2011/12 Assessment of Clearing and Settlement Facilities in Australia 3. Developments in the Clearing and Settlement Industry in 2011/12

The number of trades on the equities and derivatives markets served by the ASX Group (ASX) central counterparties (CCPs) increased in 2011/12. However, consistent with a further decline in average trade size and a broad fall in equity prices, the overall value of cash equity trading fell slightly. Volatility in market prices was higher overall and contributed to an increase in the margins collected on derivatives positions by ASX Clear Pty Limited (ASX Clear) and ASX Clear (Futures) Pty Limited (ASX Clear (Futures)). However, for cash equities, despite the increased volatility, the ‘notional’ margin (calculated by ASX Clear for risk monitoring purposes, but not currently collected from participants) fell due to the decrease in value traded. This decrease was also reflected in a lower value of settlements of cash equities by ASX Settlement Pty Limited (ASX Settlement). The value of debt securities settled by Austraclear Limited (Austraclear) was broadly unchanged. During 2011/12, the ASX CCPs also handled their first ever default of an active clearing participant when the subsidiaries of MF Global Holdings Limited (MF Global) went into administration in November 2011.

There were a number of important regulatory developments in 2011/12. These included a review of the framework for regulation of financial market infrastructures (FMIs) in Australia, public consultation on the central clearing of over-the-counter (OTC) derivatives in Australia, and the finalisation of the new Principles for Financial Market Infrastructures (the Principles) by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO).

Meanwhile, trading in ASX-listed equities on the market operated by Chi-X Australia Pty Ltd (Chi-X) commenced on 31 October 2011. Separately, the Financial and Energy Exchange Limited (FEX) has applied for a market licence to offer trading in commodity, energy and environmental derivatives, and LCH.Clearnet Limited (LCH), a London-based CCP, has applied for a clearing and settlement (CS) facility licence to clear for FEX.

Activity in the Licensed CS Facilities

In 2011/12, markets cleared and settled by ASX CS facilities exhibited periods of increased price volatility. This was particularly the case in August 2011, as a result of global market factors such as the legislative gridlock over the US debt ceiling, and continuing European sovereign debt concerns. Volatility rose once more in May and June 2012, as euro zone issues escalated further. Despite this, trading turnover was generally higher across all markets. Trends in daily average trading value, however, varied from market to market: falling for cash equities, while increasing slightly for debt securities settled by Austraclear. The level of risk faced by the CCPs, as indicated by margin held, increased in 2011/12, although peak levels remained well below those of 2008.

The average volatility in equity prices, as measured by the 10-day moving average of absolute daily percentage changes in the S&P ASX All Ordinaries Index, increased from 0.6 per cent in 2010/11 to 0.9 per cent in 2011/12 (Graph 1, top panel). Although volatility increased significantly in August 2011, its peak at this time remained around half that observed in 2008. Volatility returned to around the 10-year average in early 2012, before increasing again as markets reacted to renewed concerns over events in Europe.

Trends in the growth of the number and value of cash equity trades continued to diverge over 2011/12. The daily average volume of these trades increased by 15 per cent in 2011/12, while daily average value fell by 11 per cent (Graph 2). The average daily value of securities transactions settled by ASX Settlement decreased by 10 per cent in 2011/12, to $7.3 billion; some difference between traded values and settlement values is to be expected due to settlement of non-market transactions and multilateral netting of participants' obligations. The average size of trades declined by 23 per cent; in part this reflected falls in equity prices, with the All Ordinaries down 9 per cent on a financial year average basis (Graph 1, bottom panel). Other factors in the decline in the average size of trades since 2005 are the growth in algorithmic trading and an increasingly common practice of breaking up large trade orders for gradual release into the market.

The average daily number of equitiy derivative contracts traded on the ASX market increased by 19 per cent in 2011/12, while the daily average number of derivative contracts traded on the ASX 24 market grew by 6 per cent in 2011/12.[3] Although there were decreases in the daily average for many of the less heavily traded contracts, this was more than offset by significant increases for several major contracts, most notably 10-year Treasury bond futures (up 13 per cent), ASX SPI 200 index futures (up 12 per cent) and 3-year Treasury bond futures (up 9 per cent).

In 2011/12, the average daily value of debt securities settled through Austraclear increased slightly, by around 1 per cent, to $40 billion, which includes outright purchases and sales of securities, and securities transferred to effect repurchase agreements (other than intraday repurchase agreements with the Reserve Bank).

Risk Management in the Licensed CCPs

A CCP is exposed to credit risk arising from potential changes in the market value of a defaulting participant's open positions between the last settlement of variation margin and close out by the CCP. To mitigate this risk, initial margin is calibrated against expected volatility in normal market conditions.

As measured by margin requirements, the total credit exposure assumed by the CCPs increased in 2011/12, but peak levels remained well below those of 2008. In derivatives markets this was due to the combination of an increased volume of transactions processed by the CCPs and higher volatility in market prices. In the case of cash equities, however, higher volatility was offset by lower values traded.

