realisable or otherwise convertible to cash within 30 days) and therefore will generally be limited to debt or equity securities. Any collateral which is held in escrow and unable to be converted to cash within 30 days would not meet the definition of liquid;

2. the collateral must be unrelated to a particular or specific transaction (that is, in accordance with the discussion in the “Application of ASX Clear Operating Rule 7.2” section above, the securities underlying a client purchase are not considered to be collateral);




3. the Participant must have full control over the collateral so that if the client or counterparty defaults, the Participant can liquidate the collateral to recover the amount owing. This would require, in the case of equity securities lodged as collateral, that the securities be lodged in a participant sponsored account. Securities lodged as collateral which cannot be accessed by the Participant without the approval of a third party or are otherwise encumbered cannot be recognised as collateral for the purposes of this Rule;

4. the lodgement of the collateral must be evidenced in writing (ie, it must be documented by a legally binding agreement between the Participant and the client or counterparty). The Participant must have established that the client or counterparty and the persons signing have the legal capacity to enter into the agreement and to provide the nominated collateral (eg, the client or counterparty is an appropriately registered company and the person executing the agreement has the authority to enter into the agreement on behalf of that company). The collateral agreement must provide for the Participant to deal with that collateral in the event that the client or counterparty defaults on its settlement of the relevant transactions to recover any amounts owed to the Participant. Alternatively, if an ASX Clear Operating Rule permits a Participant to deal with a “collateral” type amount in the event of a client default, then there is no need to have a separate written collateral agreement covering the same transaction for the purposes of the Risk Based Capital Requirements. Separate written collateral agreements are, however, always recommended to ensure the client is aware of the actions that the Participant may take in the event of a default (also see comment below on ASX Settlement Rule 7.2.2). ASX Clear recommends that independent legal advice be obtained to assist the Participant with the documentation of collateral arrangements; and

5. the collateral must be valued at market value or at another value approved by ASX Clear.

Collateral must satisfy the above criteria and may only be applied in accordance with the conditions specified in the collateral agreement and to the extent allowed under the following guidance.

(2) Guidance

For the purpose of this guidance, references to collateral are limited to securities. It is assumed that cash lodged as collateral would be placed by the Participant in either a client cash management account or the participant’s trust account and any reduction of the counterparty risk amount arising from such monies would be according to the guidance provided above that deals with cash management accounts and trust accounts.

If the security lodged as collateral is subject to a trading halt, the last market value may be used since a trading halt is only placed on a security for two days. If, however, the security is subject to suspension, the market value should be taken as nil on the basis that the security is not liquid.




If the collateral in its entirety is not considered liquid, it cannot be used to reduce the counterparty risk amount. If only a percentage of the collateral can be considered liquid, only that percentage can be applied to reduce the counterparty risk amount. The guidance given for Rule S1.2.1 in the section on Excluded Assets (Principal Positions in Financial Instruments) in relation to identifying if a position is liquid should also be applied to determine if the collateral is liquid.

(A) ≤ T+10

In reducing a client balance or transaction value by the amount of collateral, the collateral must be marked to market and must be offset on a transaction by transaction basis. That is, prior to calculating the client balance, collateral held against transactions that make up that client balance should be offset against the value of those transactions. Thus, for example, if there are several transactions that make up a client balance, the Participant must allocate the market value of collateral to the extent provided for in the collateral agreement to the individual transactions prior to calculating the overall client balance.

Collateral cannot be used to directly reduce a counterparty risk amount; it can only be applied to reduce the client balance or a contract value.

(B) > T+10

Where a transaction is outstanding for greater than 10 Business Days, collateral can be used to reduce the contract value and excess (ie, loss) on the unsettled purchase or sale.

(3) ASX Settlement Rule 7.2.2

While ASX Settlement Rule 7.2.2(f) gives the right to a Participant to refuse to comply with a client’s withdrawal instructions where that client is participant sponsored, and to retain securities equal to 120% of the current value claimed, as it does not permit the Participant to deal with the securities held, it may not be used to reduce any counterparty risk amounts.

