Financial Stability Standard for Securities Settlement Facilities February 2009

This Standard is no longer in effect. See the current Financial Stability Standards for Securities Settlement Facilities.

Introduction

This standard is determined under section 827D(1) of the Corporations Act 2001 (Cth) and applies to Australian clearing and settlement (CS) facility licensees, under Part 7.3 of the Act, that operate a securities settlement facility. For the purposes of this standard, a securities settlement facility is a clearing and settlement facility operated by an Australian CS facility licensee which enables its participants to transfer title to or other interests in securities, typically in return for payment. Securities settlement facilities usually (although not always) also hold physical securities, or an electronic record of title, or other interests in securities, on behalf of their participants. A separate standard applies to CS facility licensees that operate a central counterparty.

The objective of this standard is to ensure that CS facility licensees identify and properly control risks associated with the operation of the securities settlement facility, thereby promoting the stability of the Australian financial system. Primary responsibility for risk control lies with each CS facility licensee's board and senior management.

This standard sets a general requirement for a CS facility licensee that operates a securities settlement facility to conduct its affairs in a prudent manner. This objective test is then supplemented by a series of measures which the Reserve Bank considers relevant for the purposes of meeting the standard.

Terminology

In this standard and associated measures:

"cash settlement asset" is an asset which carries little or no credit or liquidity risk and is used to settle payment obligations arising from trades in financial products;

"central counterparty" is a clearing and settlement facility operated by an Australian CS facility licensee where the CS facility licensee interposes itself between trade counterparties, taking on the trade obligations of trade counterparties to each other. The central counterparty enters into a new contract, as principal, with each of the existing counterparties, or with new counterparties who take on the obligations of the original counterparties to the central counterparty. This process is a form of novation (see definition below);

"contingency" is the failure of one or more components of a system;

"delivery-versus-payment", in the settlement of a financial product transaction, means the action of a facility in ensuring that the final transfer of a financial asset occurs if and only if the final transfer of another financial asset (typically, a payment) occurs;

"Exchange Settlement Account" means an account held at the Reserve Bank of Australia which is used for the final settlement of obligations between Exchange Settlement Account holders;

"external administration" has the meaning given to that term in the Payment Systems and Netting Act 1998 (Cth);

"novation" means the satisfaction and discharge of existing contractual obligations by means of their replacement by new obligations. The parties to the new obligations may be the same as to the existing obligations, or in the case of a central counterparty, there is a substitution of a new party or parties;

"principal risk" is the risk that the seller of the financial product delivers a financial product but does not receive value for the sale of the financial product, or that a buyer of financial products provides value for the purchase of the financial product but does not receive delivery of the financial product;

"real-time gross settlement" means the continuous (real-time) settlement of funds or securities transfers individually on a transaction-by-transaction basis;

"related body" has the meaning given to the term "related body corporate" in section 50 of the Corporations Act 2001 (Cth);

"securities settlement facility" is a clearing and settlement facility operated by an Australian CS facility licensee which enables its participants to transfer title to or other interests in securities, typically in return for payment. Securities settlement facilities usually (although not always) also hold physical securities, or an electronic record of title, or other interests in securities, on behalf of their participants; and

"securities" includes any financial product which gives rise to obligations prescribed under the Corporations Regulations for the purposes of section 768A(1)(b) of the Corporations Act 2001 (Cth).

The Standard - FSS 2009.2

A CS facility licensee must conduct its affairs in a prudent manner, in accordance with the standards of a reasonable CS facility licensee in contributing to the overall stability of the Australian financial system, to the extent that it is reasonably practicable to do so.

This standard only applies to CS facility licensees that provide a facility where the value of financial obligations settled in a financial year exceeds a threshold value of $100 million. When this threshold is exceeded for the first time, the provider of the facility must meet the standard by the beginning of the next financial year.

How A Licensee Meets the Standard

Parts 1–8 below identify the minimum measures that the Reserve Bank considers are relevant in determining whether a CS facility licensee has met the standard.

The standard is to be interpreted in accordance with its objective, and by looking beyond form to substance. Where the requirements of the measures and those of the Corporations Act 2001 (Cth) and Corporations Regulations are inconsistent, the requirements of the Corporations Act 2001 (Cth) and Corporations Regulations will prevail to the extent of such inconsistency.

The Reserve Bank may, from time to time, issue guidance containing further information on specific aspects of the measures listed below.

