2007/08 Assessment of Clearing and Settlement Facilities in Australia Attachment 1: Detailed Information Relevant to Assessment against the Financial Stability Standards

A1. Financial Stability Standard for Central Counterparties

There are ten measures that the Reserve Bank considers relevant in determining whether a facility has met the Financial Stability Standard for Central Counterparties. The full text of the measures and associated guidance is available on the Reserve Bank's website. The following provides summary details of the information the Reserve Bank has used to assess ACH and SFECC against each of the relevant measures. This report updates the information presented in the Reserve Bank's 2006/07 assessment report, highlighting material changes in policies and procedures over the past year.

A1.1 Australian Clearing House (ACH)

1. Legal framework

The central counterparty must have a well-founded legal basis.

ACH Pty Limited is a wholly owned subsidiary of ASX Limited. It acts as the central counterparty for equities, equity derivatives, certain interest rate products and warrants t raded on the ASX market.

The legal basis for ACH's operations is set out in its Clearing Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between ACH and each of its participants, and between each participant and each other participant. Furthermore, the netting arrangements contained in ACH's Clearing Rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of a participant.

ACH's Clearing Rules define the nature and scope of its obligation to provide clearing support to participants, and describe the conditions under which final and irrevocable settlement of obligations is deemed to have occurred. The Clearing Rules also set out the rights and obligations of participants, including in the event of default or suspension.

2. Participation requirements

The requirements for participation in the central counterparty must promote the safety and integrity of the central counterparty and ensure fair and open access.

At the end of June 2008, ACH had 65 participants. Of these 62 were also participants of ASX markets, while three provided specialist third-party clearing services.

ACH has objective and transparent participation requirements, which are publicly available and form part of the Clearing Rules and Procedures. The Clearing Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated.

ACH's participation requirements are designed to promote the safety and integrity of the central counterparty. Participants clearing cash equities or options are required to comply with a risk-based capital regime under which, subject to maintaining a minimum of $100,000 in core liquid capital, they must hold liquid capital in excess of a ‘total risk requirement’, which reflects counterparty risk, large exposure risk, position risk and operational risk. Work on an additional risk category, underwriting risk, is nearing completion. Participants with ‘non-standard’ exposures, including those arising from dealings in margin lending, credit derivatives and OTC contracts for difference, are subject to an additional risk-capital requirement. Those participants clearing futures only may elect to be covered by an alternative capital regime, based either on a net tangible asset requirement or compliance with the regime of another prudential supervisor.^[1] At the end of the assessment period all but two of ACH's 65 participants were subject to the risk-based regime; the remaining two were subject to a net tangible asset requirement. ACH has announced its intention to increase the minimum capital requirement for participants operating under the risk-based regime. By end 2008, participants will be required to hold a minimum of $2 million in core liquid capital, with this rising to $10 million by end 2009.

Participants are subject to ongoing monitoring by ACH. As part of this process, participants are assigned an internal credit rating which, following the implementation of a new ratings framework in January 2008, is based on the participant's external credit rating (if available) or that of its parent, if that parent provides a guarantee to the participant. Otherwise, the rating is based on the participant's capital position, which must be reported on at least a monthly basis. More stringent reporting requirements apply where a participant's capital falls below certain stated thresholds. The monitoring, assessment and investigation of matters relating to financial requirements is dealt with by the capital- and liquidity-monitoring unit of ASX Markets Supervision, a separate subsidiary within the ASX group with its own board. The information flow between ASX Markets Supervision and ASX Clearing and Settlement Operations is governed by a ‘Supervisory Code of Conduct’ and a ‘Commercial and Supervisory Conflict of Interest Policy’, which together aim to address potential conflicts between ASX's supervisory responsibilities and its commercial interests. ASX Markets Supervision uses a number of triggers for follow-up enquiries upon submission of risk-based returns, including: a fall to below 1.7 in the ratio of liquid capital to the total risk requirement; sustained losses on outstanding positions; and a significant fall in liquid capital held.

ACH participants are also subject to requirements regarding business and management integrity that aim to ensure compliance with the ACH Clearing Rules. Standards for technical and operational capacity, including business continuity, also apply.

