Payments System Board Annual Report – 2009 Performance of Australia's Payments Infrastructure during the Market Turbulence

An important issue for the Board in 2008/09 was the performance of Australia's payments infrastructure during the period of market turbulence in late 2008. Market volatility had increased significantly over 2007/08 as financial market strains first emerged, but rose further in late 2008 following the collapse of Lehman Brothers in September. During this period, the payments infrastructure (including central counterparties, securities settlement systems and high-value payment systems) continued to function well. Australia's central counterparties implemented a number of additional risk-management measures and settlement performance, both in the securities settlement facilities and the high-value payments system, remained sound.

Clearing and Settlement Facilities

The clearing and settlement facilities performed well during the period of market turbulence. The two central counterparties took a number of steps to manage increased risk, including more intensive participant monitoring, increased margins and revisions to stress-test parameters.

Central counterparty risk management

A central counterparty interposes itself as the legal counterparty to sales and purchases of financial instruments via a process known as novation. This simplifies market participants' counterparty risk management – as they are exposed only to the central counterparty – but concentrates risk in the central counterparty. With large price movements and concerns over the financial standing of some clearing participants, the risks faced by Australia's licensed central counterparties – Australian Clearing House (ACH) and SFE Clearing Corporation (SFECC) – increased in late 2008. Accordingly, the central counterparties intensified their risk management activities in a number of ways.

Participant monitoring

The central counterparties assign internal credit ratings as part of their participant monitoring procedures. These ratings are based on the external credit rating or net tangible assets of the participant or its parent and are used to better understand the distribution of the central counterparties' risk exposures and assist in the interpretation of stress-test results (discussed below). During the heightened market uncertainty in late 2008, a number of participants were downgraded within this framework: ACH downgraded eight participants and SFECC downgraded two participants. As conditions stabilised during the first half of 2009, six ACH participants' ratings were upgraded.

The central counterparties also maintain a ‘watch list’ of participants deemed to warrant more intensive monitoring. Inclusion on the watch list might, for instance, reflect issues arising from routine review of financial returns by ASX Markets Supervision, or concerns emerging from a specific event or media report. In the first stage of intensive monitoring, there is greater scrutiny of the exposures participants bring to the central counterparty. Should a participant's perceived financial standing deteriorate further, restrictions may be placed on its trading, clearing and settlement activities. At its peak, 15 ACH participants and six SFECC participants were on the watch list (some of which were related group entities). By mid-2009, the number of participants on the watch list had dropped back, to eight at ACH, and three at SFECC.


Initial margins are collected by the central counterparties to cover any losses arising in the close out of derivatives positions should a default occur. Both ACH and SFECC set initial margin intervals on the basis of a three standard deviation confidence interval for price movements over an assumed close-out period of either one or two days.

During the period of heightened market volatility in late 2008, the central counterparties took steps to increase the degree of margin coverage. In the December quarter, ACH carried out eight ad hoc reviews of exchange-traded option margin intervals, and SFECC carried out two reviews of margin rates for its main futures contracts. Some large adjustments were implemented, including sharp increases in margin rates for the major interest rate contracts traded on the Sydney Futures Exchange (SFE). These rate increases led to large calls on participants – the two SFECC reviews led to calls amounting to a total of $900 million in October 2008. The large increase in margin rates in late 2008 has since been largely unwound for many – though not all – contracts as market conditions have stabilised and volatility has receded (Graphs 16 and 17).

The central counterparties also typically call for intraday margin in the event that initial margin coverage is eroded by 50 per cent. During the turbulent period, intraday margin was called at a lower erosion threshold of 40 per cent (or 30 per cent for participants on the watch list), leading to a substantial increase in the frequency of such calls. These calls were often sizeable. At SFECC, for instance, almost 100 intraday calls took place in the final quarter of 2008, mostly in October, for a total of more than $6 billion. Again, as market conditions stabilised, the frequency of intraday calls declined. Just 19 calls were made in the first half of 2009, totalling less than $200 million.

Stress testing

Both central counterparties use stress testing to assess the adequacy of their risk resources and call additional collateral to cover large and concentrated exposures identified via the stress-testing process. At SFECC, collateral called in this way is termed Additional Initial Margin; at ACH, such calls are known as Contributions and Additional Cover. Calls for additional collateral were made by both central counterparties during late 2008. At ACH these were concentrated around the time of the December index futures expiry, which traditionally leads to large cash market exposures associated with the unwinding of index arbitrage positions. At SFECC, there were also some high stress-test exposures through October and November 2008, which led to a peak in Additional Initial Margin held of more than $300 million.

The extreme market conditions in late 2008 resulted in some price movements that were close to, and in one case exceeded, the scenarios used by the central counterparties in stress testing. At ACH, the magnitude of some stress tests was adjusted in conjunction with an expansion of the range of stress-test scenarios in December 2008. These changes had been planned prior to the market turbulence and the revised price-move scenarios are all more extreme than those experienced during that period. SFECC also revised upwards some of its stress-test parameters in its annual review of these scenarios in late 2008.

Equity settlement performance during the market turbulence

Despite an increase in equity settlement fails during the turbulence, due in part to complications arising from Lehman's failure, fail rates remained low by international standards.

