2011/12 Assessment of Clearing and Settlement Facilities in Australia 1. Introduction and Executive Summary

Under the Corporations Act 2001, a licensed clearing and settlement (CS) facility must comply with the Reserve Bank's Financial Stability Standards (FSSs) and do all other things necessary to reduce systemic risk. The Reserve Bank (the Bank) is required to assess annually how well each CS facility is complying with these obligations.

Currently, five CS facilities are licensed to operate in Australia. Of these, two are central counterparties (CCPs) – ASX Clear Pty Limited (ASX Clear) and ASX Clear (Futures) Pty Limited (ASX Clear (Futures)) – and three are securities settlement facilities (SSFs) – ASX Settlement Pty Limited (ASX Settlement), Austraclear Limited (Austraclear) and IMB Limited (IMB).

This report presents the Bank's annual Assessment of the four licensed CS facilities in the ASX Group (ASX). All four facilities were found to have complied with the relevant obligations in the Assessment period.

IMB is a building society that also operates a market for trading in its own shares by its members, and an associated SSF to settle these trades.[1] In light of its small size and limited scope, the operations of IMB's SSF are unlikely to have implications for the stability of the financial system and therefore its activities are not covered in this report.

Developments in 2011/12

The number of trades on the equities and derivatives markets served by the ASX CCPs increased in 2011/12. However, consistent with 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 and ASX Clear (Futures). However, for cash equities, despite the increased volatility, the notional margins calculated (not currently collected) by ASX Clear fell, due in part to the decrease in value traded. This was also reflected in a lower value of cash equity settlements by ASX Settlement. The value of debt securities settled by Austraclear was broadly unchanged.

There were also a number of important regulatory developments in 2011/12. These included a review of the framework for regulation of financial market infrastructures 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).

Also during the period, Chi-X Australia Pty Ltd (Chi-X) commenced offering trading in ASX-listed equities. Chi-X's trades are cleared and settled by ASX Clear and ASX Settlement, respectively, via a Trade Acceptance Service developed by ASX.

Central counterparties

Both CCPs continued to improve their risk and operating frameworks over the Assessment period. In particular, the facilities made changes in the following areas:

  • CME SPAN. ASX has introduced CME SPAN, a widely used margining system, at ASX Clear (Futures) and will do so shortly at ASX Clear. This is expected to facilitate better calibration of exposures to ASX's risk tolerance, and will consolidate the two CCPs' risk management for derivatives on a common platform.
  • Default management. ASX's CCPs successfully handled the default of the MF Global Holdings Limited subsidiaries in November 2011, in accordance with their 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.
  • Participant monitoring. ASX improved its participant monitoring processes by refining its participant ‘watch list’; in particular, arrangements were put in place to coordinate actions and information sharing between different areas within ASX. ASX also increased its face-to-face engagement with participants, and progressed a number of projects related to monitoring participants' compliance with ASX's rules.
  • Participation requirements. From 1 January 2012 the minimum ‘core capital’ requirement for participants that offer third-party clearing was increased from $10 million to $20 million. Subject to further review in late 2012, an increase in the minimum core capital requirement for all other participants, from $5 million to $10 million, is planned for January 2014.

The Bank welcomes these measures, which should further enhance the CCPs' risk management frameworks. Progress has also been made by ASX Clear to introduce routine margining of cash equities. However, the Bank notes that this work has fallen behind the intended time frame, with implementation now scheduled for June 2013. While the Bank appreciates the complexities involved in implementing cash equity margining, and fully acknowledges the competing demands on participants' technology resources, this remains an important improvement to risk management at ASX Clear. Furthermore, the implementation of new FSSs, aligned with the Principles, in 2012/13 will require that margining arrangements are in place. While, as a general matter, transitional arrangements will be considered in implementing the new FSSs, the Bank is not considering transitional relief for the application of routine margining of cash equities beyond 30 June 2013. The Bank therefore expects collection of margin to be implemented in line with ASX Clear's revised timetable and will continue to monitor developments over the coming months.

Securities settlement facilities

Other than the operational and strategic developments discussed below, there were no material developments in Austraclear over the Assessment period.

ASX Settlement, however, continued to refine its settlement process, in accordance with recommendations in the Bank's 2008 Review of Settlement Practices for Australian Equities.[2] In particular, in August 2012, ASX finalised an agreement with authorised deposit-taking institutions that act as Payment Providers within the system to establish an earlier deadline for authorisation of the funding of settlement participants' obligations. The Bank welcomes this development. Setting an earlier deadline reduces the potential for settlement delay and should therefore mitigate the possibility that uncertainty over a participant's ability to meet its obligations affects confidence in the market at large. The Bank also welcomes the forthcoming introduction of so-called ‘prolonged margining’ of low exercise price options (LEPOs) using CME SPAN as a permanent solution to manage the risk around LEPO expiries.