ACH has wide-ranging powers to sanction its participants in order to preserve the integrity of the central counterparty. ACH may terminate a participant's authority to clear all, or any category of, market transactions in the event of a default, or in the event of a breach of the Clearing Rules which may have an adverse impact on the central counterparty. The action taken in the event of a breach will depend on a number of factors, including the participant's history of compliance and whether the breach is suggestive of negligence, incompetence or dishonesty. Where a breach has been identified and the participant has taken appropriate steps to rectify it, ACH will typically continue to monitor the participant closely for a period of time. Breaches are also referred to ASIC and, in most cases, to ASX Markets Supervision Investigations.

Some amendments were made to ACH's disciplinary processes in March 2008, with a new single Disciplinary Processes and Appeals Rulebook introduced for all four licensed CS facilities in the ASX group. Furthermore, the ACH and ASTC Disciplinary Tribunals were integrated with SFECC's Business Conduct and Market Practices Committees and Austraclear's disciplinary framework to form a single ‘peer review’ disciplinary tribunal. Changes were also made to financial penalties applied in the event of a breach.

3. Understanding risks

The central counterparty's rules and procedures must enable each participant to understand the central counterparty's impact on each of the financial risks the participant incurs through participation in the central counterparty.

ACH's Clearing Rules and Procedures are comprehensive and publicly available. The Rules and Procedures explain the role and responsibilities of each category of participant and ACH. Some background information on ACH's operations and risk management is also available on the ASX website.

ACH must lodge any changes to its Clearing Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. ACH consults with its participants on important rule changes, and notifies participants of all changes to the Clearing Rules or Procedures.

In late 2007, ASX established a Clearing Participant Strategic Forum as a vehicle to provide information to participants on relevant changes to central counterparty policies and procedures and obtain feedback. A particular focus has been on efforts towards harmonisation of practices across ACH and SFECC.

4. Novation

The rules and procedures governing the central counterparty must clearly identify:

the nature and scope of novation; and
the point in the clearing process at which trades are novated.

The nature and scope of novation is set out in ACH's Clearing Rules. Through the process of novation, ACH takes on the financial obligations of the seller to the buyer, and of the buyer to the seller. The obligations of ACH are to each clearing participant as principal, irrespective of whether that participant is acting for itself or as an agent on behalf of a client.

The point at which trades are novated is set out in the Clearing Rules. These specify that a broker-to-broker transaction on the ASX market is novated to ACH upon the acceptance and registration of the details of that market transaction within the clearing system. For physical equities transactions, novation occurs almost immediately after the matching of the trade on the market. In the case of derivatives transactions, novation takes place on the evening of the day of the trade, when trade details are allocated to participants' accounts.

5. Settlement

Settlement arrangements must ensure that the central counterparty's exposures are clearly and irrevocably extinguished on settlement.

Settlement of obligations between ACH and its participants can involve two processes:

the exchange of one asset for another – mainly physical equities transactions. In this case, ACH utilises the settlement facility provided by ASTC; or
payments to or from the central counterparty, including margin payments relating to derivatives positions. In this instance, the facilities provided by either ASTC or Austraclear may be used.

In each case, ACH calculates bilateral net positions between itself and each of its clearing participants. These positions reflect both cash payment and securities obligations. These netting arrangements are outlined in ACH's Clearing Rules and are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act.

ASTC's settlement process involves the use of a Model 3 DVP mechanism, whereby cash payments and securities transfers are settled simultaneously in a single daily multilateral net batch. An ASTC settlement participant's obligations in the batch may relate to cash equity and derivatives transactions involving ACH as central counterparty, including margin payments, as well as cash equity transactions not novated to ACH. As the outcome of this process, ASTC participants face a net cash settlement obligation to or from ASTC and a net securities settlement obligation in respect of each line of stock.

Once participants' net obligations have been calculated, ASTC confirms that sufficient securities are available in each participant's securities account in CHESS. The transfer of securities within the system is then restricted until the settlement process has been completed. Net cash payment obligations are forwarded for settlement in RITS across payment providers' ES accounts. Once cash settlement has been confirmed, ASTC effects the net transfer of securities within CHESS.

Where a participant elects to settle cash derivatives obligations using Austraclear, settlements are made via cash transfers. These settle in real time across ES accounts, again via RITS.

Settlement in ASTC or Austraclear is final and irrevocable. In the case of ASTC, this is supported both by its Settlement Rules and ASTC's approval under Part 3 of the Payment Systems and Netting Act. Settlement according to Austraclear's Regulations is also final and irrevocable by virtue of its [Payment Systems and Netting Act.^[2]

ASTC holds an ES account for the purposes of effecting batch settlement. While ACH does not currently hold an ES account, it is intended that it will apply for an account in the near future. Obligations to and from ACH are currently settled across an account with a commercial bank.

