Financial Stability Standards for Central Counterparties Standard 15: Custody and Investment Risks
Note: The headline standard and numbered ‘sub’-standards determined under section 827D(1) of the Corporations Act 2001 have been formatted in bold text while the guidance to these standards has been formatted as plain text. For more information see the Introduction for Standards and Introduction for Guidance. Although the Reserve Bank has taken due care in compiling this page, the published version of the Standards and Guidance should be used in the case of any differences between the two.
A central counterparty should safeguard its own and its participants' assets and minimise the risk of loss on and delay in access to these assets. A central counterparty's investments should be in instruments with minimal credit, market and liquidity risks.
Guidance
A central counterparty has the responsibility to safeguard its assets, such as cash and securities, as well as the assets that its participants have provided to the central counterparty. Assets that are used by a central counterparty to support its operating funds or capital funds or that have been provided by participants to secure their obligations to the central counterparty should be held at supervised or regulated entities that have strong processes, systems and credit profiles, including other FMIs (for example, central securities depositories). In addition, assets should generally be held in a manner that assures the central counterparty of prompt access to those assets in the event that the central counterparty needs to draw on them.
A central counterparty should ensure that its investment strategy is consistent with its overall risk management strategy. Resources held by a central counterparty to cover credit, liquidity or general business risks should not be exposed to credit, market or liquidity risks (including through concentrated exposures to investment counterparties) that may compromise the ability of the central counterparty to use these resources when needed.
15.1 A central counterparty should hold its own and its participants' assets at supervised and regulated entities that have robust accounting practices, safekeeping procedures and internal controls that fully protect these assets.
15.1.1 A central counterparty should mitigate its custody risk by using only supervised and regulated entities with robust accounting practices, safekeeping procedures, and internal controls that fully protect its own and its participants' assets. It is particularly important that assets held in custody are protected against claims of a custodian's creditors. The custodian should have a sound legal basis supporting its activities, including the segregation of assets (see also CCP Standard 1 on legal basis). The custodian also should have a strong financial position to be able to sustain losses from operational problems or ancillary non-custodial activities.
15.2 A central counterparty should have prompt access to its assets and the assets provided by participants, when required.
15.2.1 A central counterparty should confirm that its interest or ownership rights in the assets can be enforced and that it can have prompt access to its assets and the assets provided by participants, when required. Timely availability and access should be ensured even if these securities are held in another time zone or jurisdiction. Furthermore, the central counterparty should confirm it has prompt access to the assets in the event of the default of a participant.
15.3 A central counterparty should evaluate and understand its exposures to its custodians, taking into account the full scope of its relationships with each.
15.3.1 A central counterparty should evaluate and understand its exposures to its custodians, taking into account the full scope of its relationships with each custodian. For example, a financial institution may serve as a custodian to a central counterparty as well as a money settlement agent or liquidity provider to the central counterparty. The custodian also may be a participant in the central counterparty and offer clearing services to other participants. A central counterparty should carefully consider all of its relationships with a particular custodian to ensure that its overall risk exposure to an individual custodian remains within acceptable limits. Where feasible, a central counterparty could consider using multiple custodians for the safekeeping of its assets to diversify its exposure to any single custodian. For example, a central counterparty may use one custodian for its margin assets and another custodian for its prefunded default resources. Such a central counterparty, however, may need to balance the benefits of risk diversification against the benefits of pooling resources at one or a small number of custodians. In any event, a central counterparty should monitor the concentration of risk exposures to, and financial condition of, its custodians on an ongoing basis.
15.4 A central counterparty's investment strategy should be consistent with its overall risk management strategy and fully disclosed to its participants, and investments should be secured by, or be claims on, high-quality obligors. These investments should allow for quick liquidation with little, if any, adverse price effect.
15.4.1 A central counterparty's strategy for investing its own and its participants' assets should be consistent with its overall risk management strategy and fully disclosed to its participants. When making its investment choices, the central counterparty should not allow pursuit of profit to compromise its financial soundness and liquidity risk management. Investments should be secured by, or be claims on, high-quality obligors to mitigate the credit risk to which the central counterparty is exposed. Within these parameters, a central counterparty should, to the extent reasonably practicable, have a high degree of confidence that its own capital would be sufficient to withstand losses associated with the failure of any individual non-government investment counterparty. This implies the imposition of conservative limits on the size and concentration of counterparty exposures. In considering its overall credit risk exposures to individual obligors, a central counterparty should also take into account other relationships with the obligor that create additional exposures, such as where an obligor is also a participant or an affiliate of a participant in the central counterparty. In addition, a central counterparty should ensure that any investment of participant assets in the securities of participants or their affiliates is subject to appropriate controls for specific wrong-way risk.
15.4.2 Because the value of a central counterparty's investments may need to be realised quickly, investments should allow for quick liquidation with little, if any, adverse price effect. For example, a central counterparty could invest in overnight reverse repo agreements backed by liquid securities with low credit risk. In allowing for quick liquidation with minimal adverse price effect, a central counterparty should also impose limits on the concentration of certain assets in its investment portfolio.