However, if a Participant has a separate legal agreement (or the appropriate clause is included in the client agreement form signed by the client) that satisfies the five criteria noted above, other stocks held by the Participant may be applied as collateral against the outstanding transaction. A Participant should obtain legal advice on this matter before it utilises this type of collateral.

(4) Optimisation

In certain instances, the removal from the client balance of a contract value in the manner noted above may result in an increased counterparty risk amount. The reason for this is that the method set out for the T0 to T+10 period is not strictly risk based. In recognition of this, Participants may optimise, that is, choose the minimum counterparty risk amount where a strict interpretation of the Rule may cause




dichotomous results. However, for a Participant to do this, it requires a system capable of recognising these anomalies and of applying optimisation in a manner that is consistent with the spirit of the Rule.

(E) Counterparty Risk Weighting

(1) General

Under clause 8 of Annexure 1, once the counterparty risk amount has been calculated it can be multiplied, at the option of the Participant, by the counterparty risk weighting applicable for that counterparty as specified in Annexure 5, Table 2.1 (refer to the guidance section for clause 8). This calculation must be applied to a counterparty consistently. That is, the Participant cannot selectively apply the weighting and once it weights a counterparty, it must weight that counterparty consistently across all methods within Annexure 1. This process is undertaken under each of the methods in clauses 2 to 7 of Annexure 1.

(d) EXAMPLES

A number of examples are provided below to assist in the understanding of this Rule.

The calculations are based on close of business balances and would differ if calculating the risk amounts during the Business Day prior to settlement of the transactions (ie, the capital liquidity requirements of this Rule must be satisfied at all times).

Brokerage amounts have been ignored for ease of calculation only.

Reference to this calendar may assist.

MARCH NOVEMBER 20116

S M T W T F S

T0

1

T+1

2

T+2

3

T+3

4

5

6

T+4

7

T+5

8

T+6

9

T+7

10

T+8

11

12

13

T+9

14

T+10

15

T+11

16

T+12

17

T+13

18

19

20

T+14

21

T+15

22

T+16

23

T+17

24

T+18

25

26

27

T+19

28

T+20

29

T+21

30

T+22

31




(i) Example 1 – AUD Client Agency Trades – No collateral held

(A) Buy and Sell, < 32 Business Days

Transaction Details

Client XYZ is an approved institution (and the Participant has the documentation to support this) and both trades remain unsettled.

Current Date Transaction Date Buy / Sell Stock Details Units Amount

32/311/116 1/311/116 Buy ABC @0.57 25,000 $14,250

32/311/116 1/311/116 Sell DEF @ 0.61 27,936 ($17,041)

client balance= ($2,791)

Calculation Current

Date client

balance less

collateral

Risk Amount @ 3%

Transactions unsettled > 10 Business Days

Counterparty Risk Amount

Risk Weighted Counterparty Risk Amount

(@ 50%) 3% MTM risk amount

1 2

(1 × 3%)

3 4 5

(max {3 , 4})

6

(2 + 5)

7

(6 × 50%)

32/311/116

$2,791 $84 - - - $84 $42

RECONCILIATION - before applying the counterparty risk weighting

1/311/116 transactions

As at close of business 32/311/116 these transactions have been outstanding for 21 Business Days following transaction date.

Accordingly, the counterparty risk amount is 3% of the client balance:

client balance * 3 % = 2,791 * 3% = 84

(B) Buy and Sell Outstanding < 32 Business Days – cash management account access and participant sponsored

Transaction Details

Client XYZ is an approved institution (and the Participant has the documentation to support this) and both trades remain unsettled. The client has a cash management account that the Participant has access to and the Participant is able to lock the funds required to settle the purchase. The client is also participant sponsored and has the stock subject to the sale in its sponsored account and the Participant is able to lock that stock or has internal controls in place to prevent its release.





32/311/116 1/311/116 Buy ABC @0.57 25,000 $14,250

32/311/116 1/311/116 Sell DEF @ 0.61 27,936 ($17,041)

client balance= ($2,791)

Calculation Current

Date client

balance less

collateral

Risk Amount @ 3%





1 2

(1 × 3%)

3 4 5

(max {3 , 4})

6

(2 + 5)

7

(6 × 50%)

32/311/11

$2,791 - - - - - -



As at close of business 32/311/116 these transactions have been outstanding for 21 Business Days following transaction date.