ACH also clears grain and wool futures. These instruments may be physically settled through commodity warehouses, with ACH transferring title to the buyer only once payment is received from the seller.

6. Default arrangements

The CS facility licensee as operator of the central counterparty must ensure that it has clear rules and procedures to deal with the possibility of a participant being unable to fulfil its obligations to the central counterparty. The arrangements for dealing with a default must ensure that in this scenario timely action is taken by the central counterparty and the participants in the central counterparty, and that risks to the central counterparty and its participants are minimised.

ACH's Clearing Rules set out notification requirements that participants must meet in relation to a default. A participant is required to inform ACH should it default under the Clearing Rules. A range of default events are set out in the Clearing Rules, including: the appointment of an external administrator (or a reasonable expectation that one will be appointed); a breach of ACH's capital requirements; or a failure to meet payment or settlement obligations to ACH.

The Clearing Rules provide ACH with the authority and flexibility to deal with a participant default and to ensure that settlement of novated positions occurs. For equities, ACH is able to reschedule any settlements involving the failed participant, or those affected by its failure. ACH may also enter into market transactions to sell or purchase securities to facilitate the settlement of novated transactions. For derivatives, ACH has the ability to close out a defaulted participant's positions, or to seek to transfer the client positions of the defaulted participant to a surviving participant. These rules are supplemented by an internal default management plan.

ACH also has a range of financial resources available to enable it to act on the default powers set out above and to meet its obligations as central counterparty.

7. Risk controls

The CS facility licensee as operator of a central counterparty must have comprehensive risk-control arrangements in place. These arrangements must provide the operator of the central counterparty with a high degree of confidence that, in the event of extreme volatility in relevant markets, the central counterparty will be able to settle all of its obligations in a timely manner. As a minimum, the risk-control arrangements must provide the CS facility licensee as operator of the central counterparty with a high degree of confidence that the central counterparty will be able to settle its obligations in the event that the participant with the largest settlement obligations cannot meet them. In all but the most extreme circumstances, a central counterparty must be able to settle its obligations using liquid assets as defined in this standard.

The CS facility licensee as operator of a central counterparty must:

ensure that its risk-control measures, typically a combination of its own capital, margins, guarantee funds and pre-determined loss-sharing arrangements, provide sufficient coverage and liquidity; and
undertake regular and rigorous stress testing to ensure the adequacy of its risk controls.

The adequacy of risk-control measures must be approved by the board of the central counterparty, or an appropriate body as delegated by the board.

The risk controls of a central counterparty are crucial in providing a high degree of confidence that it would be able to meet its obligations in the event of a participant failure. The inability of a central counterparty to meet its obligations could be extremely disruptive to the financial system. The focus of the Reserve Bank in this area is not on specifying which risk controls a central counterparty should use, but rather on ensuring that the combination of risk controls achieves a very low probability of failure of the central counterparty.

The tools used by ACH to control risks operate at three broad levels: calling collateral based on participants' positions; pooled financial resources to cover the failure of a participant; and stress testing aimed at assessing the adequacy of financial resources overall and monitoring the risks associated with individual participants' positions. These risk controls are supplemented by ACH's participation requirements (Measure 2) and monitoring and supervisory arrangements.

ACH levies margins on equity derivatives products, but does not do so for cash equity products. Initial (risk) margins are calculated for each derivative instrument so as to cover three standard deviations of the distribution of price movements until a position can be closed out. Under a new harmonised margin-setting methodology recently introduced at ACH and SFECC, the higher of a one or two-day close-out period is applied. ACH calculates total initial margin requirements across each participant's portfolio using the internationally accepted Theoretical Inter-market Margining System (TIMS) methodology, developed by the Options Clearing Corporation. Margins are calculated overnight based on closing contract prices each day, and are notified to participants the next morning. If settled via Austraclear, margin obligations are required to be met by 10.30am; if settled via ASTC's CHESS batch process, obligations are typically met by around noon. Participants generally meet their margin obligations using cash, although they may also use non-cash collateral. ACH has recently communicated new collateral eligibility criteria, with a view to implementing these in the near future. These new criteria place greater emphasis on credit quality and liquidity. As such, some previously eligible equities have been removed from the eligible collateral list due to their low liquidity: only the top 200 equities will be accepted under the new rules (unless these are being posted as specific cover for an options position).

