2012/13 Assessment of ASX Clearing and Settlement Facilities B2.1 ASX Settlement

Standard 10: Exchange-of-value Settlement Systems

If a securities settlement facility settles transactions that comprise the settlement of two linked obligations (for example, securities or foreign exchange transactions), it should eliminate principal risk by conditioning the final settlement of one obligation upon the final settlement of the other.

Rating: Observed

ASX Settlement eliminates principal risk in settlements involving the transfer of a security in exchange for cash or another security by ensuring that delivery occurs if and only if payment can be settled at the same time (SSF Standard 10.1). For the purchase of securities, ASX Settlement does this through the use of a DvP model 3 settlement mechanism, which completes settlement via a multilateral net batch (SSF Standard 10.2).

Based on this information, the Bank's assessment is that ASX Settlement has observed the requirements of SSF Standard 10 during the 2012/13 Assessment period. ASX Settlement's arrangements for achieving exchange-of-value settlements are described in further detail under the following sub-standards.

10.1 A securities settlement facility that is an exchange-of-value settlement system should eliminate principal risk by ensuring that the final settlement of one obligation occurs if and only if the final settlement of the linked obligation also occurs, regardless of whether the securities settlement facility settles on a gross or net basis and when finality occurs.

ASX Settlement eliminates principal risk by ensuring that the settlement of securities delivery obligations occurs if and only if payment obligations are completed. It does so by performing both its cash and securities settlements in a multilateral net batch on a DvP model 3 basis (see SSF Standard 10.2).

10.2 A securities settlement facility that is an exchange-of-value settlement system should eliminate principal risk by linking the final settlement of one obligation to the final settlement of the other through an appropriate delivery versus payment (DvP), delivery versus delivery (DvD) or payment versus payment (PvP) settlement mechanism.

ASX Settlement links the final settlement of securities and payment obligations through a DvP 3 model, where final securities and payments transfers occur contemporaneously on a multilateral net basis through a single batch of instructions. The settlement of securities via this mechanism involves several steps (including related steps taken for the clearing of novated transactions in ASX Clear and the ‘priming’ of settlement accounts) (Figure 1).

Step 1: Once a trade has been executed on either the ASX or Chi-X markets, a trade-related instruction is sent to CHESS.

Step 2: Once CHESS validates these trades they are novated in real time to ASX Clear and CHESS sends messages to the relevant clearing participants (and to Chi-X if the trade was executed on its market), notifying them that the trade has been accepted and cleared. Trades that have the same clearing participant as buyer and seller, called clearing crossings, are not novated, netted or scheduled for settlement in the CHESS batch. To facilitate the remaining back-office processes for these trades, CHESS will send a single message to the clearing participant confirming the trade's details. The settlement of clearing crossings are negotiated bilaterally between brokers and their clients and occur when securities are transferred between broker and client settlement accounts.

Step 3: At T+1, CHESS generates a single net batch instruction reflecting the net position of each participant's novated trades in each line of stock. Before netting, clearing participants can mutually agree to block a transaction from netting, or delete or modify existing novated transactions. If matching instructions are sent from both clearing participants that are counterparties to a particular trade, CHESS sends messages to the clearing participants confirming that instructions for that trade have been processed.

Step 4: 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 2012/13, an average of around 83 per cent of the value of net securities settled in the final batch was in respect of non-novated transactions. Non-novated trades mainly arise from three types of activities: pre-positioning transfers of securities across accounts; securities lending to cover a short sale or a shortfall in a participant's securities account; and off-market trades. Pre-positioning involves transferring securities to a participant's entrepot settlement account, i.e. a centralised settlement account.

Step 5: On the evening before settlement, ASX Settlement notifies each participant of its projected net cash payment obligations. Participants have until 10.30 am to negotiate any additional non-novated transfers necessary to ‘prime’ their accounts for settlement. After the cut-off for new instructions, transfer of securities positions is stopped in CHESS pending completion of transfer once cash movements have been confirmed (Step 6), and participants' Payment Providers are requested to fund the net cash obligations of settlement participants.

Step 6: Payment obligations are settled between Payment Providers in RITS as a single daily multilateral net batch. Immediately upon confirmation from RITS that the funds transfers have been settled, ASX Settlement completes the net securities transfers in CHESS, thus ensuring DvP settlement. This typically occurs at around 11.30 am. CHESS then notifies the participants that settlement has been completed successfully.

Step 7: At the end of the day CHESS reports net movements on each sub-register to the holder of the issuer's complete register.

There is considerable activity in the hours prior to the 10.30 am cut-off for settlement instructions as participants arrange to lend and transfer securities in order to prime their settlement accounts. Settlement participants may wait until the morning of T+3 to complete the priming of their accounts, partly due to the need to wait for final matched settlement instructions from offshore clients. As a consequence, fails in delivery of securities are a daily occurrence, although fail rates are relatively low by international comparison. The failure of a participant to meet payment obligations is a much rarer occurrence and may be indicative of problems that are not merely operational.

If, due to a shortfall of either securities or funds, a participant is unable to settle its scheduled obligations in the batch, ASX Settlement's rules allow for all or some of the transactions of the affected participant to be ‘backed out’. These transactions are then rescheduled for settlement on the next settlement day. The precise nature of the back-out process depends upon whether or not the failing participant is in default. If the participant is in default, ASX Clear, as part of its default management strategy, may inject liquidity to ensure the settlement of novated trades. ASX Settlement's back-out algorithm seeks to remove as few transactions from the batch as possible, maximising settlement values and volumes, while minimising the spillover to other participants. Transactions unrelated to novated settlement obligations are typically backed out first. In 2012/13 an average of 0.07 per cent of settlement transactions were recorded as ‘initial fails’ (where a participant has insufficient stock on t+3), with an average of 0.32 per cent of settlements rescheduled following the application of the back-out algorithm. Both initial fails and rescheduled settlements were lower as a proportion of total settlements than in 2011/12.

The use of the DvP model 3 settlement mechanism described above is acceptable for ASX Settlement given the relatively low average value of securities transactions involved. In 2012/13, the average value of individual gross settlement instructions in ASX Settlement (for both novated and non-novated transactions) was around $12,500. This compares with an average of $28.3 million for an individual DvP settlement instruction for debt securities in Austraclear. While, in its 2008 Review of Settlement Practices for Australian Equities, the Bank encouraged ASX to consider introducing a DvP Model 1 settlement mechanism for cash equities over the medium term, the Bank accepts that neither ASX nor market participants are persuaded of the need to move to a new settlement model at this time. ASX has since taken measures to strengthen the resilience of the batch settlement process, including by moving payment authorisation deadlines earlier to allow for earlier time frames for the back out of failed settlement obligations. The change in deadlines was achieved via an amendment to the Payment Provider Deed in September 2012. The new deadlines provide that payment authorisations must be received by 2.30 pm, and impose a 1.00 pm cut-off time for ASX to notify Payment Providers of settlement obligations. Another amendment requires Payment Providers to notify ASX if they expect to take more than 60 minutes to authorise a payment.