2010/11 Assessment of Clearing and Settlement Facilities in Australia 1. Introduction and Executive Summary

Under the Corporations Act 2001, the Reserve Bank is required to conduct an assessment at least once a year to determine whether licensed clearing and settlement (CS) facilities have complied with the Reserve Bank's Financial Stability Standards (FSS) and done all other things necessary to reduce systemic risk. This report presents the Reserve Bank's assessment of licensed CS facilities for 2010/11. There are two licensed central counterparties – ASX Clear Pty Limited (ASX Clear) and ASX Clear (Futures) Pty Limited (ASX Clear (Futures)) – and two licensed securities settlement facilities – ASX Settlement Pty Limited (ASX Settlement) and Austraclear Limited (Austraclear) – that fall within the scope of the FSS. These facilities are all owned by the ASX Group (ASX). All four facilities were found to have complied with the relevant FSS.

The number of trades on the equities and derivatives markets served by the central counterparties increased in 2010/11. However, both the value of cash equities trades and the value of securities processed by the settlement facilities decreased. None of the CS facilities experienced capacity or other problems relevant to the stability of market infrastructure.

For the central counterparties, notwithstanding increased activity, exposure to the risks associated with the potential failure of a clearing participant declined owing to lower market volatility over the period. Nevertheless, the facilities continued to improve their risk and operating frameworks. In particular, the central counterparties made changes in the following areas:

  • Improvements to participant-monitoring arrangements. A number of enhancements have been made to the capital- and liquidity-monitoring arrangements for ASX Clear and ASX Clear (Futures) participants.
  • System changes to facilitate intraday margin calls on equity derivatives positions. From September 2010, enhancements to systems have enabled ASX Clear to make intraday calls that reflect changes in participants' positions.
  • Refinement of the treatment of promissory resources. ASX Clear (Futures) has recognised that promissory resources may not be available on a sufficiently timely basis, if called upon in the manner contemplated by the ASX Clear (Futures) rules. So while they provide some level of additional comfort, the potential delay in receipt of these funds means they should be given less weight in determining the adequacy of ASX Clear (Futures)' default resources under Measure 7 of the relevant FSS. ASX has agreed not to treat those resources as default resources for risk management purposes. Accordingly, ASX has removed the promissory component from calculations of participants' stress-test exposure limits.
  • Improvements to the liquidity requirements of ASX's treasury investment policy. ASX has modified its liquidity stress tests to be better aligned with worst-case default scenarios, increased the robustness of the threshold it uses to assess whether it holds sufficient liquid assets to meet ordinary requirements, and changed its definition of liquid assets so that it is more focused on market liquidity than investment maturity.
  • Publication of standards and pricing options for the Trade Acceptance Service (TAS). In June 2011, ASX published final legal terms together with operational and technical standards and pricing options for the TAS, ahead of Chi-X Australia Pty Ltd (Chi-X) commencing operations.

Progress has also been made in the following areas by the central counterparties, although work in these areas remains under way:

  • Participation requirements. ASX Clear proposes to increase the minimum ‘core capital’ requirement for General Participants (specialist third-party clearers) to $20 million from 1 January 2012. ASX Clear also proposes to increase the minimum ‘core capital’ requirement for Direct Participants to $10 million from 1 January 2013 and in that context it is expected that ASX, in conjunction with the Australian Securities and Investments Commission (ASIC) and the Reserve Bank, will consider developments in the third-party clearing market to determine whether it is appropriate to pursue this timetable for Direct Participants. As noted in the 2008/09 Assessment, ASIC and the Reserve Bank view the depth of the third-party clearing market as an important consideration for ASX Clear's plans to increase capital requirements further.
  • Routine margining of cash equities. In the 2008/09 Assessment, the Reserve Bank set out the strong case for ASX Clear to introduce margining for cash equities in line with international best practice. Margining is desirable because it provides participants with incentives to manage the risk they bring to the central counterparty. It also provides an additional layer of protection for the central counterparty, reducing reliance on pooled risk resources, use of which in the event of a participant default may carry reputational costs. Over the past year, ASX has continued to work on this proposal by consulting with market participants, industry bodies and clearing participants, and initiating development of a ‘futures-style’ margining system.
  • Risk calculation. ASX intends to introduce the CME version of Standard Portfolio Analysis Risk, widely regarded as the industry standard for risk margining, for ASX Clear (Futures) from early 2012 and for ASX Clear from mid 2012. This will place margining for both central counterparties on a common platform.
  • Business continuity arrangements. ASX currently has redundancy for all key systems. Over the year ASX has been finalising the development of a new operations centre, which is due to open in late 2011. Once the new site becomes fully operational, ASX will implement dual redundancy for all four core systems at both primary and back-up sites (currently only EXIGO, the system operating Austraclear, has this capacity). The Reserve Bank strongly endorses this project, which is consistent with international best practice for systemically important systems.

