2007/08 Assessment of Clearing and Settlement Facilities in Australia 1. Introduction and Executive Summary

Under powers set out in the Corporations Act 2001, the Reserve Bank has determined a set of Financial Stability Standards which aim to ensure that licensed clearing and settlement facilities conduct their affairs in such a way as to promote overall stability in the Australian financial system. Under Section 823CA of the Act, the Reserve Bank is required to conduct an assessment at least once a year of whether licensed facilities have complied with the standards and done ‘all other things necessary to reduce systemic risk’, reporting its findings to the Minister with portfolio responsibility for financial markets, and to the Australian Securities and Investments Commission (ASIC). In addition, under Section 25M of the Reserve Bank Act 1959, the Payments System Board is required to report annually to the Minister on material developments in clearing and settlement in Australia and any changes to the Financial Stability Standards.

This report fulfils both reporting obligations, covering the 12 months to end June 2008. It includes the assessment for the two licensed central counterparties – Australian Clearing House (ACH) and SFE Clearing Corporation (SFECC) – and the two securities settlement facilities – ASX Settlement and Transfer Corporation (ASTC) and Austraclear – operated by the Australian Securities Exchange (ASX). The Reserve Bank welcomes the open and constructive dialogue with ASX both in preparing this report and throughout this period.

The past year has been a more challenging one for Australia's clearing and settlement facilities than has been the case over recent years. Market volatility has increased and traded volumes and values have continued to grow in several markets, most notably in cash equities. In addition, the licensed facilities' risk-management processes have come under increased scrutiny as a result of financial problems experienced by a small number of broker participants during the first half of 2008. Reflecting these developments, the 2007/08 assessment has paid particular attention to risk-control procedures, both in terms of ongoing monitoring of participants and the management of financial risks.

Over the past year, the two central counterparties have focused increasingly on the quantification of the risks that they face and the calibration of their risk resources, as well as enhancing and harmonising their risk-management processes. The assessment draws out a number of important developments in these areas during the period under review. These include:

  • enhancements to stress-testing capabilities: Both ACH and SFECC have taken steps to enhance their stress-testing arrangements over recent years, with SFECC implementing a new stress-testing framework during 2007/08. Improvements to stress-testing capabilities will help the central counterparties to gauge the adequacy of their risk resources (i.e. the resources they have at their disposal to meet losses arising in the event of a participant default). This is particularly important as the value of novated trades increases over time.
  • mapping stress-test outcomes to risk resources: During the past year, ACH completed the second of three phases of implementation of a regime whereby collateral is called from participants to cover large exposures identified by daily stress tests. SFECC has had a similar arrangement in place for some time.
  • enhancements to margin-setting processes: A new harmonised margining process was introduced late in the assessment period at ACH and SFECC. Under the new regime, a close-out period of the higher of one or two days is assumed and initial margins are set so as to capture three standard deviations of price moves. The new regime also takes into account qualitative factors and implied volatility in setting margins.
  • the introduction of greater flexibility to treasury investments and the management of risk resources: Over the past year, ASX has created a new corporate entity, ASX Clearing Corporation, which will be used in the future to manage the treasury function for its two central counterparties. The new structure will also add flexibility to the central counterparties' funding and capital-management processes. The Reserve Bank is currently reviewing the form and legal robustness of potential new funding arrangements.

Overall, it is the Reserve Bank's judgement that all four licensed clearing and settlement facilities have complied with the relevant Financial Stability Standards over 2007/08. Importantly, however, best practice in operational and risk-management standards evolves over time in response to changes in the operating and market environment. Accordingly, the assessment identifies a number of areas for further consideration by the licensed facilities over the period ahead.

In the case of the central counterparties, the assessment draws out the following:

  • the arrangements for the ongoing monitoring of participants: In light of the financial difficulties experienced by a small number of brokers over the past year, two of whom were clearing participants, this assessment has looked closely at arrangements for monitoring participants. As acknowledged in the market assessment report released by ASIC in August, the recent problems highlighted some gaps in the general framework for market supervision and regulation, with certain business activities, including margin lending and securities lending, falling outside of the scope of existing industry-wide arrangements.[1] In the Reserve Bank's view, this episode also suggested that ASX's participant-monitoring arrangements did not adequately capture risks to the clearing and settlement facilities arising from participants' engagement in such off-market activities. The Reserve Bank therefore welcomes the review of capital- and liquidity-monitoring policies currently underway at ASX Markets Supervision and will continue to closely monitor developments in this area over the coming year.
  • participation requirements: ACH and SFECC have both recently announced their intention to raise minimum capital requirements for participants. The Reserve Bank supports efforts to raise the average financial standing of clearing participants, as this directly contributes to the stability of the central counterparty. It is important, however, that access criteria continue to be risk based and that the imposition of higher threshold capital requirements complements and does not substitute for rigorous ongoing monitoring of participants. This is acknowledged by ASX.
  • the timing of collateral calls on participants with very large positions: The regimes now in place at both ACH and SFECC for calling collateral to cover large exposures identified by stress testing are an important component of the central counterparties' risk-management processes and compare favourably with international best practice in this area. However, under these arrangements, calls can only be made in respect of participants' positions at the close of the previous day's trading. Hence, the central counterparties can retain uncovered exposure for more than 24 hours – and indeed up to 42 hours in the case of SFECC. While acknowledging the likely technological challenges involved and the protections afforded by other elements of the central counterparties' risk-management frameworks, the Reserve Bank sees a case for ASX to give further consideration to how these regimes might be enhanced to allow for the calling of collateral sooner after a large position has been established.
  • the monitoring of intraday positions: In a similar vein, the 2006/07 assessment report noted the importance of planned system enhancements at ACH to allow for changes in participants' positions to be reflected in intraday margin calls. ACH is scheduled to implement these enhancements during the forthcoming period and is strongly encouraged to proceed on this basis.
  • arrangements for the settlement of ACH margin calls: Margin calls in respect of ASX derivatives can currently be made either via Austraclear or within the daily Clearing House Electronic Sub-register System (CHESS) settlement batch operated by ASTC. The disruption to CHESS settlement in January, which resulted in a lengthy delay, revealed a vulnerability in using CHESS to settle margin payments. The Reserve Bank and ASX see a strong case to consider whether the robustness of the system would be improved by settling margin payments via Austraclear or an alternative real-time gross settlement channel. Such a change would help ensure that timely settlement of margin payments was not dependent on completion of the cash equity settlement process. The Reserve Bank understands that ASX intends to consult with the marketplace on the operational implications of such a change, in the wider context of potential modifications to settlement arrangements in CHESS.
  • treasury investment policies: Towards the end of the assessment period, a new harmonised treasury investment policy was established for ACH and SFECC, which will form the basis for the investment mandate to be applied by ASX Clearing Corporation. The policy restricts investments to high-quality, liquid assets and, except in the case of the four largest domestic banks, sets counterparty limits within the value of capital allocated to treasury investment. While this represents an improvement over previous arrangements, the limited availability of suitably high quality and liquid Australian dollar assets means that the policy leaves open the potential for large, concentrated exposures to the four largest domestic banks. The Reserve Bank will be discussing the investment mandate further with ASX during the forthcoming period as the proposed new treasury arrangements via ASX Clearing Corporation are finalised.

The assessment also draws out some issues previously discussed in the context of the Reserve Bank's review of equity settlement practices which was conducted in the first half of 2008 in response to the delays to the settlement process in late January. In its review, the Reserve Bank made a number of recommendations, including: changes to the settlement model; enhancements to the settlement fails regime; and transparency and disclosure of securities lending activity.[2] ASX has since announced amendments to the settlement fails regime and the Reserve Bank has been in dialogue with ASX and market participants in respect of the other recommendations. In this report, the Reserve Bank reiterates:

  • the need for enhancements to current settlement arrangements for cash equities: In the review, the Reserve Bank recommended a number of changes to existing settlement processes to address the risks revealed by the disruption to settlement in late January. In particular, it concluded that a move to trade-by-trade (DVP Model 1) settlement would reduce the dependence of market-wide settlements on a single participant. However, neither ASX nor market participants are persuaded of the need to move to a new settlement model and, while the Reserve Bank continues to see a case for considering such a move over the medium term, it does not see the matter as being so pressing as to require a change through regulation. In the meantime, the Reserve Bank supports the actions already taken by ASX, particularly in relation to settlement fails, and encourages ASX to give further consideration to how the resilience of the existing settlement model might be strengthened, in particular by introducing a firm deadline for completion of the batch settlement process.
  • the need for transparency and disclosure of securities lending activity: The events of late January were triggered by a participant's inability to settle obligations arising as a result of securities lending transactions. While securities lending is critical to the functioning of an efficient equities market, this activity lacks market-wide transparency and settlement participants are unable to gauge fully any potential risks to the settlement process arising from the inclusion of securities-lending transactions in the daily CHESS settlement batch. The Reserve Bank is considering a variation to the ‘Understanding Risks’ measure of the Financial Stability Standard for Securities Settlement Facilities to require the collection and dissemination of data on securities lending.

More generally, the Reserve Bank has examined the case for amending other measures underpinning the Financial Stability Standards to more directly address specific identifiable risks. The current standards and measures are largely principles based, rather than relying on prescriptive requirements. The Reserve Bank continues to favour this approach, again recognising that best practice will necessarily evolve over time. Nevertheless, the Reserve Bank would introduce more prescriptive measures if this were deemed necessary.

This report is structured as follows. Section 2 provides an overview of the clearing and settlement landscape in Australia, with Section 3 offering a summary of key developments in the clearing and settlement industry over the past year. Section 4 discusses the Financial Stability Standards against which the clearing and settlement facilities have been assessed, with Section 5 presenting assessments for each facility. More detailed information considered by the Reserve Bank in assessing the clearing and settlement facilities against each relevant measure is provided in the attachment to the report.


The report is available at: <http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/REP_135.pdf/$file/REP_135.pdf> [1]

The report is available at: <https://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/consultations/review-practices/> [2]