2008/09 Assessment of Clearing and Settlement Facilities in Australia Attachment: Detailed Information Relevant to Assessment against the Financial Stability Standards

A1. Financial Stability Standard for Central Counterparties

There are 10 measures that the Reserve Bank considers relevant in determining whether a facility has met the Financial Stability Standard for Central Counterparties. The full text of the measures and associated guidance is available on the Reserve Bank's website. The following provides summary details of the information the Reserve Bank has used to assess ACH and SFECC against each of the relevant measures. This updates the information presented in the Reserve Bank's 2007/08 Assessment for material changes in policies and procedures over 2008/09.

A1.1 Australian Clearing House (ACH)

1. Legal framework

The central counterparty must have a well-founded legal basis.

ACH Pty Limited is a wholly owned subsidiary of ASX Clearing Corporation, itself a wholly owned subsidiary of ASX Limited. It acts as the central counterparty for cash equities, equity derivatives, certain interest-rate products and warrants traded on the ASX market.

The legal basis for ACH's operations is set out in its Clearing Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between ACH and each of its participants, and between each participant and each other participant. Furthermore, the netting arrangements contained in ACH's Clearing Rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of a participant. During the assessment period, ASX implemented some rule-book clarifications around the protections afforded by this Act.

ACH's Clearing Rules define the nature and scope of its obligation to provide clearing support to participants, and describe the conditions under which final and irrevocable settlement of obligations is deemed to have occurred. The Clearing Rules also set out the rights and obligations of participants, including in the event of default or suspension.

2. Participation requirements

The requirements for participation in the central counterparty must promote the safety and integrity of the central counterparty and ensure fair and open access. Participation requirements must:

  1. be based on objective and publicly disclosed criteria;

ACH has objective and transparent participation requirements, which are publicly available and form part of the Clearing Rules and Procedures. The Clearing Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated.

At the end of June 2009, ACH had 57 participants – 55 of these were also ASX market participants, while two provided specialist third-party clearing services.

  1. ensure that participants in the central counterparty are of a sufficient financial standing such that the central counterparty is not exposed to unacceptable credit risks;

ACH's participation requirements are designed to promote the safety and integrity of the central counterparty. Participants clearing cash equities or options are required to comply with a risk-based capital regime under which, subject to maintaining a minimum of $2 million in ‘core liquid’ capital, they must hold ‘liquid’ capital in excess of a ‘total risk requirement’, which reflects counterparty risk, large exposure risk, position risk and operational risk. Work on an additional risk category, underwriting risk, continues, and a project was launched during the assessment period to refine the risk-calculation methodology for a number of other transaction types (including securities lending and margin lending). Participants that clear futures only may elect to be covered by an alternative capital regime, based either on a net tangible asset requirement[1] or compliance with the regime of another prudential supervisor. At the end of the assessment period all but two of ACH's 57 participants were subject to the risk-based regime; the remaining two were subject to net tangible asset requirements.

ACH has announced its intention to implement a further increase in the minimum capital requirement for participants operating under the risk-based regime. This was the subject of a joint review by ASIC and the Reserve Bank in early 2009. Following this review, ACH adjusted the time-line for implementing this increase and now intends to raise minimum requirements in two stages: $5 million in mid-2010, and $10 million in January 2012 (with a higher requirement for third-party clearers).

Participants are subject to ongoing monitoring by ACH, with this conducted by two units within ASX, ASXMS and Clearing Risk Operations:

  • The monitoring, assessment and investigation of matters relating to financial requirements is dealt with by the capital- and liquidity-monitoring unit of ASXMS, a separate subsidiary within the ASX group with its own board. Participants are required to submit capital and liquidity returns on a monthly basis, which ASXMS then monitors for exceptions (an improved technical solution is under development for the delivery of these reports). ASXMS applies a number of triggers for follow-up enquiries, including: a fall to below 1.7 in the ratio of liquid capital to the total risk requirement; sustained losses on outstanding positions; and a significant fall in liquid capital held. More stringent reporting requirements apply where a participant's capital falls below certain stated thresholds.
  • Clearing Risk Operations, a unit located within the central counterparties, focuses on day-to-day participant activity and monitors risk profiles, open positions and settlement of obligations to the central counterparties. It also determines and reviews participants' ICRs, drawing on information provided by participants in their returns to ASXMS. The ICR is based on the participant's external credit rating (if available) or that of its parent, if either that parent provides a formal guarantee to the central counterparty or the participant carries the parental corporate name. Otherwise, the rating is based on the participant's capital position. ASX Clearing Risk Operations also maintains a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list might, for instance, reflect issues arising from routine review of financial returns by ASXMS, or concerns emerging from a specific event or media report. Participants on the watch list are subject to greater scrutiny in respect of the exposures they bring to the central counterparty and, should a participant's perceived financial standing deteriorate further, restrictions may be placed on its trading, clearing and settlement activities.

ACH has developed policies that allow for relevant information to flow between ASXMS and other business units within ASX. These are embodied in a ‘Supervisory Code of Conduct’ and ‘Commercial and Supervisory Conflict of Interest Policy’, which together aim to ensure that potential conflicts between ASX's supervisory responsibilities and its commercial interests are avoided. During the assessment period a formal monthly liaison meeting between ASXMS, Clearing Risk Operations and Clearing and Settlement Operations was introduced, to facilitate the exchange of clearing risk-relevant information on clearing participants.

  1. require that participants have the operational capacity to settle their obligations with the central counterparty in a timely manner; and

ACH participants are subject to requirements regarding technical and operational capacity, including business continuity. Standards for business and management integrity also apply, aimed at ensuring compliance with the ACH Clearing Rules.

  1. allow the CS facility licensee as operator of the central counterparty to suspend or cancel the participation of an institution which breaches the applicable participation or other risk-control requirements.

ACH has wide-ranging powers to sanction its participants in order to preserve the integrity of the central counterparty. ACH may terminate a participant's authority to clear all, or any category of, market transactions in the event of a default, or in the event of a breach of the Clearing Rules which may have an adverse impact on the central counterparty. The action taken in the event of a breach will depend on a number of factors, including the participant's history of compliance and whether the breach is suggestive of negligence, incompetence or dishonesty. Where a breach has been identified and the participant has taken appropriate steps to rectify it, ACH will typically continue to monitor the participant closely for a period of time. Breaches are also referred to ASIC and, in most cases, are investigated by ASXMS.

3. Understanding risks

The central counterparty's rules and procedures must enable each participant to understand the central counterparty's impact on each of the financial risks the participant incurs through participation in the central counterparty.

ACH's Clearing Rules and Procedures are comprehensive and publicly available. The Rules and Procedures explain the role and responsibilities of each category of participant and ACH. Some background information on ACH's operations and risk management is also available on the ASX website.

ACH must lodge any changes to its Clearing Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. ACH consults with its participants on important rule changes, and notifies participants of all changes to the Clearing Rules or Procedures.

4. Novation

The rules and procedures governing the central counterparty must clearly identify:

  1. the nature and scope of novation; and

The nature and scope of novation is set out in ACH's Clearing Rules. Through the process of novation, ACH takes on the financial obligations of the seller to the buyer, and the buyer to the seller. The obligations of ACH are to each clearing participant as principal, irrespective of whether that participant is acting as an agent on behalf of a client.

  1. the point in the clearing process at which trades are novated.

The point at which trades are novated is set out in the Clearing Rules. These specify that a broker-to-broker transaction on the ASX market is novated to ACH upon the acceptance and registration of the details of that market transaction within the clearing system. For physical equities transactions, novation occurs almost immediately after the matching of the trade on the market. In the case of derivatives transactions, novation takes place on the evening of the day of the trade, when trade details are allocated to participants' accounts.

