2006/07 Assessment of Clearing and Settlement Facilities in Australia Attachment 2: Approvals under the Payment Systems and Netting Act

The Payment Systems and Netting Act 1998 sets out a range of legal protections for payments systems and netting arrangements within the Australian financial system. Of particular relevance to licensed clearing and settlement (CS) facilities are three of these protections which apply to:

• market netting contracts;
• approved multilateral netting arrangements; and
• approved real-time gross settlement (RTGS) payment systems.

Market netting contracts

Approvals under Part 5 of the Payment Systems and Netting Act are granted by the Minister with portfolio responsibility for financial markets. These approvals provide legal certainty to netting undertaken as part of the process of clearing financial market transactions, and to the novation of transactions to a central counterparty. Part 5 approvals also protect any margin or collateral payments lodged with a central counterparty by a participant in the event that the participant enters external administration, allowing the central counterparty to apply these assets to offset any losses it may incur.

ACH and SFECC have each been approved under Part 5 for the netting they conduct with respect to transactions undertaken in the ASX and SFE markets respectively.

Approved multilateral netting arrangements

Approvals under Part 3 of the Payment Systems and Netting Act are made by the Reserve Bank and relate to multilateral netting arrangements. Rather than routinely paying and receiving gross obligations, some payment systems calculate net amounts which participants in the system are obliged to pay or receive. This is convenient and efficient, but carries the risk that where a participant enters external administration, its administrator might ‘cherry pick’ and insist that solvent institutions meet their gross obligations to pay it while refusing to honour its obligation to do likewise. Solvent parties would then receive little in return for their payments to the failed institution, putting them under liquidity pressures and potentially threatening their own solvency. An approval under Part 3 ensures that the amounts calculated through a multilateral netting arrangement cannot be set aside.

The multilateral netting arrangement operated by ASTC with respect to the settlement of equities and derivatives obligations was approved under Part 3 of the Payment Systems and Netting Act in May 2007.

Approved RTGS payment systems

Approvals under Part 2 of the Payment Systems and Netting Act are made by the Reserve Bank and apply to RTGS systems. These systems allow for the continuous settlement of funds or securities transactions individually on an order-by-order basis. The strength of such a system is that payments cannot be unwound if a participant were to fail after having made payments earlier in the day. However, under the so-called ‘zero hour’ rule, a court may date the bankruptcy of an institution from the midnight before the bankruptcy order is made. Such a rule would threaten the irrevocable nature of payments in an RTGS system. An approval under Part 2 exempts transactions in approved RTGS systems from a possible ‘zero hour’ ruling.

Austraclear and RITS have each been approved under Part 2 of the Payment Systems and Netting Act.