As the Participant has access to and total control over the funds for the purchase and stock for the sale, the counterparty risk amount is $0.

(C) Buy and Sell Outstanding > 32 and ≤ 10 Business Days (ASX Clear Operating Rule 7.2 IS NOT applied)

Transaction Details

Client XYZ is an approved institution (and the Participant has the documentation to support this) and all trades remain unsettled.


11/311/116 1/311/116 Buy ABC @0.57 25,000 $14,250

11/311/116 1/311/116 Sell DEF @ 0.61 27,936 ($17,041)

11/311/116 2/311/116 Buy ABC @0.61 27,936 $17,041

client balance= $14,250




Calculation Current

Date client

balance less

collateral

Risk Amount @ 3%



Risk Weighted Counterparty Risk amount


1 2

(1 × 3%)

3 4 5

(max {3 , 4})

6

(2 + 5)

7

(6 × 50%)

11/311/116

$14,250 $428 - - - $428 $214


1 and 2/311/116 transactions

As at close of business 11/311/116 these transactions have been outstanding for 8 and 7 Business Days respectively.

Accordingly, the counterparty risk amount is 3% of the client balance:

client balance * 3 % = 14,250 * 3% = 428

(D) One Buy Outstanding > 32 and ≤ 10 Business Days (ASX Clear Operating Rule 7.2 IS applied) and One Buy Outstanding > 10 Business Days

Transaction Details

Client XYZ is an approved institution (and the Participant has the documentation to support this) and both trades remain unsettled.


15/311/116 1/311/116 Buy ABC @0.57 25,000 $14,250

15/311/116 2/311/116 Buy ABC @0.61 27,936 $17,041

$31,291

Calculation Current

Date client

balance less

collateral

Risk Amount @ 3%





1 2 1

(1 × 3%)

3 4 5

(max {3 , 4})

6

(2 + 5)

7

(6 × 50%)

15/311/116

$17,041 $75 $428 $1,250 $1,250 $1,325 $663

1 ASX Clear Operating Rule 7.2 has been applied, as the transaction has been outstanding for more than 3 2 Business Days but not more than 10 Business Days.





1/311/116 transaction

As at close of business 15/311/116 this transaction has been outstanding for greater than 10 Business Days following transaction date and the Participant has elected to follow the mark to market approach permitted within the Rule rather than taking 100% of the contract value. The market price of the stock is $0.52 on 15/311/116 so the market value of the stock is $13,000 (25,000 units @ 0.52).

Accordingly, the counterparty risk amount is the greater of:

loss = contract value – market value = 14,250 – 13,000= 1,250

or

contract value * 3 % = 14,250 * 3% = 428

2/311/116 transaction

As at close of business 15/311/116 this transaction has been outstanding for more than 32 Business Days but less than 10 Business Days following transaction date and the Participant has chosen to apply ASX Clear Operating Rule 7.2.

Accordingly, the counterparty risk amount is 3% of the mark to market loss:

contract value = 17,041

market value= 27,936 units @ 0.52 = 14,526

loss = 2,515 * 3% = 75

(ii) Example 2 – AUD Client Agency Trades – Collateral held

(A) Buy and Sell Outstanding < 32 Business Days

Transaction Details

Client XYZ is an approved institution (and the Participant has the documentation to support this) and both trades remain unsettled, however a separate collateral agreement exists and $1,000 scrip is currently held (assume the market value of the scrip does not change).





32/311/116 1/311/116 Buy ABC @0.57 25,000 $14,250

32/311/116 1/311/116 Sell DEF @ 0.61 27,936 ($17,041)

client balance before collateral

($2,791)

client balance after collateral

($1,791)

Calculation Current

Date client

balance less

collateral

Risk Amount @ 3%





1 2

(1 × 3%)

3 4 5

(max {3 , 4})

6

(2 + 5)

7

(6 × 50%)

32/311/116

$1,791 $54 - - - $54 $27



As at close of business 32/311/116 these transactions have been outstanding for 21 Business Days following transaction date. The Participant may optimise the allocation of the collateral and this is achieved by applying the collateral against the contract value for the sell rather than the buy.

