Payments System Board Annual Report – 2008 Oversight of Clearing and Settlement Facilities

Under the Reserve Bank Act 1959, the Board is responsible for ensuring that the powers and functions of the Bank to oversee clearing and settlement facilities are ‘exercised in a way that, in the Board's opinion, will best contribute to the overall stability of the financial system’. The Board undertook two main activities in this area over 2007/08: assessments of the licensed clearing and settlement facilities against the Financial Stability Standards and a review of settlement practices for Australian equities.

The Financial Stability Standards

Under powers in the Corporations Act 2001, the Reserve Bank has oversight responsibility for financial stability and risk issues arising from clearing and settlement (CS) facilities operating in Australia. To meet this responsibility, the Bank determined, in May 2003, Financial Stability Standards for central counterparties and securities settlement facilities.[6] These standards are supplemented by a number of minimum measures the Bank considers relevant for meeting the standards. As part of its obligations under the Corporations Act, the Bank conducts a formal annual assessment of how well each licensed CS facility has complied with the standards.

The latest assessment, covering the nine-month period to June 2007, was published in January 2008 (see below).[7] This was the first time that the assessments had been published. It followed a decision by the Board that publication of the report would assist public understanding of the risks in clearing and settlement and the way in which those risks are managed, and would also improve the transparency of the oversight process.

Four licensed CS facilities are currently obliged to meet the Financial Stability Standards:[8]

  • The Australian Clearing House (ACH) and SFE Clearing Corporation (SFECC) are obliged to comply with the standard for central counterparties. ACH is the central counterparty for cash equities, warrants and equity-related derivatives traded on the ASX market. SFECC is the central counterparty for derivatives traded on the Sydney Futures Exchange; and
  • ASX Settlement and Transfer Corporation (ASTC) and Austraclear are required to meet the standard for securities settlement facilities. ASTC provides the settlement facility for cash equities and warrants traded on the ASX market. Austraclear settles fixed-income securities traded in over-the-counter markets.

Since the merger of the Australian Stock Exchange Limited and Sydney Futures Exchange Limited in July 2006, all four facilities have been part of the same corporate group, the Australian Securities Exchange.

Developments in the Clearing and Settlement Industry

The past 12 months have seen a substantial increase in volatility and traded volumes in a number of markets served by Australia's clearing and settlement facilities. The most notable growth has been in cash equities volumes, which rose by 86 per cent, outstripping growth of 22 per cent in values traded. Reflecting the faster growth in volumes than values, the average transaction size has continued to fall (Graph 18). This is partly the result of more widespread application of automated trading strategies and other mechanisms to split large orders and release them gradually into the market.

As traded values have grown, the average settlement value on each side of the daily net CHESS settlement batch has also increased, rising by 20 per cent over the year to approximately $630 million. The peak value of settlements was $3.7 billion, on 25 September 2007.

Volumes traded on the ASX derivatives market were broadly flat over the assessment period, although the daily notional value of contracts traded expanded by 18 per cent to $2.3 billion. Volumes and notional values traded on the much larger SFE market both expanded by around 3 per cent over the period, with daily notional value traded averaging $152 billion. This was slower than the growth in previous years reflecting, in particular, the scaling back of traders' positions during the first half of 2008 in response to higher market volatility (Graph 19).

The average daily settlement of debt securities through Austraclear, comprising outright purchases and sales of debt securities and repos, also increased significantly over the period, rising by 27 per cent to $42 billion.

As values traded have risen, exposures faced by the central counterparties, ACH and SFECC, have grown. On average, 73 per cent of cash equities and warrants traded on the ASX market were novated to ACH during the year to June 2008. The resultant exposure faced by ACH can be captured by the sum of participants' settlement obligations to the central counterparty in respect of their trades. ACH's average exposure (over the three-day settlement cycle) rose by 37 per cent over the year, from $950 million to $1.3 billion. ACH does not routinely levy margins in respect of participants' cash equity positions, but has recently introduced a regime whereby participants are required to post collateral to cover large exposures.

ACH and SFECC manage the risk associated with participants' derivatives positions partly via the imposition of initial margins. For ASX-traded derivatives, aggregate initial margins held during 2007/08 rose by 44 per cent to an average of almost $730 million. This reflected both the increase in notional values traded and higher market volatility. On the SFE market, where traders scaled back their positions markedly, initial margins posted to SFECC declined from a peak of $4.7 billion on 29 June 2007 to between $2 billion to $3 billion during most of the first half of 2008 (Graph 20). The average for the year as a whole was approximately $3 billion, similar to the previous year.