ACH also levies mark-to-market (variation) margins on derivatives positions to cover gains or losses arising from price movements on the preceding day. In the event of sharp price movements intraday, ACH may also call mark-to-market margins intraday. These must be met by participants within two hours of notification. In order to facilitate timely settlement of intraday margin calls, ACH has imposed a requirement that these be settled via Austraclear. While at present ACH is only able to calculate intraday margin calls on the basis of price movements, planned system enhancements will enable calls to be made on the basis of changes in participants' positions also.

ACH has recently strengthened its robustness to the failure of a participant carrying large exposures in either cash equities or derivatives via the implementation of a Contributions and Additional Cover (CAC) regime. Two of three phases of implementation of this regime have been completed – in March 2007 and December 2007. The regime is closely linked to ACH's capital stress-testing arrangements. Should stress-test outcomes reveal that the projected stress loss arising from a participant's positions as at the close of the previous day will exceed the aggregate of ACH's immediately available risk resources – the Risk Resource Requirement (RRR) – that participant is required to post collateral to cover the excess projected stress loss. Calls are typically made on participants by 9.30am and must be settled within two hours, either via a transfer of cash across the Austraclear system, via the provision of a guarantee from an approved bank, or via the posting of Commonwealth Government Bonds.^[3]

ACH recently announced further intended changes to the CAC regime. In order to reflect differences in participants' credit quality, ACH plans to introduce a regime of Stress-test Exposure Limits (STELs). A participant's STEL will define the threshold beyond which projected stress losses will attract a call under the CAC regime. Highly rated participants will have a STEL somewhat above the RRR and will be required to post collateral only when stress-test outcomes exceed that threshold; low-rated participants will have STELS below the RRR and hence be required to post collateral at a lower threshold. Furthermore, in normal market conditions, highly rated counterparties will be required to cover only a proportion of the excess exposure beyond the stated threshold.^[4] Such a regime is already in place at SFECC (see A2, below).

ACH maintains additional pooled financial resources to protect against losses in excess of margins and other collateral assets directly attributable to a defaulting participant. ACH's core financial resources – the RRR – consist of funds paid into a restricted capital reserve from the NGF in 2005 and other ACH capital, including a subordinated loan provided by ASX Limited. The RRR is currently $150 million and is held in the form of liquid assets – primarily bank bills and certificates of deposit. In addition, ACH holds default insurance of $100 million and has the ability through its Clearing Rules to levy its participants up to $300 million collectively in ‘Emergency Assessments’ should a loss caused by a participant's default exceed its other resources.

In addition to its capital resources, ACH needs to have access to sufficient liquidity to allow cash market settlement to proceed in the event of a participant default. Currently, in addition to the liquid assets held in respect of the RRR of $150 million, ACH has access to a further $150 million under a committed standby facility from a commercial bank.

ACH uses daily capital stress tests to monitor the risks undertaken by individual participants and the adequacy of the central counterparty's financial resources. In June 2007, ACH implemented a new range of stress-test scenarios which significantly increased the information it has to undertake this analysis. Stress tests are based on 24 scenarios, each calibrated to a once-in-30-years probability of occurring. The scenarios cover extreme price moves and volatility shifts at the market-wide, sector, and individual stock levels. ACH plans to further expand the range of stock-specific stress scenarios by the end of 2008.

ACH also implemented a liquidity stress-test regime in June 2007. This regime is based on a subset of the capital stress-test scenarios and is designed to assess the adequacy of its liquid resources.

8. Governance

The central counterparty must have effective, accountable and transparent governance arrangements.

The ACH Board is responsible for oversight of the operation of the central counterparty. It meets between six and eight times each year, and receives detailed reports on ACH's business and operations, risk management and financial performance. It is responsible for approving capital, liquidity and stress-testing arrangements.

The ACH Board consists of ten directors. These include four members of ASX management (including the CEO and CFO), four ASX directors, and two external directors (one of whom chairs the Board). The ten directors filling these positions are also on the Boards of SFECC, ASTC and Austraclear. ACH and ASTC share a common chair, as do SFECC and Austraclear.

