2008/09 Assessment of Clearing and Settlement Facilities in Australia 1. Introduction and Executive Summary

In accordance with obligations under the Corporations Act 2001, the Reserve Bank is required to conduct an assessment at least once a year of whether licensed clearing and settlement (CS) facilities have complied with its Financial Stability Standards and done ‘all other things necessary to reduce systemic risk’. The four CS facilities in the Australian Securities Exchange (ASX) group fall within the scope of the Standards: the two licensed central counterparties – the Australian Clearing House (ACH) and SFE Clearing Corporation (SFECC) – and the two licensed securities settlement facilities – ASX Settlement and Transfer Corporation (ASTC) and Austraclear. All four facilities were found to have complied with the relevant Standards over the year to end-June 2009.

The assessment period was characterised by heightened volatility in financial markets in late 2008, following the failure of the US investment bank, Lehman Brothers. While Lehman Brothers was not a direct participant in either central counterparty or ASTC, its failure and resulting spillover to securities and derivatives markets did pose some challenges. The central counterparties, in particular, faced an increase in risk exposure as volatility rose and the financial standing of some participants or their overseas parents was questioned. Both ACH and SFECC responded to the changing risk environment by intensifying their participant monitoring, increasing margin requirements, and pro-actively adjusting other risk-control parameters as necessary. In the event, all four licensed CS facilities were resilient to the turbulent market conditions during this period.

In light of these events, the Reserve Bank examined the facilities' response to the challenges posed by the volatility in financial markets. It also assessed a number of other developments through the period, including ongoing refinements to risk-management and operational processes. Particularly given the events of the past year, the Payments System Board took a heightened interest in matters related to the stability of the market infrastructure and will continue to do so.

At the central counterparties, there were a number of important developments, including the following:

  • Review of participant-monitoring arrangements: Further to the broker failures of early 2008 and heightened counterparty credit concerns in markets more generally, ASX Markets Supervision (ASXMS) undertook a review of participant-monitoring activities and launched a range of projects to enhance capital- and liquidity-monitoring arrangements. ACH also implemented an increase in minimum capital requirements for participants. Following a joint review of this policy by the Reserve Bank and the Australian Securities and Investments Commission (ASIC), the time-line for implementation of further increases in participants' capital requirements was revised.
  • Review of default-management processes: Again, in light of some issues raised by the broker failures of early 2008, ASX embarked on a thorough review of default-management processes. In a first stage of this work, ASX has drawn up a comprehensive list of ‘default intentions’, setting out the factors to be taken into consideration at each key decision point, and reviewing capabilities. In a second phase of the work, ASX aims to further clarify the legal underpinning for intended actions, identify any necessary rule changes, and implement identified enhancements.
  • Exit from default-insurance arrangements: Late in the period, both central counterparties announced their intention to exit from default-insurance arrangements with Radian Asset Assurance Inc. (Radian). This followed further ratings downgrades at the insurer. ACH has already implemented alternative arrangements, negotiating a fully drawn-down subordinated loan from a commercial bank. SFECC has retained its insurance arrangements for the time being, but has reduced the stress-test exposure limits beyond which participants are required to post additional collateral so that insurance is not taken into account. Ultimately, both central counterparties had intended to replace their insurance contracts with paid-up funds raised via the external issuance of debt by ASXCC. In the event, however, given difficult conditions in credit markets, the issuance of debt has been postponed indefinitely. Alternative sources of funding are under consideration.

Having reviewed these and other developments, and followed up on a number of issues raised in the 2007/08 Assessment, the Reserve Bank has identified a number of areas for further consideration by the central counterparties during the 2009/10 assessment period. These include:

  • Routine margining of cash equities: Notwithstanding that the size and duration of replacement-cost risk associated with cash equities is low relative to that in derivatives contracts, recent high volatility in the cash equity market argues in favour of ACH routinely collecting initial and variation margin over the three-day pre-settlement period.[1] This would be consistent with the approach taken by many central counterparties internationally and the Reserve Bank welcomes ACH's decision to consult on this in the near future.
  • Account segregation: ACH recently consulted on a proposal to require that clearing participants maintain separate house and client accounts for cash equities. Segregation would be consistent with international best practice in this area and would be particularly important should ACH proceed with routine margining of cash equities.
  • Triggers for an increase in fixed risk resources: The Reserve Bank supports the current policy whereby participants are required to post additional collateral when the exposures they bring to the central counterparties give rise to projected stress-test losses beyond a specified threshold. This policy is appropriate where such exposures are infrequent, short-lived or highly concentrated among a few participants, as has generally been the case for both central counterparties over the past year. Nonetheless, ASX is encouraged to develop clear guidance on the circumstances in which it would increase the central counterparties' fixed risk resources (either routine margin or pooled resources), rather than relying on additional collateral. As noted in the 2007/08 Assessment, there are shortcomings to relying too heavily on variable calls for additional collateral, particularly given lags in the calculation and settlement of such calls.
  • Review of the composition of pooled risk resources: In light of the postponement of the proposed external debt issuance, the Reserve Bank will remain in dialogue with ASX in relation to the composition of the central counterparties' pooled risk resources. An important element of this will be ASX's plans in respect of an alternate long-term source of funding to replace the central counterparties' default insurance. It is anticipated that the future composition of pooled risk resources will also be referenced in ASX's forthcoming consultation on the central counterparties' risk control frameworks.
  • Intraday margining capabilities: The Reserve Bank accepts the basis on which ACH has delayed the implementation of system enhancements to improve intraday margining capabilities. However, the Reserve Bank reiterates its interest in delivery of these capabilities and will continue to monitor progress during the forthcoming assessment period.
  • Treasury investment policy: In the 2007/08 Assessment, the Reserve Bank observed that the central counterparties' treasury investment policy could give rise to sizeable, concentrated exposures with the large domestic banks. Having discussed the policy further with ASX during the current assessment period, the Reserve Bank acknowledges that it would be difficult for the central counterparties to reduce the concentration of investments among the largest domestic banks without compromising credit quality or liquidity. However, were the domestic repo market to deepen, perhaps due to continued expansion of government debt issuance, ASX would consider exploring this alternative for at least a portion of the treasury portfolio. The Reserve Bank encourages ASX to keep under review the various options for reducing concentration in the treasury investment portfolio.
  • Participant-monitoring arrangements: The Reserve Bank welcomes the enhancements to capital- and liquidity-monitoring arrangements at ASXMS. It is noted, however, that the central counterparties' arrangements for monitoring clearing participants may change further in due course, in light of the recent government announcement of reforms to the supervision of Australia's financial markets. The Reserve Bank will remain in dialogue with ASX and ASIC over 2009/10 to examine any implications of the reforms for clearing participant-monitoring arrangements.

In the case of the securities settlement facilities, an important focus of the current Assessment has been developments at ASTC to enhance equity settlement arrangements. In the 2007/08 Assessment, the Reserve Bank drew out two key recommendations from its earlier Review of Settlement Practices for Australian Equities (published in May 2008).[2] This review followed the significant delays to the completion of settlement of Australian equities transactions on two days in January 2008. In particular, the Reserve Bank recommended modifications to the existing batch-settlement model, and improvements to the transparency of equities securities lending. ASTC took steps in response to both recommendations during the assessment period, while also proceeding with pre-announced enhancements to the settlement-fails regime and implementing an earlier start-of-day for submission of instructions to ASTC's settlement system, Clearing House Electronic Sub-register System (CHESS).

In respect of the recommended modifications to the batch process, ASX released a consultation document in December 2008, Enhancing Australia's Equity Settlement System, which sought feedback from participants on a range of potential measures.[3] Further to the consultation, ASTC plans to implement several measures, including:

  • A firm deadline for the back out of settlement obligations: 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 (although some flexibility will be retained in the event of operational problems). Had such arrangements been in place in January 2008, the back out of the troubled participant's settlement obligations and the recalculation of the batch could have been accelerated, reducing the overall length of the settlement delay and mitigating the uncertainty and spillover to the market at large.
  • Removal of ACH derivatives margins from the CHESS settlement batch: This will ensure that ACH's risk-management arrangements are not dependent on the completion of settlement in the cash equity market.