As discussed in Section 5.1 of this Assessment, ASX Clear plans to introduce margining of cash equities in the coming financial year. Although margins are not currently collected for cash equities, ASX Clear, as part of its internal risk management process, monitors its credit exposure by calculating notional margin requirements using its ‘Real Risk’ model. Average daily notional initial margin requirements calculated by the model decreased by 30 per cent to $218 million in 2011/12 (Graph 3). These were largely driven by lower market prices for cash equities and smaller net end-of-day positions (on which margin is calculated), though the decrease was in part due to the average for 2010/11 having been inflated by a short period of high notional margin requirements following the initial public offering of QR National in November 2010. ASX noted that this reflected more the current treatment of new stocks in its Real Risk model than a significant increase in actual risk to the CCP. The cash equity margining model to be introduced by ASX Clear will provide for more tailored treatment of new stocks.

The average of daily margins (both initial and variation) collected by ASX Clear on derivatives positions increased 6 per cent in 2011/12, to $917 million (Graph 4, top panel). This was due to an increase in volume, as well as increases in margin rates in the second half of 2011 as the volatility in equity prices picked up.

The average of daily initial margins collected by ASX Clear (Futures) increased by 8 per cent to $2 billion (Graph 4, bottom panel). The increase in margins reflected the overall rise in the average number of contracts traded on the ASX 24 market, as well as an increase in margin rates in late 2011. Nevertheless, the total amount of initial margin held remained significantly below the levels at the height of the global financial crisis in 2008/09. Margin rates for derivatives traded on ASX 24 were reduced in early 2012, but generally remained at or above the levels of 2010/11 for the remainder of 2011/12.

During 2011/12, the ASX CCPs also handled their first ever active clearing participant default when the subsidiaries of MF Global went into administration in November 2011.[4] The ASX CCPs' exposures were well covered by margin from the MF Global subsidiaries. There was therefore no need for ASX to call on pooled risk resources. ASX successfully managed the defaults in accordance with its default management framework. ASX nevertheless continues to review and enhance its default management arrangements on an ongoing basis and has implemented some changes in response to lessons learned from this event (discussed in Box B).

Regulatory Developments

In April 2011, the Council of Financial Regulators (the Council) was asked by the Deputy Prime Minister and Treasurer (the Treasurer) to consider possible changes to the regulation of FMIs to strengthen regulators' ability to provide effective oversight and manage risks to both stability and market integrity. In response, a Working Group, chaired by the Treasury and comprising representatives of the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investment Commission (ASIC) and the Reserve Bank (the Bank), developed a series of proposals, which were released for consultation in October 2011.[5] Having reviewed submissions and engaged directly with stakeholders, the Council recommended to the Treasurer a program of legislative reform in line with the proposals in its original consultation paper. The Treasurer released the Council's advice publicly in March 2012, inviting further consultation with stakeholders on the final framework for implementation of the Council's proposals.[6]

One core concern of regulators is how to ensure the continuity of critical services when an FMI is in financial distress (and possibly insolvent). If an FMI is unable to implement an effective recovery plan, regulators may need to intervene in order to maintain continuity of services while organising a recapitalisation or orderly wind-down (resolution) of the FMI. The Council therefore recommended legislative change to provide for the appointment of a statutory manager (a so-called ‘step in’) to a distressed FMI. A similar power is available to APRA in relation to authorised deposit-taking institutions (ADIs) under the Banking Act 1959. Implementation of the Council's recommendation needs to be considered in the context of broader international work on resolution of FMIs. Particularly relevant here is a consultation paper released by CPSS and IOSCO in July 2012 which addresses key issues in the design of an effective resolution regime for FMIs.[7] The paper identifies the power to appoint a statutory manager as one of a number of potential tools to be applied as part of a broader resolution plan.

Another important element of the package of regulatory reform measures for FMIs recommended by the Council is cross-border policy. In order for the Bank and ASIC to carry out their regulatory responsibilities with respect to cross-border CS facilities, they must have sufficient influence over the activities and risk management practices of such facilities, including in stressed circumstances. Accordingly, the Council recommended giving the regulators explicit powers under the Corporations Act 2001 to support a ‘proportional and graduated’ policy that could require certain elements of a licensed facility's operations to be located in Australia. To give stakeholders further clarity on the specific measures that might be applied under such a policy, the Council issued a supplementary paper in July 2012.[8] Consistent with a graduated approach, the paper describes a framework within which incremental requirements could be imposed on cross-border CS facilities that are systemically important in Australia, or that have a strong connection to the Australian financial system and real economy.

The Council's advice to the Treasurer also noted that the Council was continuing its work with the Australian Competition and Consumer Commission to develop further analysis of issues around competition in clearing and settlement. The first phase of the agencies' work on these issues comprised development of a discussion paper on competition in the clearing of cash equities, which was released on 15 June 2012. While recognising the potential benefits, the paper acknowledges that the entry of competing CCPs could significantly alter the way in which key financial markets operate. Stakeholder feedback was therefore sought on a number of policy matters relevant to the responsibilities of the Council agencies, and possible responses.