As a result of post-merger reorganisation within ASX, the risk policy and risk operations areas have been separated, with each having separate functions and reporting lines to the ACH Board. In addition, an internal Capital and Liquidity Committee has been established in order to provide greater focus to capital and liquidity issues across the ASX group.

9. Operational risk

The CS facility licensee as operator of a central counterparty must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

ACH's key systems are the Derivatives Clearing System (DCS) and CHESS. Operational risk in the CHESS system is dealt with in the discussion of ASTC (see A3, below).

DCS has been highly reliable, with the system available for 100 per cent of the time over the period of this assessment. On an average day, around 22 per cent of DCS's available capacity is used. Peak utilisation in 2007/08 was 61 per cent of system capacity.

The security of the DCS system is supported by access controls which are subject to external audit. The audit report for the assessment period was satisfactory. External penetration testing of DCS is also conducted regularly. ACH also has a fraud control policy in place which seeks to minimise the risk of fraud occurring within ACH, as well as providing procedures for its timely identification and appropriate responses should it occur.

ACH has arrangements in place to allow the timely recovery of its usual operations in the event of a contingency. It maintains an unmanned remote back-up facility which replicates the systems at the primary site. ACH has detailed contingency procedures that focus on the potential effects of a disruptive event. These contingency procedures are set out in ACH's Incident Management Plan.

A test is completed annually to demonstrate that normal functions can be carried out using systems located at the back-up site. ACH also regularly tests its ability to operate its primary systems from its back-up site. A more extensive test, involving utilisation of back-up systems as the production environment for a day, took place in November 2007. Through its Clearing Rules, ACH also requires its participants to have appropriate disaster-recovery arrangements.

ASX Operations, a subsidiary of ASX Limited, is responsible for supplying ACH and other ASX group companies with personnel and technological resources. ACH has a written support agreement with ASX Operations which helps to ensure its access to these resources in the event of the external administration of ASX Operations, to the extent permissible by law.

10. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the relevant standard; the failure of a participant to fulfil the central counterparty's risk-control requirements; and the central counterparty's failure to enforce its own risk-control requirements. There are also obligations to report financial and stress-testing results on a quarterly basis. ACH satisfied all reporting obligations during the assessment period.

A1.2 SFE Clearing Corporation (SFECC)

1. Legal framework

The central counterparty must have a well-founded legal basis.

SFE Clearing Corporation Pty Limited is a wholly owned subsidiary of ASX Limited. It acts as the central counterparty for the SFE market.

The legal basis for SFECC's operations is set out in its Clearing Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between SFECC and each of its participants, and between each participant and each other participant. Furthermore, the netting arrangements contained in SFECC's Clearing Rules are protected as a ‘netting market’ under Part 5 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of a participant.

SFECC's Clearing Rules define the nature and scope of its obligation to provide clearing support to participants, and describe the conditions under which final and irrevocable settlement of obligations is deemed to have occurred. The Clearing Rules also set out the rights and obligations of participants, including in the event of default or suspension.

2. Participation requirements

The requirements for participation in the central counterparty must promote the safety and integrity of the central counterparty and ensure fair and open access.

At the end of June 2008, SFECC had 15 participants. Of these, 13 were also participants of the Sydney Futures Exchange, while two provided specialist clearing and settlement services.

SFECC has objective and transparent participation requirements, which are publicly available and form part of the Clearing Rules and Procedures. The Clearing Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated.

SFECC's participation requirements are designed to promote the safety and integrity of the central counterparty. They cover: minimum capital and financial obligations; business and managerial requirements; operational resources; business continuity arrangements; and risk and liquidity-management arrangements.

Participants are subject to a minimum net tangible asset requirement of $5 million, with management discretion to impose a higher requirement. SFECC has announced that this minimum will be raised to $10 million for clearing participants that are not ADIs, and to $20 million for those clearing for third parties. The timing of this change has not yet been finalised. Participants are obliged to lodge a detailed financial report with the capital- and liquidity-monitoring unit of ASX Markets Supervision on a monthly basis, or more frequently in the event that their net tangible assets fall below a certain threshold.

Participants are subject to ongoing monitoring by SFECC. As part of this process, participants are assigned an internal credit rating which, following the implementation of a new ratings framework in January 2008, is based on the participant's external credit rating (if available) or that of its parent, if that parent provides a guarantee to the participant. Otherwise, the rating is based on the participant's capital position. A participant's credit rating is a key determinant of its stress-test exposure limit (see Measure 7 below). A participant's capital position also determines its capital-based position limit, which restricts the size of its market exposures.