5. Settlement

Settlement arrangements must ensure that the central counterparty's exposures are clearly and irrevocably extinguished on settlement.

Settlement of obligations between a central counterparty and its participants can involve two processes:

  • The exchange of one asset for another, such as cash equities. In this case, ACH utilises the settlement facility provided by ASTC.
  • Payments to or from the central counterparty, including margin payments relating to derivatives positions. In this instance, the facilities provided by either ASTC or Austraclear may be used.

In each case, ACH calculates bilateral net positions between itself and each of its clearing participants. These positions reflect both cash payment and securities obligations. The relevant netting arrangements are outlined in ACH's Clearing Rules and are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act.

ASTC's settlement process involves the use of a Model 3 DVP mechanism, whereby cash payments and securities transfers are settled simultaneously in a single daily multilateral net batch. As the outcome of this process, ASTC participants face a net cash settlement obligation to or from ASTC and a net securities settlement obligation in respect of each line of stock. Once participants' net obligations have been calculated, ASTC confirms that sufficient securities are available in each participant's securities account in CHESS. The transfer of securities within the system is then restricted until the settlement process has been completed. Net cash payment obligations are forwarded for settlement in RITS across payment providers' ES accounts. Once cash settlement has been confirmed, ASTC effects the net transfer of securities within CHESS.

Under current arrangements, ACH participants can choose whether to settle routine margin payments in respect of ASX derivatives positions via Austraclear or alongside securities-related settlement obligations in the daily batch-settlement process in CHESS. Where a participant elects to settle derivatives margin obligations using Austraclear, settlements are made via cash transfers. These settle in real time across ES accounts, again via RITS. Having consulted with industry, ACH intends to require that all derivatives margins payments be settled via Austraclear. This is consistent with the requirement that all intraday margin payments and obligations under the CAC regime be settled via Austraclear.

Settlement in both ASTC and Austraclear is final and irrevocable. In the case of ASTC, finality is supported both by its Settlement Rules and ASTC's approval under Part 3 of the Payment Systems and Netting Act. Settlement according to Austraclear's Regulations is also final and irrevocable by virtue of its approval under Part 2 of the Payment Systems and Netting Act.[2]

In a related development, foreshadowed in the 2007/08 Assessment, ACH recently gained approval to operate an ES account with the Reserve Bank. ACH will use the account for margin-related funds movements and treasury investment-related settlements in RITS. These payments were previously settled under an agency agreement with a commercial bank. This agency arrangement will continue to be used in relation to securities-related settlements in CHESS.

ACH also clears grain and wool futures. These instruments may be physically settled through commodity warehouses, with ACH transferring title to the buyer only once payment is received from the seller.

6. Default arrangements

The CS facility licensee as operator of the central counterparty must ensure that it has clear rules and procedures to deal with the possibility of a participant being unable to fulfil its obligations to the central counterparty. The arrangements for dealing with a default must ensure that in this scenario timely action is taken by the central counterparty and the participants in the central counterparty, and that risks to the central counterparty and its participants are minimised.

  1. require its participants to inform it if they:
    1. become subject to external administration, or have reasonable grounds for suspecting that they will become subject to external administration; or
    2. have breached, or are likely to breach, a risk-control requirement of the central counterparty.

ACH's Clearing Rules set out notification requirements that participants must meet in relation to a default. A participant is required to inform ACH should it default under the Clearing Rules. A range of default events are set out in the Clearing Rules, including: the appointment of an external administrator (or a reasonable expectation that one will be appointed); a breach of ACH's capital requirements; or a failure to meet payment or settlement obligations to ACH.

  1. have the ability to close out, or otherwise deal with a participant's open contracts in order to appropriately control risk if a participant:
    1. (i) becomes subject to external administration; or
    2. (ii) breaches a risk-control requirement of the central counterparty.

The Clearing Rules provide ACH with the authority and flexibility to deal with a participant default and to ensure that settlement of novated positions occurs. For equities, ACH is able to reschedule any settlements involving the failed participant, or those affected by its failure. ACH may also enter into market transactions to sell or purchase securities to facilitate the settlement of novated transactions. For derivatives, ACH has the ability to close out a defaulted participant's positions, or to seek to transfer the client positions of the defaulted participant to a surviving participant.

These rules are supplemented by an internal default-management plan. ASX is working to enhance default-management processes for both central counterparties, with the aim of managing legal, operational and liquidity risk, and minimising potential losses and spillovers that could arise in a default scenario. In a first stage of this work, ASX has sought to clarify key decision points and ‘default intentions’. In a second stage, ASX will establish whether any changes are required to its Clearing Rules to support its default intentions. Some steps have already been taken, including the conclusion of a formal ex-ante agreement with a broker to assist in the close out of a defaulting participant's positions.

ACH also has a range of financial resources available to ensure that it can meet its obligations in the event of a participant default (Measure 7).

7. Risk controls

The CS facility licensee as operator of a central counterparty must have comprehensive risk-control arrangements in place. These arrangements must provide the operator of the central counterparty with a high degree of confidence that, in the event of extreme volatility in relevant markets, the central counterparty will be able to settle all of its obligations in a timely manner. As a minimum, the risk-control arrangements must provide the CS facility licensee as operator of the central counterparty with a high degree of confidence that the central counterparty will be able to settle its obligations in the event that the participant with the largest settlement obligations cannot meet them. In all but the most extreme circumstances, a central counterparty must be able to settle its obligations using liquid assets as defined in this standard.

The CS facility licensee as operator of a central counterparty must:

  1. ensure that its risk-control measures, typically a combination of its own capital, margins, guarantee funds and pre-determined loss-sharing arrangements, provide sufficient coverage and liquidity; and
  2. undertake regular and rigorous stress testing to ensure the adequacy of its risk controls.

The adequacy of risk-control measures must be approved by the board of the central counterparty, or an appropriate body as delegated by the board.

The risk controls of a central counterparty are crucial in providing a high degree of confidence that it would be able to meet its obligations in the event of a participant failure. The inability of a central counterparty to meet its obligations could be extremely disruptive to the financial system. The focus of the Reserve Bank in this area is on ensuring that the combination of risk controls applied achieves a very low probability of failure of the central counterparty.

At the core of ACH's risk controls is its financial resources. These comprise: margin and other collateral calls based on participants' positions; and pooled financial resources of $550 million (of which $250 million is fully paid up and invested in high-quality liquid assets). Stress testing is carried out daily to gauge the adequacy of financial resources and to monitor the risks associated with individual participants' positions. Where large or concentrated exposures are identified by stress testing, additional collateral calls are made on participants. These risk controls are supplemented by ACH's participation requirements and participant-monitoring arrangements (Measure 2).

i. Margins

ACH levies margin on equity derivatives products, but does not do so for cash equities.

Initial (risk) margin provides cover in the event that a participant defaults and an adverse price change occurs before the central counterparty can close out the participant's positions. Initial margin is calibrated so as to cover three standard deviations of the distribution of price movements until a position can be closed out, assuming a close-out period of either one or two days. ACH also levies so-called premium margin on sold exchange-traded option positions, updating this daily to reflect mark-to-market changes in the close-out price, and levies mark-to-market margin on both bought and sold low-exercise-price options, and all futures positions. All margin rates are reviewed on a three-monthly cycle, supplemented with ad hoc reviews in volatile market conditions.

ACH calculates total initial margin requirements across each participant's portfolio using the internationally accepted TIMS methodology, developed by the Options Clearing Corporation. ACH has a project underway to migrate the calculation of margin under the TIMS methodology to ACH's in-house DCS.