At the same time, the Council agencies continue to work on the implementation of Australia's G-20 commitments to undertake significant reforms to strengthen OTC derivatives markets. In June 2011, the Bank, on behalf of the Council agencies, issued a discussion paper, Central Clearing of OTC Derivatives in Australia.[9] Further to this consultation, in March 2012 the Council provided a report to the Australian Government outlining its view that, in the first instance, industry-led solutions should be the preferred route to increasing the use of central clearing within the Australian OTC derivatives market, but that the capacity to mandate central clearing should be developed through legislation.[10] This report also recommended that a similar power should be developed around possible mandatory trade reporting and trade execution obligations. Following this report, the Australian Government consulted on a legislative framework to ensure the implementation of the key G-20 commitments, and has now introduced a bill into parliament that would give effect to this through amendments to the Corporations Act.[11]

Another significant global regulatory development is the release of new best-practice standards for FMIs. In April 2012, CPSS and IOSCO finalised a single set of Principles for Financial Market Infrastructures (the Principles), which is intended to replace the three existing sets of standards.[12] The new Principles acknowledge the critical, and expanding, role played by FMIs, including CS facilities, in the financial system and aim to strengthen and harmonise the standards to which they are held internationally. The Bank's proposed approach to implementing the Principles in its oversight of CS facilities is discussed in Chapter 4. ASIC has also released a consultation paper on proposed changes to its Regulatory Guide 211.[13]

New Financial Market Infrastructure

Chi-X commenced offering trading in ASX-listed equities on 31 October 2011. Currently, Chi-X's trades are cleared and settled through ASX's Trade Acceptance Service. However, Chi-X's market licence permits clearing and settlement to be conducted by any CS facility licensee approved for the purpose.

A new derivatives exchange, FEX, has also applied for a market licence. FEX plans to offer trading in commodity, energy and environmental derivatives, and has approached LCH to provide clearing services. LCH is a London-based CCP that clears equities and derivatives for a number of exchange-traded and OTC markets overseas. It is regulated and supervised by the UK's Financial Services Authority. In order to clear for FEX, however, LCH must be licensed in Australia.

The Corporations Act provides for an alternative licensing process for overseas CS facilities that operate under a regulatory regime deemed to be sufficiently equivalent to the Australian regime.[14] LCH's application is being considered under that process.


In May 2011, the standard equity derivative contract size was changed from 1,000 shares to 100 shares. To calculate a consistent measure of equity derivatives growth, the data have been adjusted to reflect trading volumes based on the earlier contract size. [3]

While Opes Prime was technically an ASX Clear participant when it went into receivership in March 2008, its membership was inactive as it cleared indirectly. ASX Clear therefore had no exposure to Opes Prime. [4]

The consultation paper released by the Council is available at <http://www.treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/2011/ Review%20of%20Financial%20Market%20Infrastructure%20Regulation/Key%20Documents/CFR_review_of_FMI_regulation_issues.ashx>. [5]

The Council's letter to the Deputy Prime Minister and Treasurer is available at <http://www.treasury.gov.au/~/media/Treasury/Consultations%20 and%20Reviews/2012/Council%20of%20Financial%20Regulators%20Working%20Group%20on%20Financial%20Market%20Infrastructure%20 Regulation/Key%20Documents/CoFR_Letter_to_Deputy_PM.ashx>. [6]

CPSS-IOSCO (2012), Recovery and Resolution of Financial Market Infrastructures: Consultative Report, July. Available at <http://www.bis.org/publ/cpss103. htm>. [7]

Council of Financial Regulators (2012), Ensuring Appropriate Influence for Australian Regulators over Cross-border Clearing and Settlement Facilities, July. Available at <http://www.treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/2012/cross%20border%20clearing/key%20 documents/pdf/cross-border-provision.ashx>. [8]

Available at <http://www.rba.gov.au/publications/consultations/201106-otc-derivatives/pdf/201106-otc-derivatives.pdf>. [9]

Council of Financial Regulators (2012), ‘OTC Derivatives Market Reform Considerations’, March. Available at <http://www.rba.gov.au/payments-system/ clearing-settlement/otc-derivatives/201203-otc-der-mkt-ref-con/>. [10]

The bill is available at <https://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2Fbillhome%2Fr4879%22>. [11]

The Principles are available at <http://www.bis.org/publ/cpss101.htm>. The three existing sets of standards are: Core Principles for Systemically Important Payment Systems (CPSS, 2001); Recommendations for Securities Settlement Systems (CPSS and IOSCO, 2001); and Recommendations for Central Counterparties (CPSS and IOSCO, 2004). [12]

ASIC's consultation on amendments to its regulatory guidance for CS facilities is available at <http://www.asic.gov.au/asic/asic.nsf/byHeadline/ 12-221MR%20ASIC%20consults%20on%20amendments%20to%20clearing%20and%20settlement%20facilities%20guidance?opendocument>. [13]

While ‘sufficient equivalence’ is not defined in the Corporations Act, the Bank has developed guidance on the matters it would take into consideration in its assessment of equivalence. This guidance is available at <http://www.rba.gov.au/payments-system/clearing-settlement/standards/overseas-equivalence.html>. [14]