SFECC has developed policies that allow for relevant information to flow between ASX Markets Supervision and ASX Clearing and Settlement Operations. These are embodied in a ‘Supervisory Code of Conduct’ and ‘Commercial and Supervisory Conflict of Interest Policy’, which together aim to address potential conflicts between ASX's supervisory responsibilities and its commercial interests.

Under the Clearing Rules, a clearing participant may be automatically suspended under a number of circumstances, including the participant's default, the appointment of external management, or the breach of financial requirements. The SFECC Board can also suspend a clearing participant for misconduct, breaches of the Clearing Rules, or if it ceases to satisfy the admission requirements. The Clearing Rules require SFECC to provide notice of a suspension, and detail on appeal procedures for participants.

Some amendments were made to SFECC's disciplinary processes in March 2008, with a new single Disciplinary Processes and Appeals Rulebook introduced for all four licensed CS facilities in the ASX group. Furthermore, SFECC's Business Conduct and Market Practices Committees were integrated with the ACH and ASTC Disciplinary Tribunals and Austraclear's disciplinary framework to form a single ‘peer review’ disciplinary tribunal. Changes were also made to financial penalties applied in the event of a breach.

3. Understanding risks

SFECC's Clearing Rules and Procedures are comprehensive and publicly available. The Rules and Procedures explain the roles and responsibilities of participants and SFECC. Substantial background information on SFECC's operations and risk management is also available on the ASX website.

SFECC must lodge any changes to its Clearing Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. SFECC consults with its participants on important rule changes. Announcements ‘SFE Notices’.

4. Novation

The rules and procedures governing the central counterparty must clearly identify:

the nature and scope of novation; and
the point in the clearing process at which trades are novated.

The nature and scope of novation is set out in SFECC's Clearing Rules. Through the process of novation, SFECC takes on the financial obligations of the seller to the buyer, and of the buyer to the seller. The obligations of SFECC are to each participant as principal, irrespective of whether that participant is acting for itself or as an agent on behalf of a client.

The point at which trades are novated is set out in the Clearing Rules. These specify that a transaction on the SFE market is novated to SFECC upon the registering of a matched trade by the market. Non-market trades are novated once their details have been approved and registered by SFECC.

5. Settlement

Settlement arrangements must ensure that the central counterparty's exposures are clearly and irrevocably extinguished on settlement.

The vast majority of SFECC settlements involve cash payments to or from the central counterparty. These include margin payments and the settlement of cash-settled derivative contracts. Settlement of payments generally occurs on a net basis. Each day, SFECC calculates the net obligations of each of its participants. SFECC participants calculated to have a net obligation to the central counterparty are required to make payments to SFECC in Austraclear by 11.00am each morning. Once these payments have been received, SFECC makes payments to those participants with a net obligation from the central counterparty. Interbank settlement of these payments occurs between participants' appointed bankers across ES accounts at the Reserve Bank. SFECC is an ES account holder.

In some cases, the settlement of derivatives contracts cleared by SFECC involves the transfer of a security or physical asset, with a corresponding transfer of cash. For each type of security or asset, SFECC's arrangements ensure that delivery occurs if, and only if, payment occurs and vice versa.

For 90-day bank bill futures, SFECC utilises the standard settlement process in Austraclear. For the settlement of deliverable equity futures, SFECC makes use of the ASTC settlement system, CHESS. In this case, the buyer makes payment to SFECC's Austraclear account and the payment is only released to the seller when both the buyer and the seller have confirmed the transfer of securities. Similar procedures exist for the delivery of New Zealand equities, with the transfer of securities occurring in the New Zealand Stock Exchange's settlement system. The delivery of greasy wool is via a warehouse, with SFECC retaining title documentation until payment has been made.

The settlement of obligations is final and irrevocable according to the terms of SFECC's Clearing Rules and SFE's Market Rules – which set out contract specifications, including the means of settlement. For payments and securities obligations settled through Austraclear, finality is reinforced by Austraclear's Regulations and its approval under Part 2 of the Payment Systems and Netting Act. Any interbank transactions arising from these settlements are settled across ES accounts held with the Reserve Bank. Payments within this system are also final and irrevocable, and are supported by the approval of RITS under Part 2 of the Payment Systems and Netting Act. The settlement of equities in ASTC is also final and irrevocable according to the terms of ASTC's Settlement Rules, which are supported by the facility's approval under the Payment Systems and Netting Act.

