2006/07 Assessment of Clearing and Settlement Facilities in Australia 2. Clearing and Settlement in Australia
Two types of licensed CS facilities operate in Australia – central counterparties and securities settlement facilities.
Central counterparties provide novation of trades between buyers and sellers. Under novation, the original contract is replaced by separate contracts between the buyer and the central counterparty and between the seller and the central counterparty.[1] While these arrangements provide significant benefits in terms of counterparty risk management and greater opportunities for netting of obligations, they result in a significant concentration of risk in the central counterparty. This risk can crystallise if a participant defaults on its obligations to the central counterparty, in which case the central counterparty must continue to meet its obligations to the defaulter's original counterparties. The central counterparty must therefore have measures in place to provide confidence that, in all but the most extreme circumstances, such a default can be accommodated without threatening the central counterparty's solvency or significantly disrupting financial markets or the financial system more generally.
There are two central counterparties licensed as CS facilities under the Corporations Act:
- Australian Clearing House (ACH), which provides central counterparty services for a range of financial products traded on the ASX market, including equities, warrants and equity-related derivatives, among other products; and
- SFE Clearing Corporation (SFECC), which provides central counterparty services for derivatives on the SFE market.
These facilities are required to comply with the Financial Stability Standard for Central Counterparties, as determined by the Reserve Bank.
Securities settlement facilities provide for the final settlement of transactions undertaken on securities markets. Settlement involves up to three steps. Firstly, title to the security must be transferred from seller to buyer. Securities settlement facilities provide the mechanism for the transfer of securities title and may maintain records of title. Secondly, cash must be transferred from the buyer of the security to the seller. Thirdly, where the buyer and seller hold accounts at different financial institutions, funds must be transferred from the buyer's financial institution to that of the seller.
Unless these three settlement functions are linked effectively, there is a risk that a participant may pay away securities or cash without receiving consideration in kind. Thus a key consideration of a securities settlement facility's operations is the effectiveness of its delivery-versus-payment (DVP) arrangements. The legal and operational mechanisms that underpin these arrangements are also crucial.
Two main securities settlement facilities are licensed under the Corporations Act:
- ASX Settlement and Transfer Corporation (ASTC), which provides for the settlement of equities and warrants traded on the ASX market; and
- Austraclear, which offers securities settlement services for over-the-counter trades in debt securities.
These facilities are required to comply with the Financial Stability Standard for Securities Settlement Facilities.[2]
Following the merger of Australian Stock Exchange Limited and Sydney Futures Exchange Limited in July 2006, ACH, SFECC, ASTC and Austraclear are part of a single corporate group, now known as Australian Securities Exchange (ASX). However, each continues to hold an individual licence under the Corporations Act.
Footnotes
Typically a central counterparty deals only with the small number of direct central counterparty participants. Most buyers and sellers must appoint a central counterparty participant to act on their behalf. The central counterparty will therefore have a contract with the participant acting on behalf of the buyer and the participant acting on behalf of the seller, rather than directly with the buyer and seller. [1]
A third securities settlement facility – operated by IMB Limited – falls outside the application of the Financial Stability Standards due to its small size and the low likelihood of it affecting the overall stability of the Australian financial system. [2]