As noted in last year's assessment, ASX is working towards further improving settlement procedures for cash equities. The objective is to minimise the risk that a participant's inability to settle disrupts settlement across the entire market. These issues were discussed in the Reserve Bank's Review of Settlement Practices for Australian Equities.[1] Currently, the cash leg of cash equities is settled in a batch (the Clearing House Electronic Sub-register System (CHESS) batch), which comprises both novated and non-novated transactions. ASX has been in discussions with banks that participate in the CHESS batch, through the Australian Payments Clearing Association, to ascertain the capacity to shorten the 90-minute window in which banks must commit to fund settlement participant positions. In the event that a settlement participant position is not funded, ASX plans to establish an earlier deadline for the back-out of settlement obligations from the CHESS batch (a fuller discussion of default management is provided in Section 6). Setting an earlier deadline will reduce the potential for settlement delay and thus reduce the uncertainty that may affect the market at large in the event that a participant fails to meet its obligations. The Reserve Bank encourages ASX Settlement to engage in further discussions with its stakeholders to implement these enhancements as soon as practicable and will monitor progress over the period ahead.

The key focus for the assessment of Austraclear remained operational risk management. Although Austraclear experienced a number of operational incidents during the assessment period, of which none caused a system outage, the Reserve Bank is satisfied with both ASX's immediate responses to these incidents, as well as the responses to prevent a recurrence.

Preparation for potential competition between markets for trading in equities in Australia was another important development during the past year. In August 2010, responsibility for market supervision was transferred from ASX to ASIC. With ASIC as the whole-of-market supervisor, streamlined and complete supervision of trading on the market is ensured should any new trading platforms enter the Australian market; in May 2011, the Minister for Financial Services and Superannuation (the Minister) granted Chi-X a licence to operate a financial market in Australia. From 31 October 2011, subject to satisfying certain pre-conditions, Chi-X plans to offer a platform to conduct secondary trading in ASX-listed shares. The TAS will enable trades executed on approved market operators' platforms to be cleared and settled through ASX Clear and ASX Settlement in an equivalent fashion to trades executed on ASX's own market.

As with previous assessments, this year the Reserve Bank conducted a detailed assessment of the licensed CS facilities against one particular measure of the FSS. This year the focus was on Measure 6 of the Financial Stability Standard for Central Counterparties, which specifies that default arrangements need to minimise the risks to the central counterparty and its participants in the event of a participant default. It is the Reserve Bank's assessment that the default arrangements of the ASX central counterparties – ASX Clear and ASX Clear (Futures) – comply with the relevant measure of the FSS for Central Counterparties.

The rest of the Assessment is organised as follows. Section 2 introduces the Australian clearing and settlement landscape. Sections 3 and 4 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 FSS. Sections 5 and 6 fulfil the Reserve Bank's statutory obligations under section 823CA of the Corporations Act to report to the Minister, and to ASIC, on its annual assessment of the licensed CS facilities.

The Reserve Bank welcomes ASX's continued efforts towards ensuring its CS facilities contribute to financial stability, and appreciates the open and constructive dialogue between the Reserve Bank and ASX in relation to financial stability matters.