6. Default arrangements

SFECC's Clearing Rules require that participants inform SFECC immediately in the event of a default, or if there is a reasonable expectation of such an event. The Clearing Rules envisage a number of possible events of default. These include: becoming subject to external administration; being unable to meet obligations relating to open contracts; and being in breach of the central counterparty's risk-control requirements, such as failing to fulfil margin or other payment obligations to the central counterparty.

The Clearing Rules provide SFECC with the authority and flexibility to deal with a participant default. SFECC has the ability to close out any open contracts, to exercise or terminate open contracts, or to transfer client positions along with related margin payments. These formal rules are supplemented by an internal default management plan.

SFECC also has a range of financial resources available to enable it to act on the default powers set out above and to meet its obligations as central counterparty (see Measure 7).

7. Risk controls

The CS facility licensee as operator of a central counterparty must:

ensure that its risk-control measures, typically a combination of its own capital, margins, guarantee funds and pre-determined loss-sharing arrangements, provide sufficient coverage and liquidity; and
undertake regular and rigorous stress testing to ensure the adequacy of its risk controls.

The adequacy of risk-control measures must be approved by the board of the central counterparty, or an appropriate body as delegated by the board.

The risk controls of a central counterparty are crucial in providing a high degree of confidence that it is able to meet its obligations in the event of a participant failure. The inability of a central counterparty to meet these obligations could be extremely disruptive to the financial system. The focus of the Reserve Bank in this area is not on specifying which risk controls a central counterparty should use, but rather on ensuring that the combination of risk controls achieves a very low probability of failure of the central counterparty.

The tools used by SFECC to control risks operate at three broad levels: calling collateral based on participants' positions; pooled financial resources to cover the failure of a participant; and stress testing aimed at both assessing the adequacy of financial resources overall and monitoringthe risks being undertaken by individual participants. These risk controls are supplemented by SFECC's participation requirements (Measure 2) and monitoring and supervisory arrangements.

SFECC levies margins on the derivatives products it clears. Following a review of margin-setting arrangements at SFECC and ACH, a common approach has now been established. Initial margins for SFE futures positions are now set on the basis of a three standard deviation confidence interval for price movements, with an assumed close-out period of the higher of one or two days. This compares with the previous methodology of a 99 per cent confidence interval and a one-day close-out assumption for all but the four major contracts (for which the higher of one-day or two-day close-out was applied). All margin rates will be reviewed on a quarterly cycle.^[5]

SFECC calculates total initial margin requirements across each participant's portfolio using the internationally accepted Standard Portfolio Analysis of Risk (SPAN) methodology, developed by the Chicago Mercantile Exchange. Margins are calculated overnight based on closing contract prices each day, and are notified to participants by 7am the next morning. Margin obligations must be met by 11am. Participants generally meet these obligations using cash, although they may also use non-cash collateral, such as eligible debt securities and equities, and foreign currency deposits. Haircuts are applied to all non-cash collateral posted. SFECC has announced that it intends to change the list of eligible criteria to exclude parental/self guarantees, to reduce the possibility of SFECC facing a simultaneous default of a clearing participant and a collateral issuer. It will also remove New Zealand stocks and Hong Kong Dollars from the list of eligible criteria due to the limited use of these types of collateral.

SFECC also levies variation (mark-to-market) margins on derivatives positions to cover gains or losses arising from price movements over the preceding day. Should conditions warrant, SFECC is also able to call variation margins intraday, based on movements in either positions or prices. Participants are required to meet an intraday margin call within two hours of notification. Both variation and intraday margin obligations must be settled in cash.

SFECC also uses a system of additional initial margins (AIMs), based on participants' exposures in SFE's four largest contracts. AIMs are intended to cover potential losses from very large positions with the central counterparty in extreme market conditions. SFECC calculates potential exposures using a system of stress tests and makes AIMs calls to cover projected stress losses in excess of a stated threshold – the participant's STEL – which is linked to the value of SFECC's risk resources. STELs vary according to the credit quality of the participant, rising from 50 per cent of the value of the CGF for low-rated participants, to 100 per cent of the CGF for highly rated participants. Further to changes to the regime implemented in March 2008, highly rated participants are eligible for discounts on their AIMs calls of up to 50 per cent of the projected stress loss in normal market conditions (up to a maximum discount of $500 million).^[34]

This system is designed to provide a high degree of confidence that the central counterparty will be able to meet its obligations, even when losses from a participant default exceed SFECC's pooled risk resources. Like other margins, AIMs are calculated overnight, notified to participants at 7am the next day, and must be met by 11am. Participants may meet these obligations using cash or non-cash collateral, including Commonwealth Government securities and bank bills or letters of credit from ADIs.