Also in 2011/12, ASX Settlement developed two new settlement services: a delivery-versus-payment (DvP) settlement service for non-ASX listed securities; and a payment and unit allocation service for managed funds. In extending DvP settlement to non-ASX listed securities, ASX Settlement allows participants in these markets to avoid incurring principal risk during the settlement process. The new service for managed funds has the potential to improve the efficiency of the payment arrangements in this market. While the managed fund service is subject to approval from other regulators, the Bank is satisfied that the implementation of these new services is consistent with ASX Settlement's ongoing compliance with the FSS. Nevertheless, the Bank will continue to monitor the composition of the daily settlement batch as an indication of the potential for the settlement of novated market transactions to be disrupted by problems arising in the settlement of unrelated transactions.

Operational risk

ASX completed the move to its new operations centre. The Bank welcomes this initiative, which has improved redundancy arrangements for the core systems of all four ASX CS facilities. The new operations centre will facilitate rapid recovery in the event of an operational incident, and provides an alternative workspace for a significant proportion of ASX staff.

In general, over the Assessment period, all of the ASX CS facilities' core systems operated soundly, meeting their availability and capacity targets. A small number of operational incidents nevertheless occurred, involving the core systems of ASX Settlement and Austraclear. The Bank is satisfied with both ASX's immediate responses to these incidents, as well as the follow-up action to prevent recurrence. Since the issues at ASX Settlement affected both the ASX market and Chi-X, one response has been to develop a multi-market communication protocol in the event of an operational incident at the securities settlement facility.

The Austraclear incidents were related to a system upgrade and the move to the new operations centre. ASX is in the process of increasing the level of in-house development and support for Austraclear's core system and plans to simplify the system design to facilitate maintenance and upgrades. The Bank is supportive of these plans which, when implemented, will facilitate more timely responses to operational incidents and also give ASX greater control over initiatives to enhance the stability of the Austraclear system. The Bank will, however, continue to review developments to ensure that ASX can adequately resource this function, without impacting the quality of support for other systems.

Strategic initiatives

The Assessment also identifies a number of strategic initiatives in train that are likely to be relevant to the Bank's future Assessments of the CS facilities. These include:

  • ASX Collateral. ASX intends to introduce a new service that will assist users to more efficiently manage and reallocate the collateral they post to counterparties.
  • Central clearing of OTC derivatives. ASX is studying the feasibility of offering central clearing of OTC derivatives.
  • Retail trading in Commonwealth Government Securities (CGS). ASX has developed a proposal for trading, clearing and settling CGS depository interests using its existing cash-market infrastructure.

The Bank welcomes ASX continuing the dialogue with its regulators as these plans develop to ensure that these initiatives are pursued in a manner consistent with ASX's ongoing compliance with the FSSs.

New Financial Stability Standards

In April 2012, CPSS and IOSCO finalised the new Principles. The Bank has developed proposed new FSSs, aligned with the Principles, which were recently released for consultation and with a view to applying them in future Assessments of licensed CS facilities, subject to appropriate transitional arrangements. Given the proposed change in the FSSs, the Bank has decided to depart from its recent practice of highlighting one particular measure of the existing FSS for detailed discussion. Section 4 offers an overview of how the Bank intends to implement the new international standards in the Australian regulatory regime.

ASX is already considering the implications of various measures required under the Principles, thereby ensuring its readiness for the introduction of new FSSs aligned with the Principles. ASX's plans to introduce margining of cash equities in the forthcoming Assessment period is also consistent with explicit requirements under the Principles. Several other changes are under consideration, on which ASX plans to consult with participants and other stakeholders over the coming period. These include:

  • Alternative options for meeting new expectations around segregation and portability of client positions and collateral.
  • Amendments to the CCPs' stress-testing arrangements, including to provide for the coverage of obligations arising in the event of the default of not only the participant with the largest stress exposure, but also any affiliated entities.
  • Potential amendments to ASX Clear's rules to provide for more robust access to liquidity in the event of a participant default. This would make it less likely that cash equity settlements needed to be rescheduled in such circumstances.
  • Revisions to ASX's collateral acceptance policies.

The Bank welcomes ASX's consideration of these measures and will remain in dialogue with ASX through the consultation process and subsequent policy development.

In conjunction with this work, ASX is also encouraged to carry out a review of its Treasury Investment policy, in consultation with the Bank. The Bank's 2008/09 Assessment identified the risk that ASX assumed large concentrated exposures to the large domestic banks under its Treasury Investment policy and encouraged ASX to consider options to reduce this risk, such as entering into repurchase agreements backed by CGS. Given developments in the market for CGS since the Bank's initial recommendation it is timely for ASX to revisit this issue. Such a review will also support an assessment of ASX's Treasury Investment policy against explicit recommendations in the Principles.

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 FSSs. Section 5 fulfils the Bank's statutory obligations under section 823CA of the Corporations Act to report to the Minister, and to the Australian Securities and Investments Commission, on its annual Assessment of the licensed CS facilities.

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


IMB's SSF is currently exempt from the FSSs, since the value of financial obligations it currently settles in any financial year falls well below the $100 million threshold value specified in the relevant Standard. According to data reported to the Australian Securities and Investments Commission, the value of shares traded on IMB's market in the 12 months to 24 February 2012, and settled by IMB's SSF, was $5.3 million. [1]

The Review is available at <http://www.rba.gov.au/payments-system/clearing-settlement/review-practices/>. [2]