Accordingly, the counterparty risk amount is 3% of the adjusted client balance:

adjusted client balance * 3 % = 1,791 * 3% = 54

(iii) Example 3 – Foreign Currency Client Agency Trades

(A) Introduction

(1) General

The principles for calculating a counterparty risk amount outlined in the examples above should also be applied to any foreign currency client agency trades. However, as noted earlier in this section of the Handbook, these types of trades have an additional risk component to them and this is the foreign currency risk.

Whilst the calculation of a foreign exchange position risk amount will not be discussed here (refer to the guidance section for Annexure 3, Part 3 in the Handbook) a number of types of foreign currency client agency trades will be briefly considered to illustrate the interaction between the two risk requirements (ie, the counterparty risk requirement and the position risk requirement).




(B) Examples

(1) Client buys or sells a US security and settles in USD

If a client buys a US security and settles in USD, then the Participant would be long the USD coming from the client and short the USD to be paid to the market.

These two amounts can be offset and if they equal each other then there would be no foreign exchange position risk requirement.

A client sell would be the reverse of the above.

(2) Client buys or sells a US security settling in EUR

If a client buys a US security and settles in EUR, then the Participant would be long EUR and short the USD to be paid to the market.

To hedge these amounts the Participant would sell EUR to cover the client amount and buy USD to cover the market.

If the amounts arising from the contract are fully hedged immediately then there would be no foreign exchange position risk requirement. If, however, the amounts are not hedged, then the long EUR and short USD positions would have to be included in the calculation of a foreign exchange position risk requirement.


(3) Client buys or sells ASX security settling in USD

If a client buys an ASX security and settles in USD, then the Participant would be long USD from the client and short the AUD.

To hedge the USD amount the Participant would sell USD. There is no need to consider the AUD as there is no foreign exchange risk on AUD (assuming that the Participant’s base currency is AUD).

If the USD amount arising from the contract is fully hedged immediately then there would be no foreign exchange position risk requirement. If, however, the amount is not hedged, then the long USD position would have to be included in the calculation of a foreign exchange position risk requirement.





(4) Client buys or sells US security settling in AUD

If a client buys a US security and settles in AUD, then the Participant would be long AUD from the client and short the USD to be paid to the market.

To hedge the USD amount the Participant would buy USD. There is no need to consider the AUD as there is no foreign exchange risk on AUD (assuming that the Participant’s base currency is AUD).

If the USD amount arising from the contract is fully hedged immediately then there would be no foreign exchange position risk requirement. If, however, the amount is not hedged, then the short USD position would have to be included in the calculation of a foreign exchange position risk requirement.

(Next page is Page 580)


Annexure 1 (CRR) - Clause 3 - Free Delivery Method

Annexure 1 January 2012March 2016 Page 580

3. CLAUSE 3 - FREE DELIVERY METHOD

(a) RULE

3 FREE DELIVERY METHOD

For a Free Delivery in a Financial Instrument, the counterparty risk amount for the Counterparty is:

(a) 8% of that part of the contract value subject to a Free Delivery, where payment or delivery of the Financial Instrument which is the subject of a Free Delivery remains outstanding for less than 2 Business Days following the settlement date; and

(b) 100% of that part of the contract value subject to a Free Delivery, where payment or delivery of the Financial Instrument remains outstanding for greater than 2 Business Days following the settlement date.

A Participant may reduce the contract value by the amount of collateral held by the Participant on behalf of the Counterparty if the collateral is Liquid, valued at the mark to market value or another value approved by ASX Clear and the collateral arrangement is evidenced in writing between the Participant and Counterparty.