As Lehman Brothers participated only indirectly in the Australian central counterparties and equity settlement facility, the bankruptcy of its US parent did not result in any direct exposures for the facilities and Lehman's pre-existing cash equity trades and open derivatives positions were either settled or closed out relatively smoothly by its clearers. Some increase in equity settlement fails was, however, observed as delays occurred in obtaining approval from the European administrator for the release of Lehman's securities. Settlement fails subsequently increased further following the imposition of the ban on short selling by the Australian Securities and Investments Commission (ASIC), as some securities lenders were reluctant to lend securities due to initial uncertainties as to the scope of the ban.[2]

Nevertheless, the fail rate remained low by international standards and the increase was temporary. The downward trend in the fail rate – which had commenced in mid-2008 – resumed, with the rate settling at around 0.1 per cent during the first half of 2009 (Graph 18). This would seem to reflect enhancements to the settlement fails regime implemented during 2008/09, including an increase in penalty fees applied in the event of a failed settlement delivery, and a requirement to close out positions remaining unsettled on the fifth day after trade date. These developments are discussed further in ‘Oversight of Clearing and Settlement Facilities’ below.

CLS Bank

CLS Bank provides a settlement facility used by global financial market participants, including those in Australia, to effect payment-versus-payment (PvP) settlement in the foreign exchange market. CLS was specifically designed to manage the risk that one party might pay away the currency it is selling and, due to the failure of its counterparty, not receive in return the currency it is purchasing.

CLS performed as designed in the face of the failure of Lehman Brothers and no participants were exposed to principal risk as a result of this event. While Lehman used CLS to settle its foreign exchange transactions, it did so by engaging another bank to settle on its behalf. Between 15 September (when Lehman Brothers filed for bankruptcy) and 17 September, Lehman's settlement bank continued to settle CLS instructions on Lehman's behalf. Over this period, however, some of Lehman Brothers' counterparties chose to withdraw trades from CLS so as to minimise their overall exposure to Lehman Brothers by netting these positions against other exposures outside CLS. The CLS system required this to be done on a trade-by-trade basis, which proved inefficient and slow; CLS has been developing ‘bulk-rescind’ functionality to address this issue.

CLS also provides one-sided settlement services in respect of non-deliverable forwards and credit default swaps (CDS). The average value of one-sided settlements has typically been very low but can be much higher when there is a credit event and CLS is called upon to settle close-out obligations arising under CDS agreements. Several such events occurred over the past year, including in late 2008 following the failures of Lehman Brothers and three Icelandic banks, and the conservatorship of Fannie Mae and Freddie Mac. In each case, settlement proceeded smoothly.

High-value Payments

The high-value payments system experienced no difficulties during the period of turbulence in late 2008, although there appeared to be some changes in payment behaviour. In particular, the timeliness of settlement in the Reserve Bank Information and Transfer System (RITS) improved somewhat while, at the same time, there were more frequent RITS extensions.

The most noticeable change over the past year was a decline in the value of transactions settled across RITS. While the number of transactions settled per day rose by 5 per cent over 2008/09, the value of transactions settled fell by 5 per cent over the year (Graph 19). The decline in value is consistent with a decline in wholesale market activity since the market turbulence.

Timing of settlement in RITS

Over 2008/09, there was an improvement in the rate at which payments were settled through RITS. This was most evident from September 2008, when financial instability was at its highest. In 2006/07, around half of each day's payments by value were usually completed by 2.45 pm. By contrast, from August 2007 to mid September 2008, half of the day's payments were completed by 2.30 pm on average, with a further improvement to 2.00 pm during the period of extreme uncertainty from mid September to end October 2008. This rate of throughput continued through to the end of June 2009 (Table 6).

The improvement in ‘throughput’ times was, on the surface, somewhat surprising. In an environment of financial instability and concerns about the credit worthiness of counterparties, participants might be expected to be reluctant to ‘pay away’ first. Rather, they might be expected to conserve liquidity and minimise their underlying net-creditor positions vis-à-vis some counterparties. Instead, however, there is some evidence that the higher level of Exchange Settlement (ES) balances with the Reserve Bank in response to strained conditions in the interbank markets led to earlier payments. Some of the large subsidiaries and branches of foreign banks, in particular, appeared to have access to higher ES balances held overnight and were therefore able to make more payments earlier in the day (Graph 20). In 2009, average ES balances declined again, but a slight deterioration in the throughput of the foreign banks was outweighed by an improvement in the throughput of the larger domestic banks.

Settlement extensions

Despite the increased timeliness of settlement in RITS during late 2008, there was also an increase in end-of-day RITS extensions. The uncertainty in late 2008 appeared to result in some banks tightening internal credit monitoring processes and strengthening collateral requirements. With some banks finding it difficult to locate a willing lender, the end-of-day reallocation of liquidity in the overnight market for interbank funds was disrupted. Consequently, in September and October 2008, the frequency of RITS extensions increased to levels not seen since 2006 (Graph 21). Since then, however, the frequency of RITS extensions has declined.


ASIC subsequently published a ‘no-action’ letter, stating that sales of securities that were on loan within securities lending programmes would not be deemed short selling as long as the securities were recalled within a reasonable time frame after executing the sale. [2]