1. Legal framework

The securities settlement facility must have a well-founded legal basis. The CS facility licensee as operator of the securities settlement facility must: [See also Guidance Measure 1]

  1. be a legal entity (whose primary business activity is operating the CS facility) and one which is separate from other entities which may expose it to risks unrelated to those arising from its function as operator of a securities settlement facility; [See also Guidance Measure 1(a)]
  2. have rules which constitute a clear and legally enforceable contract or contracts, in all relevant jurisdictions, between the securities settlement facility and its participants (and between each participant and each other participant); [See also Guidance Measure 1(b)]
  3. have rules which clearly define its rights and obligations, and those of its participants, including in the event of the default or suspension of one or more of its participants;
    [See also Guidance Measure 1(c)]
  4. have rules which will operate according to their terms in the event of external administration; and
  5. to the extent possible, obtain legal certainty for its rules under all relevant legislation.
    [See also Guidance Measure 1(e)]

2. Participation requirements

The requirements for participation in the securities settlement facility must promote the safety and integrity of the securities settlement facility and ensure fair and open access. Participation requirements must:
[See also Guidance Measure 2]

  1. be based on objective and publicly disclosed criteria; [See also Guidance Measure 2(a)]
  2. require that participants have the operational capacity and financial standing to settle their obligations through the securities settlement facility in a timely manner; and [See also Guidance Measure 2(b)]
  3. allow the CS facility licensee as operator of the securities settlement facility to suspend or cancel the participation of an institution which breaches the applicable participation or other risk-control requirements. [See also Guidance Measure 2(c)]

3. Understanding risks

The securities settlement facility must make sufficient information publicly available, via its rules and procedures and the provision of relevant information on settlement activity, such that each participant is able to understand the securities settlement facility's impact on each of the financial risks the participant incurs through participation in the facility. [See also Guidance Measure 3]

4. Certainty of title

The CS facility licensee as operator of the securities settlement facility must ensure that under the facility's rules and procedures, participants, or where relevant, their clients, have a clear and unambiguous title to, or interest in, securities held, deposited or registered on their behalf, including in circumstances where the solvency of the operator of a securities settlement facility is in doubt. This requires that its rules and procedures:
[See also Guidance Measure 4]

  1. clearly identify the type of title or interest held by participants for particular securities, to the extent such title or interest is recognised by the facility's rules and procedures;
    [See also Guidance Measure 4(a)]
  2. clearly identify the way in which the transfer of (or any other forms of dealing with) securities and related payments can be effected through the facility; and [See also Guidance Measure 4(b)]
  3. ensure that, to the extent permissible by law, the creditors of the operator of the securities settlement facility have no claim over securities or other assets held, deposited or registered by participants in the facility. [See also Guidance Measure 4(c)]

5. Settlement

The CS facility licensee as operator of a securities settlement facility must ensure that its operations do not expose its participants, or the financial system more broadly, to unacceptable levels of risk. The operator of a securities settlement facility must pay particular attention to ensuring settlement finality and the use of high-quality settlement assets in payment for securities. [See also Guidance Measure 5]

i. Principal risk and settlement finality

The operation of a securities settlement facility must eliminate principal risk between its participants and ensure that settlements, once completed, are final and irrevocable. This requires that the facility's rules and procedures: [See also Guidance Measure 5(i)]

  1. ensure that settlement of transactions in the facility occurs on a delivery-versus-payment basis; and [See also Guidance Measure 5(i)(a)]
  2. clearly identify the conditions that have to be met to ensure that final and irrevocable settlement has taken place. [See also Guidance Measure 5(i)(b)]

Best practice is for securities settlement facilities to provide real-time finality by settling individual transactions on a real-time gross settlement basis. However, where settlement values are not large, other methods may be appropriate.

ii. Cash settlement assets

The assets used to settle the payment obligations in respect of a transaction in the securities settlement facility must carry little or no credit or liquidity risk. This requires that the settlement assets be:
[See also Guidance Measure 5(ii)]

  1. funds held in an Exchange Settlement Account (or in an account with a central bank in another jurisdiction); or
  2. funds provided by a financial institution which is an Authorised Deposit-taking Institution and which holds an Exchange Settlement Account at the Reserve Bank.

iii. Exposures between providers of cash settlement assets

Exposures between providers of cash settlement assets must be settled finally and irrevocably.
[See also Guidance Measure 5(iii)]

  1. Best practice is for obligations between providers of cash settlement assets to be settled on a real-time gross settlement basis across Exchange Settlement Accounts, contemporaneously with settlement of the security and payment legs of each individual transaction. This must occur where individual trade values are large.
  2. However, where trade values are small, trade obligations may be settled as a multilateral batch. In these circumstances, obligations between the providers of cash settlement assets must be settled on a real-time gross settlement basis contemporaneously with the settlement of the multilateral batch.
  3. Only where trade values are small, and where operational requirements necessitate, may obligations between the providers of cash settlement assets be settled on a real-time gross settlement basis subsequent to the settlement of one or both legs of the transaction.
    [See also Guidance Measure 5(iii)(c)]

6. External administration

The rules and procedures for the securities settlement facility must contain mechanisms to deal with the external administration of a participant, or a provider of cash settlement assets, in such a way as to limit the operational and financial impact on both the securities settlement facility and its participants. This requires that the CS facility licensee as operator of the securities settlement facility must: [See also Guidance Measure 6]

  1. allow for the cancellation or suspension of a participant or a provider of cash settlement assets from the securities settlement facility: [See also Guidance Measure 6(a)]

    1. if the participant or provider of cash settlement assets is in external administration; or
    2. if there is a reasonable suspicion of external administration; and
  2. allow participant users of a cash settlement provider which becomes subject to external administration, or which is reasonably likely to become subject to external administration, to quickly nominate a new provider.