(b) FORMULA

( ) ( )[ ][ ]ccy

n

ccy c

m

cfd CRWCVCVcra ∑ ∑

= =≥<

×+×=

1 12208.0

Where:

crafd = counterparty risk amount under the free delivery method

c = client or counterparty

m = the number of clients or counterparties (c) with whom the Participant has free delivery transactions.

n = number of currencies

ccy = currency

CV = the unpaid or undelivered portion of the contract value of unsettled trades

<2 refers to less than 2 business days, and ≥2 refers to greater than or equal to 2 business days

CRW = counterparty risk weighting




(c) GUIDANCE

(i) General

The general principle associated with this method is that where a Participant has made a free delivery, the Participant is required to hold a greater amount of capital than is required under the non-margined financial instruments method.

A free delivery is where:

1. in the case of a client purchase, the Participant has delivered the stock to the client or counterparty but the client or counterparty has not yet paid the Participant (or has only made a partial payment); or

2. in the case of a client sale, the Participant has paid the client or counterparty (either in full or in part) but the client or counterparty has not yet provided any of the stock that is the subject of the transaction (or has only provided some of the stock).

The above applies regardless of whether the client or counterparty is issuer sponsored or participant sponsored. For a client purchase, once the Participant has registered the stock into the client’s account, whether it be an issuer sponsored or participant sponsored account, the Participant has lost control of the stock as it has no right to sell the stock to recover the amount owing without the client or counterparty’s agreement.

A free delivery may be made prior to or after the Participant has settled with the market. For example, for an ASX market trade, a free delivery may be made by a Participant prior to T+32, on T+32 or after T+32.

(ii) Exchange Traded Funds

As noted in the guidance for Annexure 1, clause 1, in the event of a default in the settlement of a primary market transaction (where the Participant transfers underlying securities (in the case of a subscription for ETF units) or ETF units (in the case of a redemption), and does not receive the corresponding ETF units or underlying securities, or some other cash consideration), a counterparty risk amount under the free delivery method must be calculated from the time those assets or cash were due to be settled.

(iii) Method

(A) Partial Free Delivery

It is possible that a Participant may make a partial free delivery whereby, for a client purchase, the Participant delivers stock to the client or counterparty when the client or counterparty has made a partial payment or, for a client sale, the Participant makes




either full or part payment to the client or counterparty when the client or counterparty has not provided any or all of the particular stock.

Only that part of the contract value that is subject to a free delivery is included in the calculation under the free delivery method, ie, that portion of the contract value that the Participant has settled with the client or counterparty but which the client or counterparty has not yet settled with the Participant.

Any portion of the contract value that the Participant has not yet settled with the client or counterparty continues to form part of the client balance and continues to be subject to a counterparty risk amount under the non-margined financial instruments method.

The following tables show the possible scenarios and the approach to be followed in each case.

Table 1 - Unsettled client purchases

Criteria Method

Stock is registered in client’s account prior to the client paying any of the money owed.

Free Delivery Method

(based on full contract value)

Stock is registered in client’s account and the client has made a partial payment.


(based on proportion of contract value that the client has not yet settled)




Table 2 - Unsettled client sales

Criteria Method

Client is paid in full prior to the Participant receiving any of the stock from the client.


(based on full contract value)

Client is paid in full and the client has delivered some but not all of the stock required.


(based on proportion of contract value that the client has not yet settled)

Client is paid in part prior to the Participant receiving any or all of the stock from the client.


(based on excess of amount paid to the client over the amount settled by the client)

and

Non-Margined Financial Instruments Method

(based on amount not yet settled by either party)

(B) Timing

Once a Participant has made a free delivery, that portion of the transaction subject to a free delivery no longer forms part of the client balance.

In the context of the free delivery method, TS is the day that the Participant makes the free delivery, ie, the day that the Participant settles with the client or counterparty. It is not the market settlement date (eg, T+32 for “normal” ASX market trades).

(1) From TS to TS+2

The counterparty risk amount on these transactions is 8% of that part of the contract value that is subject to a free delivery. This applies from the date the free delivery is made and up to 2 Business Days after that date.

(2) Past TS+2

If the client or counterparty has still failed to settle after 2 Business Days the counterparty risk amount on the transaction will be 100% of that part of the contract value that is subject to a free delivery. This commences from close of business on TS+2.