ASTC decided not to pursue some other proposals included in the consultation. In particular, ASTC decided not to remove certain cash equity transaction types from the batch process and will not require that all participants connect to CHESS RTGS (a real-time settlement capability that allows securities transfers to settle on a
delivery-versus-payment (DVP) basis outside of the daily batch process). Although CHESS RTGS connectivity will not be mandatory, ASTC will strongly encourage participants to connect. The Reserve Bank regards CHESS RTGS as a useful contingency and therefore encourages ASTC to keep mandatory connectivity under consideration, at least for the largest settlement participants.

Separately, working closely with the Reserve Bank and industry participants, ASX is developing arrangements for the implementation of a disclosure regime for equities securities lending. The key elements are transactional and positional reporting requirements.

  • Transactional reporting: In conjunction with a new release of the CHESS software, due in November 2009, ASTC will require that settlement participants ‘tag’ all securities loan-related settlement instructions in CHESS. This will provide visibility for ASTC, as system operator, and also provide data for public release on the proportion of total settlements accounted for by loan-related transactions.
  • Positional reporting: ASX is developing arrangements for direct reporting of outstanding on-loan and borrowed positions by settlement participants and other voluntary providers of data. This reporting will form the basis for public reports of aggregated loans outstanding for each security, relative to some relevant comparative statistics (eg, turnover, market capitalisation, total stock available for lending). A pilot reporting regime was launched in May 2009, with full implementation scheduled for December 2009.

This year's Assessment of Austraclear has again focused on operational risk management, following a lengthy outage of the EXIGO settlement system in March 2009. The outage was due to a code change which was inadvertently written to the live production system rather than the test system. Austraclear is taking appropriate steps to mitigate the risk of similar problems occurring in the future, and the Reserve Bank will follow up with Austraclear once the new arrangements are fully implemented.

For the first time, this year's report includes a special topic (Section 6), which offers a detailed assessment against one measure of the Standards. In part in response to the developments at Austraclear, the Reserve Bank chose operational risk management as the special topic for this period. A similar detailed assessment against at least one measure will be included in future assessments.

It is the Reserve Bank's assessment that ASX's arrangements are consistent with the operational risk measure of the Financial Stability Standards. Nevertheless, the Reserve Bank notes that best practice in respect of operational risk continues to evolve and licensed CS facilities should respond both to this evolution and to specific issues identified by unfolding events. ASX's review of business continuity policy is welcome in this regard, including review of the case for introducing full redundancy for all four key systems at the business-recovery site and potential extension of remote-working arrangements. Another possible enhancement being explored in this context is to permanently locate some operational staff at the site, so as to facilitate rapid recovery in the event of a disruption and staff familiarity with the site.

The Reserve Bank will also continue to monitor implementation of enhancements to operational risk-management processes recommended by internal and external auditors. These include: completion of business-unit level pandemic planning; ongoing enhancement/update of detailed business-resumption plans; and an assessment of whether to include ‘failover testing’ within regular business continuity tests.[4]

The report is organised as follows. Section 2 introduces the Australian clearing and settlement landscape. Sections 3 and 4 of this report satisfy a requirement under Section 25M of the Reserve Bank Act 1959 for the Payments System Board to report annually to the Minister on material developments in clearing and settlement in Australia and any changes to the Financial Stability Standards. Sections 5 and 6 fulfil the Reserve Bank's statutory obligations under Section 823CA of the Corporations Act to report to the Minister for Financial Services, Superannuation and Corporations Law, and to ASIC, on its annual assessment of the licensed CS facilities.

The Reserve Bank appreciates the openness and cooperation of ASX throughout the period and in the preparation of this report.


Or other routine collateralisation of cash equity market exposures in normal market circumstances. [1]

This document is available at: <https://www.rba.gov.au/PaymentsSystem/StdClearingSettlement/Pdf/review_sttlmt_prac_aus_equities_052008.pdf>. [2]

This document is available at: <http://www.asx.com.au/about/pdf/consultation_paper_enhancing_equity_settlement_system.doc>. [3]

‘Failover testing’ involves testing the capacity to switch operations to the recovery site intraday should a disruption occur. [4]