Margin requirements are calculated overnight based on closing contract prices each day, and are notified to participants the next morning. If settled via Austraclear, margin obligations must be met by 10.30am; if settled via ASTC's CHESS batch process, obligations are typically met by around noon. Participants generally meet their margin obligations using cash, although they may also use non-cash collateral. In this regard, ACH recently introduced new collateral eligibility criteria. These new criteria place greater emphasis on credit quality and liquidity. As such, some less-liquid assets are no longer accepted (eg, warrants, perpetual income securities and partly-paid shares), and only the top-200 equities are eligible under the new rules, unless these are posted as specific cover for an options position. Changes have also been made to better manage the potential risk of correlated default of a participant and collateral issuer (eg, where parental collateral is posted). Appropriate haircuts are applied where non-cash collateral is posted.

In the event of sharp price movements intraday, ACH may also call mark-to-market margin intraday. This must be met by participants within two hours of notification. In order to facilitate timely settlement of intraday margin calls, ACH has imposed a requirement that these be settled via Austraclear. While at present ACH is only able to calculate intraday margin calls on the basis of price movements, planned system enhancements will also enable calls to be made on the basis of changes in participants' positions.

Under the so-called CAC regime, a participant is also required to post additional collateral should stress-test outcomes (see below) reveal that the projected stress loss arising from its positions as at the close of the previous day exceed a common STEL of $150 million. Until recently, this was the sum of ACH's fully paid-up risk resources. Calls under this regime are typically made on participants by 9.30am and must be settled within two hours, either via the transfer of cash in Austraclear, or through the provision of a bank guarantee from an approved ADI.

ACH has announced that it will introduce a regime whereby STELs are linked to a participant's ICR. Furthermore, in normal market conditions, highly rated counterparties will be required to cover only a proportion of the excess exposure beyond the stated threshold.[3] Such a regime is already in place at SFECC (see A1.2).

ii. Guarantee Fund

ACH maintains additional pooled financial resources to protect against losses in excess of margin and other collateral assets posted by a defaulting participant. ACH holds paid-up financial resources of $250 million, which consist of: own equity ($3.5 million); funds held in a restricted capital reserve ($71.5 million); subordinated debt issued to ASX Limited ($75 million); and a fully-drawn subordinated loan from a commercial bank ($100 million, which replaced ACH's default insurance in June 2009). ACH also has the right under its Clearing Rules to levy its participants up to $300 million collectively in ‘Emergency Assessments’ should a loss caused by a participant's default exceed its other resources.

ACH uses daily capital stress tests to monitor the risks undertaken by individual participants and the adequacy of the central counterparty's financial resources. In December 2008, ACH implemented a new range of stress-test scenarios which significantly increase the information it has to undertake this analysis. Stress tests are based on 99 scenarios, each calibrated to a one-in-30-year probability of occurring. The scenarios cover extreme price moves and volatility shifts at the market-wide, sector, and individual stock levels.

In respect of both cash margin collected and pooled risk resources, ACH invests funds in accordance with a defined treasury investment policy, endorsed by the ACH Clearing Board. The policy is designed to ensure that risk resources can be reliably accessed on a timely basis. The policy restricts treasury investments to liquid assets – such as bank bills and certificates of deposit – and applies issuer investment limits scaled according to the credit standing issuing counterparty. Eligible investment counterparties are APRA-supervised ADIs, with a minimum short-term credit rating of A1. With the exception of instruments issued by the four largest domestic banks, individual counterparty limits are set within the value of ACH's capital resources. Concentration limits also apply (the maximum exposure to any investment counterparty is 33 per cent).

The policy also sets upper limits for the average maturity of investments and the market risk of the portfolio (ie, price value of a basis point), and an overarching liquidity requirement based on assumed ‘ordinary’ liquidity needs (eg, for the return of margin to participants) and liquidity needs in the event of a default (a so-called DLR). To ensure the adequacy of the DLR, ACH carries out regular liquidity stress tests. The DLR is currently set at $300 million and is met by liquid assets held in respect of its paid-up capital resources of $250 million, and a further $50 million available under a committed standby facility from a commercial bank.

iii. Loss sharing

ACH does not use loss sharing arrangements.

8. Governance

The central counterparty must have effective, accountable and transparent governance arrangements.

The ACH Clearing Board is responsible for oversight of the operation of the central counterparty. It meets between six and eight times each year, and receives detailed reports on ACH's business and operations, risk management and financial performance. It is responsible for approving capital, liquidity and stress-testing arrangements.

The Clearing Board consists of eight directors. These include four executive directors from ASX management (including the CEO and finance director), two ASX Limited non-executive directors, and two independent directors. The independent directors are appointed for their skill and expertise in clearing and settlement operational and risk-management matters. The eight directors filling these positions are also on the boards of SFECC, ASTC and Austraclear. SFECC and Austraclear share a common chair, as do ACH and ASTC.

The risk policy and risk operations areas within the ASX group are functionally separate, with each having separate reporting lines to the Clearing Board. In addition, an internal Capital and Liquidity Committee provides focus to capital and liquidity issues across the ASX group.

9. Operational risk

The CS facility licensee as operator of a central counterparty must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

Details of the operational risk-management procedures across all four licensed CS facilities in the ASX group are provided in Section 6.

10. Regulatory reporting

CS facility licensees, as operators of central counterparties, are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standard for Central Counterparties. These obligations include the reporting of: breaches of the Standard; the failure of a participant to fulfil the central counterparty's risk-control requirements; and the central counterparty's failure to enforce its own risk-control requirements. There are also obligations to report financial and stress-testing results on a quarterly basis. ACH satisfied all reporting obligations during the assessment period.

A1.2 SFE Clearing Corporation (SFECC)

1. Legal framework

The central counterparty must have a well-founded legal basis.

SFECC is a wholly owned subsidiary of ASX Clearing Corporation, itself a wholly owned subsidiary of ASX Limited. It acts as the central counterparty for the SFE.

The legal basis for SFECC's operations is set out in its Clearing Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between SFECC and each of its participants, and between each participant and each other participant. Furthermore, the netting arrangements contained in SFECC's Clearing Rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of a participant. During the assessment period ASX implemented some rule-book clarifications around the protections afforded by this Act.

SFECC's Clearing Rules define the nature and scope of its obligation to provide clearing support to participants, and describe the conditions under which final and irrevocable settlement of obligations is deemed to have occurred. The Clearing Rules also set out the rights and obligations of participants, including in the event of default or suspension.

2. Participation requirements

The requirements for participation in the central counterparty must promote the safety and integrity of the central counterparty and ensure fair and open access. Participation requirements must:

  1. be based on objective and publicly disclosed criteria;

SFECC has objective and transparent participation requirements, which are publicly available and form part of the Clearing Rules and Procedures. The Clearing Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated.

At the end of June 2009, SFECC had 15 participants. Of these, 13 were also participants of the SFE, while two provided specialist clearing and settlement services.

  1. ensure that participants in the central counterparty are of a sufficient financial standing such that the central counterparty is not exposed to unacceptable credit risks;

SFECC's participation requirements are designed to promote the safety and integrity of the central counterparty. They cover: minimum capital and financial obligations; business and managerial requirements; operational resources: business continuity arrangements: and risk- and liquidity-management arrangements.