(iv) Reducing the Counterparty Risk Amount

At the option of the Participant, the counterparty risk amounts calculated in accordance with the free delivery method can be reduced. This can be achieved through:

1. collateralistion; and

2. counterparty risk weighting.

(A) Collateral Arrangements

(1) Criteria

Under some circumstances the counterparty risk amount can be reduced by the amount of collateral held by the Participant as long as the following conditions are met:

1. the collateral must satisfy the definition of liquid (ie, realisable or otherwise convertible to cash within 30 days) and therefore will generally be limited to debt or equity securities. Any collateral which is held in escrow and unable to be converted to cash within 30 days would not meet the definition of liquid;

2. the collateral must be unrelated to a particular or specific transaction (that is, the securities underlying a client purchase are not considered to be collateral);

3. the Participant must have full control over the collateral so that if the client or counterparty defaults, the Participant can liquidate the collateral to recover the amount owing. This would require, in the case of equity securities lodged as collateral, that the securities be lodged in a participant sponsored account. Securities lodged as collateral which cannot be accessed by the Participant without the approval of a third party or are otherwise encumbered cannot be recognised as collateral for the purposes of this Rule;

4. the lodgement of the collateral must be evidenced in writing (ie, it must be documented by a legally binding agreement between the Participant and the client or counterparty). The Participant must have established that the client or counterparty and the persons signing have the legal capacity to enter into the agreement and to provide the nominated collateral (eg, the client or counterparty is an appropriately registered company and the person executing the agreement has the authority to enter into the agreement on behalf of that company). The collateral agreement must provide for the Participant to deal with that collateral in the event that the client or counterparty defaults on its settlement of the relevant transactions to recover any amounts owed to the Participant. Alternatively, if an ASX Clear Operating Rule permits a Participant to deal with a “collateral” type amount in the event of a client default, then there is no need to have a separate written collateral agreement covering the same transaction for the




purposes of the Risk Based Capital Requirements. Separate written collateral agreements are, however, always recommended to ensure the client is aware of the actions that the Participant may take in the event of a default (also see comment below on ASX Settlement Rule 7.2.2). ASX Clear recommends that independent legal advice be obtained to assist the Participant with the documentation of collateral arrangements; and

5. the collateral must be valued at market value or at another value approved by ASX Clear.

Collateral must satisfy the above criteria and may only be applied in accordance with the conditions specified in the collateral agreement and to the extent allowed under the following guidance.

(2) Guidance

In reducing the contract value by the amount of collateral, the collateral must be marked to market and must be offset on a transaction by transaction basis.

If the security lodged as collateral is subject to a trading halt, the last market value may be used since a trading halt is only placed on a security for two days. If, however, the security is subject to suspension, the market value should be taken as nil on the basis that the security is not liquid.

If the collateral in its entirety is not considered liquid, it cannot be used to reduce the counterparty risk amount. If only a percentage of the collateral can be considered liquid, only that percentage can be applied to reduce the counterparty risk amount. The guidance given for Rule S1.2.1 in the section on Excluded Assets (Principal Positions in Financial Instruments) in relation to identifying if a position is liquid should also be applied to determine if the collateral is liquid.

(3) ASX Settlement Rule 7.2.2

While ASX Settlement Rule 7.2.2(f) gives the right to a Participant to refuse to comply with a client’s withdrawal instructions where that client is participant sponsored, and to retain securities equal to 120% of the current value claimed, as it does not permit the Participant to deal with the securities held, it may not be used to reduce any counterparty risk amounts.

However, if a Participant has a separate legal agreement (or the appropriate clause is included in the client agreement form signed by the client) that satisfies the five criteria noted above, other stocks held by the Participant may be applied as collateral against the outstanding transaction. A Participant should obtain legal advice on this matter before it utilises this type of collateral.




(B) Counterparty Risk Weighting

(1) General

Under clause 8 of Annexure 1, once the counterparty risk amount has been calculated it can be multiplied, at the option of the Participant, by the counterparty risk weighting applicable for that counterparty as specified in Annexure 5, Table 2.1 (refer to the guidance section for clause 8). This calculation must be applied to a counterparty consistently. That is, the Participant cannot selectively apply the weighting and once it weights a counterparty, it must weight that counterparty consistently across all methods within Annexure 1. This process is undertaken under each of the methods in clauses 2 to 7 of Annexure 1.