Any arrangements for dealing with the unsettled trades of a participant in external administration, such as recasting multilateral net settlement positions without the transactions of the participant in external administration, must be clear to all securities settlement facility participants and must be able to be carried out in a timely manner.

7. Operational risk

The CS facility licensee as operator of a securities settlement facility must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.
[See also Guidance Measure 7]

i. Security and operational reliability

The CS facility licensee as operator of a securities settlement facility must ensure that:
[See also Guidance Measure 7(i)]

  1. key systems, such as computer and communication systems, are secure and have robust access controls, with security reviewed and tested periodically;
  2. key systems are operationally reliable, with standards of operational reliability defined formally and documented;
  3. systems have sufficient capacity to process the expected volumes of transactions with the required speed, including at peak times and on peak days; [See also Guidance Measure 7(i)(c)]
  4. changes to technical systems and supporting infrastructure do not disrupt its usual operations; and [See also Guidance Measure 7(i)(d)]
  5. it has well-trained and competent personnel to ensure that all key systems are operated securely and reliably.

ii. Business continuity procedures

The CS facility licensee as operator of a securities settlement facility must have in place arrangements to ensure the timely recovery of its usual operations in the event of a contingency. This requires that the operator of a securities settlement facility: [See also Guidance Measure 7(ii)]

  1. have detailed contingency plans, including back-up arrangements for its critical communications and computer systems and key personnel; [See also Guidance Measure 7(ii)(a)]
  2. require its participants to have appropriate complementary arrangements in the event of a contingency; [See also Guidance Measure 7(ii)(b)]
  3. undertake regular industry testing of its business recovery arrangements; and
    [See also Guidance Measure 7(ii)(c)]
  4. conduct regular reviews of the adequacy of these arrangements and make such changes as are necessary and desirable.

iii. Outsourcing

Security, operational reliability and business continuity procedures must extend to systems and processes which have been outsourced. The CS facility licensee as operator of a securities settlement facility must ensure that service providers meet the same standards as apply to the operator of the securities settlement facility with respect to the function outsourced. However, even when systems and processes are outsourced, the operator of the securities settlement facility remains responsible for those systems and processes.
[See also Guidance Measure 7(iii)]

iv. External administration of a related body

The CS facility licensee as operator of a securities settlement facility must ensure that it would have access to the necessary staff, technical and other resources needed to continue operating in circumstances where a related body becomes subject to external administration. [See also Guidance Measure 7(iv)]

8. Regulatory reporting

The CS facility licensee as operator of a securities settlement facility must inform the Reserve Bank as soon as reasonably practicable if: [See also Guidance Measure 8]

  1. it breaches, or has reason to believe that it will breach [See also Guidance Measure 8(a)]

    1. the standard; or
    2. its broader legislative obligation to do, to the extent that it is reasonably practicable to do so, all things necessary to reduce systemic risk;
  2. it becomes subject to external administration, or has reasonable grounds for suspecting that it will become subject to external administration;
  3. a related body to the operator of the securities settlement facility becomes subject to external administration, or if the operator of the securities settlement facility has reasonable grounds for suspecting that a related body will become subject to external administration;
  4. a participant becomes subject to external administration, or if the operator of the securities settlement facility has reasonable grounds for suspecting that a participant will become subject to external administration;
  5. a participant fails to meet its obligations under the securities settlement facility's risk-control requirements or has its participation suspended or cancelled because of a failure to meet the securities settlement facility's risk-control requirements;
  6. it fails to enforce any of its own risk-control requirements;
  7. it plans to make significant changes to its risk-control requirements or its rules and procedures;
  8. it proposes to grant a security interest over its assets (other than a lien, right of retention or statutory charge that arises in the ordinary course of business);
  9. it proposes to incur or permit to subsist any loans from participants or members unless such loans are subordinated to the claims of all other creditors of the operator of the securities settlement system; or
  10. any other matter arises which has or is likely to have a significant impact on its risk-control arrangements.

The CS facility licensee as operator of a securities settlement facility must also provide to the Reserve Bank, on a timely basis:

  1. audited annual accounts; and
  2. management accounts on a regular basis, and at least quarterly.