Participants are subject to a minimum NTA requirement of $5 million, with management discretion to impose a higher requirement. SFECC has announced that this minimum will be raised to $10 million for clearing participants that are not ADIs, and to $20 million for those clearing for third parties. The timing of this change has not yet been finalised, although it is likely to be linked to the timing of increases to minimum capital requirements for ACH participants. Participants are obliged to lodge a detailed financial report with the capital- and liquidity-monitoring unit of ASXMS on a monthly basis, or more frequently in the event that their NTAs fall below a certain threshold.

Participants are subject to ongoing monitoring by SFECC, with this conducted by two units within ASX, ASXMS and Clearing Risk Operations:

  • The monitoring, assessment and investigation of matters relating to financial requirements are dealt with by the capital- and liquidity-monitoring unit of ASXMS, a separate subsidiary within the ASX group with its own board. Participants are required to submit NTA returns on a monthly basis, which ASXMS then monitors for exceptions.
  • Clearing Risk Operations, a unit located within the central counterparties, focuses on day-to-day participant activity and monitors risk profiles, open positions and settlement of obligations to the central counterparties. It also determines and reviews participants' ICRs, drawing on information provided by participants in their returns to ASXMS. The ICR is based on the participant's external credit rating (if available) or that of its parent, if either that parent provides a formal guarantee to the central counterparty or the participant carries the parental corporate name. Otherwise, the rating is based on the participant's capital position. ASX Clearing Risk Operations also maintains a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list might, for instance, reflect issues arising from routine review of financial returns by ASXMS, or concerns emerging from a specific event or media report. Participants on the watch list are subject to greater scrutiny in respect of the exposures they bring to the central counterparty and, should a participant's perceived financial standing deteriorate further, restrictions may be placed on its trading, clearing and settlement activities.

SFECC has developed policies that allow for relevant information to flow between ASXMS and other business units within ASX. These are embodied in a ‘Supervisory Code of Conduct’ and ‘Commercial and Supervisory Conflict of Interest Policy’, which together aim to ensure that potential conflicts between ASX's supervisory responsibilities and its commercial interests are avoided. During the assessment period a formal monthly liaison meeting between ASXMS, Clearing Risk Operations and Clearing and Settlement Operations was introduced, to facilitate the exchange of clearing risk-relevant information on clearing participants.

  1. require that participants have the operational capacity to settle their obligations with the central counterparty in a timely manner;

Under the Clearing Rules, the SFECC Board must be satisfied that a potential participant has (or will have) managerial, operational, financial and appropriate complementary business continuity arrangements in place to enable it to meet its ongoing obligations, and is in a position to make an immediate transfer of funds to meet its obligations.

  1. allow the CS facility licensee as operator of the central counterparty to suspend or cancel the participation of an institution which breaches the applicable participation or other risk-control requirements.

Under the Clearing Rules, a clearing participant may be automatically suspended under a number of circumstances, including the participant's default, the appointment of external management, or the breach of financial requirements. The SFECC Board can also suspend a clearing participant for misconduct, breaches of the Clearing Rules, or if it ceases to satisfy the admission requirements.

3. Understanding risks

The central counterparty's rules and procedures must enable each participant to understand the central counterparty's impact on each of the financial risks the participant incurs through participation in the central counterparty.

SFECC's Clearing Rules and Procedures are comprehensive and publicly available. The Rules and Procedures explain the role and responsibilities of participants and SFECC. Background information on SFECC's operations and risk management is also available on the ASX website.

SFECC must lodge any changes to its Clearing Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. SFECC consults with its participants on important rule changes. Announcements affecting participants are issued ‘SFE Notices’.

4. Novation

The rules and procedures governing the central counterparty must clearly identify:

  1. the nature and scope of novation;

The nature and scope of novation is set out in SFECC's Clearing Rules. Through the process of novation, SFECC takes on the financial obligations of the seller to the buyer, and the buyer to the seller. The obligations of SFECC are to each participant as principal, irrespective of whether that participant is acting as an agent on behalf of a client.

  1. the point in the clearing process at which trades are novated.

The point at which trades are novated is set out in the Clearing Rules. These specify that a transaction on the SFE market is novated to SFECC upon the registration of a matched trade by the market. Non-market trades are novated once their details have been approved and registered by SFECC.

5. Settlement

Settlement arrangements must ensure that the central counterparty's exposures are clearly and irrevocably extinguished on settlement.

The vast majority of SFECC settlements involve cash payments to or from the central counterparty. These include margin payments and the settlement of cash-settled derivative contracts. Settlement of payments generally occurs on a net basis. Each day, SFECC calculates the net obligations of each of its participants. SFECC participants calculated to have a net obligation to the central counterparty are required to make payments to SFECC in Austraclear by 11.00am each morning. Once these payments have been received, SFECC makes payments to those participants with a net obligation from the central counterparty. Interbank settlement of these payments occurs between participants' appointed bankers across ES accounts at the Reserve Bank. SFECC holds an ES account.

In some cases, the settlement of derivatives contracts cleared by SFECC involves the transfer of a security or physical asset, with a corresponding transfer of cash. For each type of security or asset, SFECC's arrangements ensure that delivery occurs if, and only if, payment occurs and vice versa. For 90-day bank accepted bill futures, SFECC utilises the standard settlement process in Austraclear. The delivery of greasy wool is via a warehouse, with SFECC retaining title documentation until payment has been made.

The settlement of obligations is final and irrevocable according to the terms of SFECC's Clearing Rules and SFE's Market Rules, which set out contract specifications, including the means of settlement. For payments and securities obligations settled through Austraclear, finality is reinforced by Austraclear's Regulations and its approval under Part 2 of the Payment Systems and Netting Act. Any interbank transactions arising from these settlements are settled across ES accounts held with the Reserve Bank. Payments within this system are also final and irrevocable; this is again Payment Systems and Netting Act.

6. Default arrangements

The CS facility licensee as operator of the central counterparty must ensure that it has clear rules and procedures to deal with the possibility of a participant being unable to fulfil its obligations to the central counterparty. The arrangements for dealing with a default must ensure that in this scenario timely action is taken by the central counterparty and the participants in the central counterparty, and that risks to the central counterparty and its participants are minimised. In meeting this requirement, the CS facility licensee as operator of the central counterparty must:

  1. require its participants to inform it if they:
    1. become subject to external administration, or have reasonable grounds for suspecting that they will become subject to external administration; or
    2. have breached, or are likely to breach, a risk-control requirement of the central counterparty.

SFECC's Clearing Rules require that participants inform SFECC immediately in the event of a default, or if there is a reasonable expectation of such an event. The Clearing Rules envisage a number of possible events of default. These include: becoming subject to external administration; being unable to meet obligations relating to open contracts; and being in breach of the central counterparty's risk-control requirements, such as failing to fulfil margin or other payment obligations to the central counterparty.

  1. have the ability to close out, or otherwise deal with a participant's open contracts in order to appropriately control risk if a participant:
    1. becomes subject to external administration; or
    2. breaches a risk-control requirement of the central counterparty.

The Clearing Rules provide SFECC with the authority and flexibility to deal with a participant default. SFECC has the ability to close out any open contracts, to exercise or terminate open contracts, or to seek to transfer client positions along with related margin payments.

These formal rules are supplemented by an internal default management plan. ASX is working to enhance default-management processes for both central counterparties, with the aim of managing legal, operational and liquidity risk, and minimising potential losses and spillovers that could arise in a default scenario. In a first stage of this work, ASX has sought to clarify key decision points and ‘default intentions’. In a second stage, ASX will establish whether any changes are required to its Clearing Rules to support its default intentions. Some steps have already been taken, including the negotiation of an ex-ante agreement with a broker to assist in the close out of a defaulting participant's positions.

