By Rick Klink
Just as no one predicted the global financial crisis (GFC) that began in 2007, no one foretold the global fallout from resulting turbulence. Investments collapsed and ponzi schemes were uncovered, venerable investment houses crumpled and governments intervened to prevent banks failing. Closer to home, retirees lost savings, the market dived and a number of investment funds were locked up or imploded.
Another substantial fallout of the GFC was the exposure of significant weaknesses in the resiliency of banks and other market participants to financial and economic shocks, both in Australia and overseas.
As a result, increasingly stringent regulations have been imposed on global capital markets. These regulations fall under varying standards including Basel III and Basel Committee and Bank Supervision - International Organization of Securities Commissions. Previously ASX Clear has proposed a new methodology to calculate minimum core capital requirements (MCCR) that reflect that the greater complexity inherent within a Clearing Participant’s (CPs) business.
The core aim of these regulations is to ensure that market participants, such as banks and stockbrokers, are suitably capitalised to operate in the financial markets, regardless of market conditions.
The International Organization of Securities Commissions (IOSCO)
IOSCO is an association of organisations that regulate the world’s securities and futures markets. It brings together markets regulators from over 120 jurisdictions –together, they account for over 90% by value of global capital markets. The Australian Securities and Investment Commission (ASIC) became a signatory to IOSCO in October 2002.
In September 1998, IOSCO released a document called Objectives and Principles of Securities Regulation, which sets out 30 tenants of securities regulation, based on three core underlying principles:
- The protection of investors
- Ensuring that markets are fair, efficient and transparent
- The reduction of systemic risk.
With regards to capital adequacy, section 12.1 of the document states:
“There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake”
From a regulatory standpoint in Australia, the ASX and ASIC have collectively implemented Market Clearing Participant Rules to ensure this IOSCO requirement is met. This includes the more recent changes to CP’s minimum core capital requirements.
Cash Market Margining (CMM)
CMM was introduced to the market in June 2013 as a way of enhancing the risk management controls of ASX Clear. The CMM is the capital that stockbrokers have to put up to ASX Clear in between trade date and T+2, a margin between the ASX Clearing House and the Clearing Participant, such as OpenMarkets.
Its purpose is to ensure the ASX Clearing house can close out a clearing participant’s unsettled net novated obligations, in the event that market participant defaults. In simple terms, it’s like an insurance policy for the ASX against non-settlement.
Changes to Clearing Participant Minimum Core Capital Requirements (MCCR)
In June 2016, the ASX upped the ante from CMM and proposed additional changes, this time to the MCCR for its clearing participants; this was outlined in its consultation paper ‘Changes to Clearing Participant Minimum Core Capital Requirements Approach’. ASX Clear’s initial response to the consultation with CPs was released in January 2017, and in July 2017 a further consultation paper was issued by ASX Clear.
ASX Clear sets the minimum core capital requirements for its CPs, which ensure that only CPs of robust financial standing use its service. The MCCR together with its other risk controls enable the CP to promote systemic stability in ASX’s markets.
In the January 2017 response to consultation, CPs were requested to submit a Business Activities Return (BAR) containing information about their activities for the quarter ended December 2016. ASX Clear analysed the BARs across the industry and developed a framework for assessing the level of own account business and non-ASX client activity undertaken by each CP.
The assessment encompasses the base capital requirement for using ASX Clear (currently $5 million) as well as additional activity-based capital requirements for:
- Client written options clearing
- Own account business
- Non-ASX client activity.
While ASX Clear has provided an initial assessment to each CP, the final capital requirements won’t be known for some time yet.
To ensure the ongoing integrity of financial markets it is inevitable that capital adequacy regulations will continue to become increasingly stringent over time. The stockbroker of tomorrow will need to run advanced trading platforms as well as sophisticated capital and risk management systems; the latter is necessary to effectively leverage their balance sheet to drive trading profits, while complying with relevant regulations. No one can predict when the next challenge to domestic and global capital markets may arise, however it’s important for brokers to be in the best possible position to weather the inevitable storm.
General Advice Warning
This information is current as at that date of the document or information is provided or presented unless otherwise specified and is provided by OpenMarkets Australia Ltd (ABN 38 090 472 012, AFSL 246705 (OpenMarkets). The information is intended to be general information only and not advice specific to any person. Each person should consider the appropriateness of any material presented having regard to their own circumstances and the information provided does not take into account the particular investment objectives, financial situation or investment needs of any person. OpenMarkets does not warrant the accuracy of, nor accept any responsibility for any information provided. Where examples, hypotheticals or case studies are used, they are used for illustrative purposes only. If the information includes statements of opinion, forward looking statements, forecasts or predictions based on current expectations about future events and results, any such statements are subject to change and actual results may be materially different from those shown.