(d) EXAMPLES

A number of examples are provided below to assist in the understanding of this Rule.

The calculations are based on close of business balances and would differ if calculating the risk amounts during the Business Day prior to settlement of the transactions (ie, the capital liquidity requirements of this Rule must be satisfied at all times).

Reference to this calendar may assist.

MARCH 2011NOVEMBER 2016

S M T W T F S

T0

1

T+1

2

T+2

3

T+3

4

5

6

T+4

7

T+5

8

T+6

9

T+7

10

T+8

11

12

13

T+9

14

T+10

15

T+11

16

T+12

17

T+13

18

19

20

T+14

21

T+15

22

T+16

23

T+17

24

T+18

25

26

27

T+19

28

T+20

29

T+21

30

T+22

31

(i) Example 1 – Full Settlement

(A) Transaction Details

On 1/311/116 the client purchases, on market, $500,000 of equity securities.




On 43/311/116, the Participant settles the transaction with the market and transfers the securities to the issuer sponsored client. The client does not pay the Participant. The Participant has a credit line to the client and this transaction exposure is within the credit limit. The client is risk weighted at 50%. The client does not settle this transaction until 10/311/116.

(B) Calculation

Date Transaction Value

Risk Factor

Risk Amount Risk Weight Weighted Risk Amount

1/311/116 1 $500,000 3% $15,000 50% $7,500

3/11/16 $500,000 8% $40,000 50% $20,000

4/311/116 $500,000 8% $40,000 50% $20,000

7/311/116 $500,000 100%8%

$500,000$40,000

50% $250,000$20,000

8/311/116 $500,000 100% $500,000 50% $250,000

9/311/116 $500,000 100% $500,000 50% $250,000

10/311/116 2 $500,000 100% $500,000 50% $250,000

1 – The transaction should be treated under the non-margined financial instruments method until the date of the free delivery. 2 - Capital required up until the time of client settlement on 10/311/116 (ie, no capital required as at cob on 10/311/116).

(ii) Example 2 – Partial Settlement

(A) Transaction Details

On 1/311/116 the client sells, on market, $500,000 of equity securities and the Participant pays the client $250,000. The client is risk weighted at 50%.

On 4/311/116, the client delivers all of the scrip subject to the sale.

(B) Calculation

Date Transaction Value

Free Delivery Amount

Client Balance Amount

Free Delivery

Risk Factor

Client Balance

Risk Factor

Total Risk Amount

Risk Weight

Weighted Risk

Amount

1/311/116

$500,000 $250,000 $250,000 8% 3% $27,500 50% $13,750

2/311/116

$500,000 $250,000 $250,000 8% 3% $27,500 50% $13,750

3/311/116

$500,000 $250,000 $250,000 100% 3% $257,500 50% $128,750

4/311/116

1 $500,000 $250,000 $250,000 100% 3% $257,500 50% $128,750

1 - Capital required up until the time of client settlement on 4/311/116 (ie, no capital required as at cob on 4/311/116).





1/311/116 to close of business 3/311/116

The transaction has been outstanding for 2 Business Days and there has only been a partial free delivery.

Accordingly, the counterparty risk amount is:

client balance * 3% = 250,000 * 3% = 7,500

plus

free delivery * 8% = 250,000 * 8% = 20,000

total = 27,500

From close of business 3/311/116 to settlement on 4/311/116

The transaction has been outstanding for greater than 2 Business Days and there has only been a partial free delivery.

Accordingly, the counterparty risk amount is:

client balance * 3% = 250,000 * 3% = 7,500

plus

free delivery * 100% = 250,000 * 100% = 250,000

total = 257,500




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2. CLAUSE 2 - NON-MARGINED FINANCIAL INSTRUMENTS METHOD · 2015-11-02 · Capital Liquidity Section 3 Handbook Risk Based Capital Requirements Guidance Annexure 1 (CRR) - Clause 2