SFECC also has a range of financial resources available to enable it to act on the default powers set out above and to meet its obligations as central counterparty (see Measure 7).

7. Risk controls

The CS facility licensee as operator of a central counterparty must have comprehensive risk-control arrangements in place. These arrangements must provide the operator of the central counterparty with a high degree of confidence that, in the event of extreme volatility in relevant markets, the central counterparty will be able to settle all of its obligations in a timely manner. As a minimum, the risk-control arrangements must provide the CS facility licensee as operator of the central counterparty with a high degree of confidence that the central counterparty will be able to settle its obligations in the event that the participant with the largest settlement obligations cannot meet them. In all but the most extreme circumstances, a central counterparty must be able to settle its obligations using liquid assets as defined in this standard.

The CS facility licensee as operator of a central counterparty must:

  1. ensure that its risk-control measures, typically a combination of its own capital, margins, guarantee funds and pre-determined loss-sharing arrangements, provide sufficient coverage and liquidity; and
  2. undertake regular and rigorous stress testing to ensure the adequacy of its risk controls.

The adequacy of risk-control measures must be approved by the board of the central counterparty, or an appropriate body as delegated by the board.

The risk controls of a central counterparty are crucial in providing a high degree of confidence that it would be able to meet its obligations in the event of a participant failure. The inability of a central counterparty to meet its obligations could be extremely disruptive to the financial system. The focus of the Reserve Bank in this area is on ensuring that the combination of risk controls applied achieves a very low probability of failure of the central counterparty.

At the core of SFECC's risk controls are its financial resources. These comprise: margin and other collateral calls based on participants' positions; and pooled financial resources of $400 million (of which $220 million is fully paid up and invested in high-quality liquid assets). Stress testing is carried out daily to gauge the adequacy of financial resources and to monitor the risks associated with individual participants' positions. Where large or concentrated exposures are identified by stress testing, additional collateral calls are made on participants. These risk controls are supplemented by SFECC's participation requirements and participant-monitoring arrangements (Measure 2).

i. Margins

SFECC levies margin on the derivatives products it clears.

Initial margin is calibrated so as to cover three standard deviations of the distribution of price movements until a position can be closed out, assuming a close-out period of either one or two days. All margin rates are reviewed on a three-monthly cycle, with the possibility of more frequent ad hoc reviews in times of market volatility.[4]

SFECC calculates total initial margin requirements across each participant's portfolio using the internationally accepted SPAN methodology. Margin requirements are calculated overnight based on closing contract prices each day, and are notified to participants by 7am the next morning. Margin obligations must be met via Austraclear by 11.00am – breaches of any margin payment deadline are escalated to ASXMS and may attract a financial penalty. Participants generally meet these obligations using cash, although they may also use high-quality liquid non-cash collateral, such as eligible debt securities, certain equities, and foreign-currency deposits. Haircuts are applied in respect of all non-cash collateral posted. Among recent changes to its collateral eligibility criteria, SFECC excluded parental/self guarantees, so as to reduce the possibility that SFECC faced the correlated default of a clearing participant and a collateral issuer.

SFECC also levies variation (mark-to-market) margin on derivatives positions to cover gains or losses arising from price movements over the preceding day. Should conditions warrant, SFECC is also able to call variation margin intraday, based on movements in either positions or prices. Intraday margin calls can be made at various times throughout the day. Participants are required to meet an intraday margin call within two hours of notification. Both variation and intraday margin obligations must be settled in cash.

SFECC also uses a system of AIMs, based on participants' exposures in SFE's four largest contracts. AIMs are intended to cover potential losses from large, concentrated positions with the central counterparty in extreme market conditions. SFECC calculates potential exposures using a system of stress tests (see below) and makes AIMs calls to cover projected stress losses in excess of a stated threshold – the participant's STEL – which is linked to the value of SFECC's risk resources and varies according to the credit quality of the participant. Highly rated participants with NTAs above a minimum threshold are eligible for discounts on their AIMs calls of up to 50 per cent of the projected stress loss in excess of the STEL in normal market conditions (up to a maximum discount of $500 million).[5]

This system is designed to provide a high degree of confidence that the central counterparty will be able to meet its obligations, even in the event that losses arising from a participant default exceed SFECC's pooled risk resources (see below). Like other margins, AIMs are calculated overnight, notified to participants at 7.00am the next day, and must be met by 11.00am. Participants may meet these obligations using cash or non-cash collateral, including Commonwealth Government securities and bank bills or letters of credit from ADIs.

In accordance with the Clearing Rules, in the event of a default by a participant, SFECC would first apply margin, securities or other property from the defaulter to satisfy its obligations to other participants.

ii. Guarantee fund

SFECC maintains a buffer of financial resources to protect against losses arising in the event of a default that exceed the value of margin and other collateral assets contributed by the defaulting participant. The value of SFECC's Clearing Guarantee Fund is $400 million, comprising SFECC's own capital ($30 million); a subordinated loan from ASX Limited ($70 million); paid-up participant commitments ($120 million); second-level (promissory) participant commitments ($30 million); and insurance coverage ($150 million). The SFECC Clearing Rules state that the SFECC Board shall be entitled to apply these resources upon default by a Clearing Participant. The rules stipulate the order in which the resources will be applied, and make it clear that the contributions of all participants, not just those in default, may be called upon in a default event.

SFECC has announced its intention to exit its default insurance arrangements in due course. SFECC has indicated that if its insurer's credit rating falls further in the near term, it will accelerate its exit from these arrangements. Indeed, an ‘in principle’ subordinated-loan agreement, similar to that negotiated by ACH, has been reached with a commercial bank which it is anticipated could be triggered at relatively short notice.

SFECC uses daily stress tests of its four major contracts to monitor the risks undertaken by individual participants and the adequacy of the Clearing Guarantee Fund. SFECC uses a suite of portfolio and single-contract stress-test scenarios based on statistical analysis of historical market movements. These provide consistent tests across contract types and are tailored to SFECC's risk tolerance, as defined by its board. The stress scenarios aim to capture one-in-30 year events for single asset scenarios and one-in-100 year events for multi-asset scenarios.

In respect of both cash margin collected and pooled risk resources, SFECC invests funds in accordance with a defined treasury investment policy, endorsed by the SFECC Board, which is designed to ensure that risk resources can be reliably accessed on a timely basis. The policy restricts treasury investments to liquid assets – such as bank bills and certificates of deposit – and applies issuer investment limits scaled according to the credit standing of the issuing counterparty. Eligible investment counterparties are APRA-supervised ADIs, with a minimum short-term credit-rating of A1. With the exception of instruments issued by the four largest domestic banks, individual counterparty limits are set within the value of SFECC's capital resources. Concentration limits also apply (the maximum exposure to any investment counterparty is 33 per cent).

The policy also sets upper limits for the average maturity of investments and the market risk of the portfolio (ie, price value of a basis point), and an overarching liquidity requirement based on assumed ‘ordinary’ liquidity needs (eg, for the return of margin to participants) and liquidity needs in the event of a default: a so-called DLR. During the assessment period, SFECC introduced a liquidity stress-testing model to assess the adequacy of its liquidity arrangements. The model, which is similar to that used by ACH, calculates the maximum liquid funds that SFECC would need to access in order to meet obligations arising in the event of a clearing participant default. The model is based on SFECC's capital stress tests.

The results of the liquidity stress test are compared with the DLR. The DLR is currently set at $220 million, comprising SFECC's own capital ($100 million) and the clearing participants' paid up commitments ($120 million). Breaches of the DLR trigger a review of the adequacy of the DLR. This review will take into account the outcome of the capital stress tests, as any AIMs calls will provide extra liquidity.

iii. Loss sharing

SFECC does not use loss sharing arrangements.