2006/07 assessment

During 2007/08, the Bank completed its assessment of the four licensed CS facilities against the Financial Stability Standards for the nine-month period ending June 2007. The Bank concluded that all four licensed facilities met the relevant standards over this period. For the first time, the Bank published its assessment of each of the CS facilities against the relevant standards, a practice that will be continued.[9]

For the two central counterparties in the ASX group, the principal focus during the assessment period was on risk-management capabilities and the adequacy of resources in the event of a participant default. A key consideration in the assessments of these areas is the capital stress-testing regime, the process by which the central counterparties establish the magnitude of risk exposures under alternative extreme but plausible market scenarios. Both ACH and SFECC took steps to enhance their stress-testing capabilities during 2006/07 and have continued to implement improvements in 2007/08.

In June 2007, ACH introduced a new suite of capital stress tests, expanding the range of scenarios considered to include a variety of market-wide, sector-specific and stock-specific scenarios. Further modifications to the scenarios were implemented in 2007/08. The breadth of the new scenarios adds considerable richness to the framework, although the changes also entail a reduction in the magnitude of the extreme upside and downside market-wide stress scenarios. Prior to implementation of the new scenarios, the Bank held extensive discussions with ASX to satisfy itself that the overall revision to the framework remained consistent with the Financial Stability Standard for Central Counterparties. ACH has plans in place to further enhance its risk-management capabilities, including intraday monitoring of positions and further expansion of the range of stress-test scenarios.

Also in June 2007, ACH introduced a framework for liquidity stress testing. The stress-test approach is designed to ensure that ACH has sufficient liquidity to assume a defaulter's cash equity settlement obligations and close out its outstanding derivatives positions.

During the assessment period, SFECC also consulted with industry participants and the Bank on a new stress-test regime. This new regime was ultimately introduced in two steps after the assessment period; the first in November 2007 and the second in March 2008. The new regime comprises 30 stress-test scenarios, based on a range of individual and composite price changes in the four largest contracts.

The stress-test outcomes map directly to the calibration of risk resources for the central counterparties with these resources comprising a mix of capital, subordinated debt, participant commitments and insurance. At ACH, stress-test exposures are gauged primarily against those elements of total resources directly held by ACH and readily available to meet obligations arising in the event of a participant default (that is, capital and subordinated debt). Taken together these make up what ACH terms the Risk Resource Requirement (RRR).

As trading activity has increased over recent years, ACH's total risk resources have grown (Graph 21). In March 2007, ACH increased its RRR to $150 million (from $110 million), at the same time raising the total amount payable by participants under ‘emergency assessments' to $300 million (from $220 million). These assessments can be called in the event that clearing losses exceed the sum of the RRR and $100 million in funds available under a default insurance policy held with a third party. As a further safeguard, ACH began the phased introduction of a scheme of ‘Contributions and Additional Cover', whereby participants are required to post cash or collateral in the event that their positions are large enough that projected stress-test losses exceed the RRR.

SFECC has for some time had in place an Additional Initial Margins (AIMs) scheme, which is similar to ACH's Contributions and Additional Cover Regime. Some modifications have been made to this scheme since the end of the assessment period, with SFECC also substantially increasing the size of its pooled risk resources, the Clearing Guarantee Fund. The fund was doubled to $400 million, via a combination of increases in own capital, participant contributions and default insurance (Graph 22).

Operational performance and capacity were also a key focus for all licensed CS facilities. ASTC implemented a significant upgrade to the processing capacity of its main settlement system, CHESS, in December 2006. Austraclear completed a major system upgrade in August 2006, just prior to the start of the assessment period. Several significant outages occurred during the period shortly after implementation, the most significant of these being in October and November 2006 and February 2007. Participants also experienced some connectivity problems and slow processing. The Bank was satisfied that Austraclear gave high priority to the resolution of these operational problems. Operational performance improved substantially through the period and during 2007/08 Austraclear has maintained a high level of reliability. Since the end of the assessment period, Austraclear has worked closely with OMX, the system provider, to in-source key levels of system support.