8. Governance

The central counterparty must have effective, accountable and transparent governance arrangements.

The SFECC Clearing Board is responsible for oversight of the operation of the central counterparty. It meets between six and eight times each year, and receives detailed reports on SFECC's business and operations, risk management and financial performance. It is responsible for approving capital, liquidity and stress-testing arrangements.

The Clearing Board consists of eight directors. These include four executive directors from ASX management (including the CEO and finance director), two ASX Limited non-executive directors, and two independent directors. The independent directors are appointed for their skill and expertise in clearing and settlement operational and risk-management matters. The eight directors filling these positions are also on the boards of ACH, ASTC and Austraclear. SFECC and Austraclear share a common chair, as do ACH and ASTC.

The risk policy and risk operations areas within the ASX group are functionally separate, with each having separate reporting lines to the SFECC Board. In addition, an internal Capital and Liquidity Committee provides focus to capital and liquidity issues across the ASX group.

9. Operational risk

The CS facility licensee as operator of a central counterparty must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

Details of the operational risk-management procedures across all four licensed CS facilities in the ASX group are provided in Section 6.

10. Regulatory reporting

CS facility licensees, as operators of central counterparties, are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standard for Central Counterparties. These obligations include the reporting of: breaches of the Standard; the failure of a participant to fulfil the central counterparty's risk-control requirements; and the central counterparty's failure to enforce its own risk-control requirements. There are also obligations to report financial and stress-testing results on a quarterly basis. SFECC satisfied all reporting obligations during the assessment period.

A2. Financial Stability Standard for Securities Settlement Facilities

There are eight measures that the Reserve Bank considers relevant in determining whether a facility has met the Financial Stability Standard for Securities Settlement Systems. The full text of the measures and associated guidance is available on the Reserve Bank's website. The following provides summary details of the information the Reserve Bank has used to assess ASTC and Austraclear against each of the relevant measures. This updates the information presented in the Reserve Bank's 2007/08 Assessment for material changes in policies and procedures over 2008/09.

A2.1 ASX Settlement and Transfer Corporation (ASTC)

1. Legal framework

The securities settlement facility must have a well-founded legal basis.

ASTC Pty Limited is a wholly owned subsidiary of ASX Limited. It provides settlement services for ASX markets, as well as a transfer service for a small number of transactions undertaken on the National Stock Exchange.

The legal basis for ASTC's operations is set out in its Settlement Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between ASTC and each of its participants, and between each participant and each other participant. The Settlement Rules set out the rights and obligations of participants and ASTC, including in the event of default or suspension.

The netting arrangements undertaken by ASTC with respect to its participants' obligations have approval as a netting arrangement under Part 3 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of an ASTC participant or a payments provider.

2. Participation requirements

The requirements for participation in the securities settlement facility must promote the safety and integrity of the securities settlement facility and ensure fair and open access. Participation requirements must:

  1. be based on objective and publicly disclosed criteria;

ASTC has objective and transparent participation requirements, which are publicly available and form part of the Settlement Rules and Procedures. The Settlement Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated. ASTC had 107 participants as at end-June 2009.

  1. require that participants have the operational capacity and financial standing to settle their obligations through the securities settlement facility in a timely manner; and

Participation requirements address financial and business integrity issues, as well as operational and technical matters.

A participant that is neither subject to prudential supervision as an ADI, nor monitored as either a clearing or market participant under ACH Clearing Rules or ASX Market Rules, must post a performance bond of $500,000. In addition, a sponsoring participant (ie, a participant that also acts in ASTC on behalf of non-participants) that is not subject to prudential or market supervision and is not covered by the NGF compensation arrangements (under the Corporations Act) must post a sponsorship bond of $500,000.

Performance and sponsorship bonds must be issued by an Australian bank or appropriately regulated insurance company. Funds held under a performance bond would be drawn upon by ASTC in the event that the participant breached ASTC Settlement rules. In a similar vein, funds held under a sponsorship bond would be drawn upon to meet any losses suffered by an issuer, participant-sponsored holder, or ASTC, arising from a breach of the rules or other offence. The monitoring, assessment and investigation of matters relating to financial requirements is dealt with by ASXMS, a separate subsidiary within the ASX group, with its own board.

  1. allow the CS facility licensee as operator of the securities settlement facility to suspend or cancel the participation of an institution which breaches the applicable participation or other risk-control requirements.

ASTC's Settlement Rules allow it to suspend or terminate a participant from its facility in the event of a failure to comply with the Settlement Rules, or where a payments provider fails to authorise a participant's payment for interbank settlement.

ASTC also levies fail fees on a participant that does not meet its settlement obligations on a timely basis. With effect from 1 September 2008, the minimum and maximum fees applied in respect of fails are set at $100 and $5,000, respectively (with an ad valorem fee of 0.1 per cent). With effect from end-March 2009, participants are also required to close out any positions remaining unsettled on the fifth day after trade date (ie, two days after the scheduled settlement date). ASTC also operates a benchmarking regime for settlement-fails performance. This regime makes use of peer-group benchmarking and provides a participant's compliance unit with a ranking of its settlement-fails performance (based on the value of its trades which have failed to settle) against its market group peers.

3. Understanding risks

The securities settlement facility must make sufficient information publicly available, via its rules and procedures and the provision of relevant information on settlement activity, such that each participant is able to understand the securities settlement facility's impact on each of the financial risks the participant incurs through participation in the facility.

ASTC's Settlement Rules are comprehensive and publicly available. The Rules and Procedures explain the role and responsibilities of each category of participant and ASTC. Background information on ASTC's operations and risk management is also available on the ASX website.

ASTC must lodge any changes to its Settlement Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. ASTC consults with its participants on important rule changes, and notifies participants of all changes to the Settlement Rules or Procedures.

Further to a variation to this measure of the Standard in February 2009, a licensed CS facility as operator of a securities settlement facility is required to make publicly available any relevant information on settlement activity. In this regard, the Reserve Bank is working with ASX and industry participants to implement a regime for the disclosure of data on equities securities lending. With effect from November 2009, settlement participants will be required to ‘tag’ securities-loan-related settlement instructions submitted to CHESS and, from December 2009, will be required to disclose outstanding on-loan and borrowed positions. A pilot phase for this reporting regime commenced in May 2009.

4. Certainty of title

The CS facility licensee as operator of the securities settlement facility must ensure that under the facility's rules and procedures, participants, or where relevant, their clients, have a clear and unambiguous title to, or interest in, securities held, deposited or registered on their behalf, including in circumstances where the solvency of the operator of a securities settlement facility is in doubt. This requires that its rules and procedures:

  1. clearly identify the type of title or interest held by participants for particular securities, to the extent such title or interest is recognised by the facility's rules or procedures;

All securities held by ASTC are dematerialised and held in CHESS. Title is held in the name of clients of ASTC participants. The system does not record any details of encumbrances, other than collateral lodged in favour of ACH.

A CHESS sub-register forms part of the issuer's securities register. Maintenance and reconciliation of the complete register is the responsibility of the issuer or its appointed agent. Most ASTC participants settle across a centralised settlement account and subsequently allocate securities to end-clients in the CHESS sub-register. As part of its end-of-day processes, CHESS reports net movements on each sub-register to the holder of the issuer's complete register. Settlement participants utilise the centralised account under ‘trust’ provisions and are obliged to give irrevocable legal title to an end client as long as that client has met all relevant conditions in respect of the settlement.

  1. clearly identify the way in which the transfer of (or any other forms of dealing with) securities and related payments can be effected through the facility;

The transfer of title to securities in CHESS is given effect by book entry, with ownership details updated electronically. Settlement occurs via a DVP process in a daily scheduled batch-settlement cycle (see Measure 5). ASTC's Settlement Rules also provide for transferring securities without payment, where required.

  1. ensure that, to the extent permissible by law, the creditors of the operator of the securities settlement facility have no claim over securities or other assets held, deposited or registered by participants in the facility.

In the event of ASTC's insolvency, the rules and arrangements for title within ASTC provide a high degree of assurance that participants' securities will be immune from claims by ASTC's creditors. ASTC is not the legal owner of any participant or client assets, with these assets recorded in CHESS in the name of the participant or sponsored client.

5. Settlement

The CS facility licensee as operator of a securities settlement facility must ensure that its operations do not expose its participants, or the financial system more broadly, to unacceptable levels of risk. The operator of a securities settlement facility must pay particular attention to ensuring settlement finality and the use of high-quality settlement assets in payment for securities:

  1. The operation of a securities settlement facility must eliminate principal risk between its participants and ensure that settlements, once completed, are final and irrevocable.
  2. The assets used to settle the payment obligations in respect of a transaction in the securities settlement facility must carry little or no credit or liquidity risk.
  3. Exposures between providers of cash settlement assets must be settled finally and irrevocably.

Settlement of securities transactions in ASTC occurs on a Model 3 DVP basis.[6] This involves the simultaneous transfer of net payment and net securities obligations between buyers and sellers at the end of the processing cycle. ASTC also currently provides for the settlement of cash obligations in relation to derivatives, which are also settled on a net basis.[7] ASTC's Settlement Rules establish that settlement according to the terms of those rules is final and irrevocable. This is reinforced through legislation (see Measure 1).

Once a trade has been executed on the ASX market, a trade-related instruction is sent to CHESS. On T+1, CHESS generates a single net batch instruction reflecting the net position of each participant's novated trades in each line of stock. Between T+1 and T+3, participants can also instruct CHESS to include additional non-novated (off-market) transactions in the batch at T+3. During 2008/09, an average of around 69 per cent (by value) of net securities settled in the final batch was in respect of non-novated transactions. The majority of these transactions were related to the priming of clearing participants' accounts to facilitate settlement of novated trades (ie, the transfer of securities to a clearing participant's securities account to ensure that they can be delivered in accordance with scheduled obligations).

By 6.00am on the settlement day, ASTC notifies each participant of its net cash and securities settlement obligations. Participants have until 10.30am to negotiate any additional non-novated trades necessary to ‘prime’ their accounts for settlement. After the cut-off for new instructions, transfer of securities positions is restricted in CHESS and participants' payment providers are requested to authorise net funding demands. ‘Payment providers’ hold ES accounts at the Reserve Bank and act on behalf of ASTC settlement participants. There were 12 payment providers operating in ASTC as at 30 June 2009. Payment obligations are settled between payment providers in the Reserve Bank's RITS system in a single daily multilateral net batch. Immediately upon notification that the funds transfer has been completed, ASTC completes the net securities transfers in CHESS, thus ensuring DVP settlement. This typically occurs at around noon.

The finality of ASTC's settlement process is reinforced by its approval under Part 3 of the Payment Systems and Netting Act. In addition, the payments between payment providers as part of the multilateral net batch are protected by virtue of the approval of RITS as an RTGS system under Part 2 of the Payment Systems and Netting Act. This approval protects payments from being voided in the case of a payments provider entering external administration.

If, due to a shortfall of either securities or funds, a participant is unable to settle its scheduled obligations in the batch, ASTC's settlement rules allow for the transactions of the affected participant to be ‘backed out’. These transactions are then rescheduled for settlement on the next settlement day. The precise parameters of the back-out process depend upon whether or not the failing participant is in default. If the participant is in default, ACH may assume an obligation for novated settlements in accordance with its default-management arrangements. ASTC's back-out algorithm seeks to remove as few transactions from the batch as possible, maximising settlement values and volumes, while minimising both the spillover to other participants and the potential injection of liquidity from ACH. Non-novated settlement obligations are typically backed out first.

Further to a delay to settlement in late January 2008, ASX has consulted on modifications to the settlement process. Following this consultation, ASTC plans to establish a firm deadline for the back out of settlement obligations in the event that a participant fails to meet its payment obligations.

6. External administration

The rules and procedures for the securities settlement facility must contain mechanisms to deal with the external administration of a participant, or a provider of cash settlement assets, in such a way as to limit the operational and financial impact on both the securities settlement facility and its participants.

  1. allow for the cancellation or suspension of a participant or a provider of cash settlement assets from the security settlement facility:
    1. if the participant or provider of cash settlement assets is in external administration; or
    2. if there is a reasonable suspicion of external administration;

ASTC's Settlement Rules allow for the cancellation or suspension of a participant or a payment provider in the event that it becomes subject to external administration, or if it reasonably suspects that this may occur. Participants and payment providers are required to notify ASTC if they, or any other participant or payment provider, become subject to external administration or if they reasonably suspect that this may occur.

  1. allow participant users of a cash settlement provider which becomes subject to external administration, or which is reasonably likely to become subject to external administration, to quickly nominate a new provider.

ASTC's Settlement Rules allow participants to nominate a new payment provider if their current provider is subject to, or is reasonably likely to become subject to, external administration.

ASTC's Settlement Rules allow it to remove transactions from batch settlement under certain circumstances, including where a participant is subject to external administration. ASTC has procedures and mechanisms in place to allow it to recast a batch ensuring that settlement can be carried out in a timely manner (see Measure 5).

7. Operational risk

The CS facility licensee as operator of a securities settlement facility must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

Details of the operational risk-management procedures across all four licensed CS facilities in the ASX group are provided in Section 6.

8. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the Standard; breaches of risk-control requirements; and quarterly financial results. ASTC satisfied all reporting obligations during the assessment period.

A2.2  Austraclear

1. Legal framework

The securities settlement facility must have a well-founded legal basis.

Austraclear Limited is a wholly owned subsidiary of ASX Limited. It provides settlement services for the OTC debt market and for derivatives traded on the SFE and ASX markets.

The legal basis for Austraclear's operations is set out in its Regulations. Under Section 822B of the Corporations Act, these regulations have effect as a contract under seal between Austraclear and each of its participants, and between each participant and each other participant. The Regulations set out the rights and obligations of participants and Austraclear, including in the event of default or suspension.

The finality of settlements undertaken by Austraclear is reinforced by its approval as an RTGS system under Part 2 of the Payment Systems and Netting Act. This approval protects the finality of payments made through Austraclear in the event of a participant entering external administration.

2. Participation requirements

The requirements for participation in the securities settlement facility must promote the safety and integrity of the securities settlement facility and ensure fair and open access. Participation requirements must:

  1. be based on objective and publicly disclosed criteria;
  2. require that participants have the operational capacity and financial standing to settle their obligations through the securities settlement facility in a timely manner;
  3. allow the CS facility licensee as operator of the securities settlement facility to suspend or cancel the participation of an institution which breaches the applicable participation or other risk-control requirements.

Austraclear had 781 participants as at end-June 2009. Austraclear has objective and transparent participation requirements, which are publicly available and form part of the Regulations and Procedures. The Regulations also provide for an appeals process should an application for participation be rejected or a participant's access be terminated. Its participation requirements address financial and operational issues, such as capital adequacy, business integrity and business continuity arrangements.