A final notable development during 2006/07 was the Bank's approval, in May 2007, of ASTC's netting arrangements under the Payment Systems and Netting Act 1998. The approval will protect the netting undertaken by ASTC from a legal challenge in the event that a participant in the netting arrangement enters external administration. This significantly strengthens the legal framework underpinning ASTC's batch settlement process in CHESS. [10]

Developments of relevance for the 2007/08 assessment

During 2007/08, the Board has continued to assess the licensed CS facilities against the standards. The formal assessment for the year to end June 2008 will be published later this year. There have been a number of important developments in the organisation, operational processes and risk management of the licensed CS facilities since the 2006/07 assessment, which will feature in the 2007/08 assessment. In particular:

  • The financial difficulties experienced by several brokers in early 2008, two of whom were ACH participants, highlight the potential risks to central counterparties from their participants. As a result, special consideration has been given in the 2007/08 assessment to the processes in place at the central counterparties for setting and enforcing participation requirements and ongoing participant monitoring. Currently, ACH participants clearing either cash equities or exchange-traded options must hold liquid capital in excess of a ‘total risk requirement’ (which captures counterparty, position, large exposure and operational risks), subject to a minimum of $100,000. ACH intends to raise the minimum capital requirement to $2 million by the end of 2008, increasing this further to $10 million by end 2009. SFECC has similar minimum requirements for its clearing participants which it intends to increase. Currently, participants are required to hold minimum net tangible assets of $5 million; SFECC plans to raise this to $10 million in due course, and to $20 million for those clearing for third parties. ACH also intends to invite bank Authorised Deposit-taking Institutions (ADIs) to become clearing participants.[11]
  • Steps have been taken since the merger of the Australian Stock Exchange Limited and Sydney Futures Exchange Limited to harmonise practices across the two central counterparties, ACH and SFECC. As part of this process, ASX Limited has established a separate wholly owned subsidiary, ASX Clearing Corporation (ASXCC). ASXCC is the immediate holding company for the two central counterparties and will, subject to the passage of proposed rule changes, become responsible for the conduct of treasury operations on their behalf. It is intended that this will entail the investment of margins, contributions, and other risk resources held by the central counterparties, as well as management of the capital structure of the two central counterparties.
  • Further steps were taken towards harmonisation of the central counterparties' processes and operations, including: the establishment of a single internal-ratings model to support participant risk management; the establishment of common (revised) treasury investment limits; establishment of common margin-setting arrangements; and the proposed harmonisation of an internal rating-dependent trigger to call for Contributions and Additional Cover at ACH and Additional Initial Margins at SFECC.

Review of Settlement Practices for Australian Equities

Over 2007/08, the Board also undertook a review of settlement practices for Australian equities. The Review was prompted by significant delays in the settlement of Australian equities in January 2008 as a result of one participant's inability to meet its obligations in the daily net batch settlement process run by ASTC.

The findings of the Review were published in May 2008.[12] It concluded that while the current batch arrangements are operationally efficient and minimise participants' liquidity requirements, the events of late January highlighted how one participant's difficulties could disrupt settlement across the system as a whole. The Review identified several features of current arrangements that warrant attention and made several recommendations for changes to existing arrangements. In particular, the Review noted that although batch settlement typically takes place at around noon each day, there is no fixed time by which settlement must be completed, and there is an apparent lack of clarity over timelines and decision points. Also, the settlement delays were in part related to difficulties arising from the troubled participant's obligations in respect of securities lending transactions. These transactions are not novated to the central counterparty, ACH, but settle together with novated trades in the batch. While securities lending is a critical feature of a well-functioning equities market, and there are efficiencies to be derived in settling novated and non-novated trades together, these events revealed a lack of transparency around securities lending activity and any risks such transactions bring to the settlement process.

The Review therefore considered several possible modifications to settlement arrangements that might address the risks exposed by the events of late January and concluded that:

  • there is a case to move to trade-by-trade settlement over the medium term;
  • consideration should be given by ASX to enhancing the existing batch settlement model;
  • ASX should take steps to strengthen the settlement fails regime; and
  • arrangements should be put in place to improve the transparency of securities lending.