Austraclear's Regulations allow it to suspend or terminate a participant from its facility in the event of a breach of its Regulations. Clearing and Settlement Operations monitors participants' operational processing performance.

3. Understanding risks

The securities settlement facility must make sufficient information publicly available, via its rules and procedures and the provision of relevant information on settlement activity, such that each participant is able to understand the securities settlement facility's impact on each of the financial risks the participant incurs through participation in the facility.

Austraclear's Regulations and Procedures are comprehensive and publicly available. The Rules and Procedures explain the role and responsibilities of each category of participant and Austraclear. Background information on Austraclear's operations, technical arrangements and risk management is also available on ASX's website.

Austraclear must lodge any changes to its Regulations with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. Austraclear consults with its participants on important rule changes. Announcements affecting participants are issued as ‘SFE Notices’ which are targeted to participants and market users.

4. Certainty of title

The CS facility licensee as operator of the securities settlement facility must ensure that under the facility's rules and procedures, participants, or where relevant, their clients, have a clear and unambiguous title to, or interest in, securities held, deposited or registered on their behalf, including in circumstances where the solvency of the operator of a securities settlement facility is in doubt.

  1. clearly identify the type of title or interest held by participants for particular securities, to the extent such title or interest is recognised by the facility's rules or procedures;

Austraclear's Regulations identify title for three different classes of securities: paper securities, non-paper securities and dematerialised securities.

Paper securities are negotiable instruments and include some certificates of deposit, promissory notes and bills of exchange. Austraclear holds these securities for the participant as bailee. The participant retains legal and beneficial title. Non-paper securities are electronic securities that are not registered within the Austraclear system. They include Commonwealth Government securities, registrable state and semi-government securities and corporate debt. In each of the registries, Austraclear holds legal title for the participant as nominee. The participant retains beneficial title. Dematerialised securities are electronic securities which are registered in the Austraclear system rather than externally. They include electronic certificates of deposit, electronic promissory notes and electronic bank-accepted bills of exchange. A dematerialised security is held by a participant as a ‘chose in action’.[8] This legal structure imposes rights and obligations which replicate the rights and obligations of a negotiable instrument.

  1. clearly identify the way in which the transfer of (or any other forms of dealing with) securities and related payments can be effected through the facility;

The transfer of title to securities in the Austraclear system is effected by book entry. Paper securities are transferred through updates to participants' security records. Austraclear also uses ‘allonges’ which maintain the negotiability of paper securities.[9] Non-paper securities are transferred through the passing of beneficial title from the seller to the buyer. Austraclear retains legal title in the relevant registry. Transfers of dematerialised securities are transfers of contractual rights within the Austraclear system.

  1. ensure that, to the extent permissible by law, the creditors of the operator of the securities settlement facility have no claim over securities or other assets held, deposited or registered by participants in the facility.

In the event of Austraclear's insolvency, the rules and arrangements for title within Austraclear provide a high degree of assurance that participants' securities will be immune from claims by Austraclear's creditors. Austraclear is not counterparty to any transactions settled in its system.

5. Settlement

The CS facility licensee as operator of a securities settlement facility must ensure that its
operations do not expose its participants, or the financial system more broadly, to unacceptable levels of risk. The operator of a securities settlement facility must pay particular attention to ensuring settlement finality and the use of high-quality settlement assets in payment for securities:

  1. The operation of a securities settlement facility must eliminate principal risk between its participants and ensure that settlements, once completed, are final and irrevocable.

Settlement of securities transactions in Austraclear occurs on a Model 1 DVP basis. This involves the simultaneous transfer of payment and securities obligations between the buyer and seller on an item-by-item basis through the settlement cycle. Austraclear also provides for one-way cash transfers between participants, which are also settled on an item-by-item basis. Austraclear's Regulations establish the basis for settlement of transactions entered into the system. By volume, DVP settlements accounted for around 41 per cent of total settlements during the assessment period, and one-way cash transfers around 59 per cent. There was also
a small volume of free-of-payment securities transfers (less than 0.5 per cent). By value, however, DVP payments predominate, accounting for 76 per cent of total transfers in the year to end-June 2009.

  1. The assets used to settle the payment obligations in respect of a transaction in the securities settlement facility must carry little or no credit or liquidity risk.

‘Participating banks’ hold ES accounts at the Reserve Bank and act on behalf of
other Austraclear participants. 57 participating banks were operating in Austraclear as at 30 June 2009. Settlement of payment obligations occurs between participating banks across ES accounts on a RTGS basis. As such, settlement occurs in central bank money. Austraclear is notified immediately upon settlement of the payment leg of a securities trade, allowing for the immediate transfer of securities title so as to ensure DVP settlement.

  1. Exposures between providers of cash settlement assets must be settled finally and irrevocably.

The finality of Austraclear's settlement process is reinforced by its approval under Part 2 of the Payment Systems and Netting Act. In addition, the payments between participating banks are also protected by virtue of the approval of RITS as an RTGS system under Part 2 of the Payment Systems and Netting Act.

6. External administration

The rules and procedures for the securities settlement facility must contain mechanisms to deal with the external administration of a participant, or a provider of cash settlemen assets, in such a way as to limit the operational and financial impact on both the securities settlement facility and its participants.

Austraclear's Regulations allow it to cancel or suspend a participant or a participating bank that becomes subject to external administration, or if it reasonably suspects that this may occur. A participant or a participating bank is also required to notify Austraclear if it becomes subject to external administration or where it reasonably suspects that this may occur.

There is no restriction within the Austraclear Regulations on a participant changing its participating bank, including where that entity is insolvent.

As a facility supporting bilateral agreements negotiated on an OTC basis, without the presence of a central counterparty, Austraclear does not have centralised arrangements for dealing with the unsettled transactions of its participants. Consequently, replacement risk for any trade left unsettled due to the insolvency of a participant is borne directly by trade counterparties. By virtue of the application of a Model 1 DVP arrangement, unsettled obligations do not give rise to principal risk.

7. Operational risk

The CS facility licensee as operator of a central counterparty must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

Austraclear's key system is EXIGO. A detailed assessment of operational risk management across all four licensed CS facilities is provided in Section 6.

8. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the Standard; breaches of risk-control requirements; and quarterly financial results. Austraclear satisfied all reporting obligations during the assessment period.

Footnotes

Under this regime, participants must hold a minimum of $5 million in NTAs. [1]

As noted, interbank transactions arising from settlements in ASTC and Austraclear are settled in RITS across ES accounts held with the Reserve Bank. RITS is also approved under Part 2 of the Payment Systems and Netting Act. [2]

ACH would suspend discounting if the EWMA of SPI volatility was 20 per cent higher than historical volatility. ACH uses seven years of daily SPI movements for both volatility measures. [3]

With the exception of electricity contracts which are subject to a monthly review. [4]

SFECC applies discounts only under normal market conditions. It will suspend discounting – thereby reverting to full collateralisation of AIMs – if EWMA volatility is 20 per cent higher than historical volatility. SFECC uses seven years of daily SPI movements for both volatility measures. [5]

There is provision for DVP to occur on a trade-by-trade basis using CHESS RTGS, but this option has yet to be used. [6]

ASX has announced that it intends to require that all ACH derivatives margin-related payments be settled in Austraclear. The timing of this change has not yet been announced. [7]

This is a legal right to intangible property. It allows the holder (in this case, the relevant Austraclear participant) to direct Austraclear to deliver to it securities of a specified description and number. [8]

Allonges are separate sheets of paper attached to a bill of exchange for the purpose of documenting endorsements. As a bill of exchange is transferable through endorsement, the allonge attached to the bill acts as a legal extension of the document. [9]