The Board concluded that there was a case to move to a trade-by-trade settlement model for equities over the medium term, as this would reduce the dependence of market-wide settlements on a single participant. Fixed income settlement in Austraclear already occurs in this way. The Board also suggested some possible modifications to existing batch settlement arrangements to increase their robustness, including:

  • the introduction of an explicit window for completion of settlement;
  • clarification of lines of communication and deadlines for decisions, including by settlement banks; and
  • an amendment to the cut-off time for new settlement instructions, so as to allow more time prior to the batch for participants to ensure that securities and funds are in place.

Since publication of the Review, the Bank has consulted with a range of interested parties. Neither ASX nor market participants are persuaded of the need to move to trade-by-trade settlement, citing in particular the high cost of transition to a new settlement model. While the Board acknowledges these costs, it continues to see a case for considering such a move over the medium term, although it does not see the matter as being so pressing as to require a change through regulation. The Bank does, however, continue to see a strong case to implement changes to the existing settlement model to strengthen its resilience and remains in close dialogue with ASX on this matter.

In respect of changes to the settlement fails regime, the Board was keen to stress the importance of timely settlement. In particular, it noted that a single failed settlement could trigger a chain of failures, undermining the integrity of the market and potentially leading to instability. A number of options were therefore discussed for enhancing arrangements for dealing with settlement fails to ensure that market participants face adequate incentive to meet their obligations on the intended settlement date. These included increases in the penalties for failed trades and consideration of borrowing and buy-in arrangements. ASX was, in parallel, considering changes to the settlement fails regime, releasing details of a prospective new arrangement in May 2008.[13]

Finally, given the circumstances leading to the events of late January, securities lending was an important focus in the Bank's Review. It was concluded that greater transparency of activity in this market would yield a number of benefits. In particular, it would: improve general understanding of potential settlement risks; ensure that all participants had access to data on the volume and value of securities lending, rather than just those directly involved in such transactions; and assist in the ‘ex post’ analysis of market events. Since publication of the Review, the Bank has been in dialogue with ASX, other regulators and market participants to identify an efficient and cost-effective means of aggregating and publishing such data.

Other Relevant Developments

Over the past couple of years, a number of companies have indicated an interest in competing with the ASX market in offering trading services and three new entrants have applied for licences to operate trading platforms for ASX-listed securities. In response to this, the Australian Securities and Investments Commission (ASIC) has been working to develop a regulatory framework for these new trading platforms, which has involved two public consultations on competition for market services.[14] ASIC has now completed this process and provided advice on the new framework to the Minister for Superannuation and Corporate Law in March 2008.

The Board's interest in these developments relates to the arrangements to be put in place to enable the new trading platforms to clear and settle via ACH and ASTC. The Bank has, therefore, been in close dialogue with ASX and ASIC on these matters. On 19 March 2008, ASX issued a high-level public consultation document, laying out the relevant issues to be addressed in establishing access to its CS facilities. This was followed by the publication of issues papers for industry consultation in April 2008 and July 2008.

In another prospective change to the clearing and settlement landscape, the US-based central counterparty The Clearing Corporation has announced that it will provide clearing services for derivatives products traded on a new Australian exchange, The Financial and Energy Exchange (FEX). FEX, via its subsidiary, Mercari, already operates a platform trading OTC derivatives products and is planning to expand its offering to include a range of exchange-traded energy, environmental, commodity and financial derivatives.


The standard for securities settlement facilities was varied in June 2005. [6]

Until September 2006, assessments were carried out with reference to the year ending in September. In 2007, a new assessment timetable was adopted, with the reference year ending in June. [7]

A fifth licensed facility, IMB Limited, falls outside the scope of the Financial Stability Standard for Securities Settlement Facilities due to its small size and the limited nature of its operation. [8]

The report is available at:
<> [9]

The details of this approval were provided in the 2007 Annual Report of the Payments System Board. [10]

ADIs have, in the past, been unable to become ACH participants because of the possibility of an unlimited levy being imposed to recapitalise the National Guarantee Fund (NGF). APRA's prudential standards prohibit ADIs from entering into arrangements that could result in such unlimited liability. However, following a recent amendment to relevant Corporations Act provisions in respect of the NGF, ADIs are now able to participate directly in ACH if they wish. [11]

The report is available at:
<> [12]

The media release is available at:
<> [13]

CP86: Competition for Market Services – trading in listed securities and related data (July 2007) and CP95: Competition for Market Services – response to CP 86 and further consultation (November 2007). [14]