SFECC maintains a buffer of financial resources to protect against losses arising in the event of a default that exceed the value of margins and other collateral assets contributed by the defaulting participant. The value of SFECC's CGF was increased from $200 million to $400 million in March 2008, comprising an increase in the value of the subordinated loan from ASX Limited (from $50 million to $70 million); a doubling of first-level participant commitments (from $60 million to $120 million); and an increase in insurance coverage from $60 million to $150 million. Pre-existing second-level participant commitments of $30 million were also brought into the Fund.

SFECC uses daily stress tests of its four major contracts to monitor the risks undertaken by individual participants and the adequacy of the CGF. SFECC has recently developed a new suite of portfolio and single-contract stress-test scenarios based on statistical analysis of historical market movements. These provide consistent tests across contract types and are tailored to SFECC's risk tolerance, as defined by its Board. The stress scenarios aim to capture once-in-30-years events for single asset scenarios and once-in-100-years events for multi-asset scenarios. Stresses applied to equity index contracts, in particular, are significantly stronger than under the previous framework. SFECC implemented the new framework in two phases – in November 2007 and March 2008 – in conjunction with the increase in its financial resources and amendment to the AIMs regime.

8. Governance

The central counterparty must have effective, accountable and transparent governance arrangements.

The SFECC Board typically meets seven times each year. At each meeting it receives reports on participant activity, management of treasury and risk functions, financial position, and operational performance. It is responsible for approving capital, liquidity and stress-testing arrangements.

The SFECC Board consists of ten directors. These include four members of ASX management (including the CEO and CFO), four ASX directors, and two external directors (one of whom chairs the Board). The ten directors filling these positions are also on the Boards of ACH, ASTC and Austraclear. ACH and ASTC share a common chair, as do SFECC and Austraclear.

As a result of post-merger reorganisation within ASX, the risk policy and risk operations areas have been separated, with each having separate functions and reporting lines to the SFECC Board. In addition, an internal Capital and Liquidity Committee has been established in order to provide greater focus to capital and liquidity issues across the ASX group.

9. Operational risk

The CS facility licensee as operator of a central counterparty must identify sources of operational risk and minimise these through the development of appropriate systems, controls and procedures.

SFECC's key system is SECUR. In April 2008, SFECC assumed responsibility for all first- and second-level computer system support and business continuity arrangements in respect of the SECUR system. Only the support provided by OMX's system developers remains outsourced.

SECUR has been available for 100 per cent of the time over the period of this assessment. The average number of trades processed per day was around 27 per cent of system capacity, with a peak number of daily trades at around 42 per cent of capacity.

The security of SECUR is supported by access controls which are subject to external audit. External penetration testing of systems is also conducted regularly. SFECC also has a fraud control policy in place which seeks to minimise the risk of fraud occurring within SFECC, as well as providing procedures for its timely identification and appropriate responses should it occur.

SFECC has arrangements in place to allow the timely recovery of its usual operations in the event of a contingency. ASX consolidated SFE's back-up facilities (including SFECC's back-up facilities) to ASX's back-up site during the assessment period. SFECC has detailed contingency procedures which focus on the potential effects of a disruptive event. These contingency procedures are set down in SFECC's Incident Management Plan.

Critical areas regularly test their ability to operate from the back-up site using systems at the primary site. Back-up systems also successfully operated as the production environment for a day in November 2007. Through its Clearing Rules, SFECC also requires its participants to have appropriate disaster recovery arrangements.

ASX Operations, a subsidiary of ASX Limited, is responsible for supplying SFECC and other ASX group companies with personnel and technological resources. SFECC has a written support agreement with ASX Operations which helps to ensure its access to these resources in the event of the external administration of ASX Operations, to the extent permissible by law.

10. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the relevant standard; the failure of a participant to fulfil the central counterparty's risk-control requirements; and the central counterparty's failure to enforce its own risk-control requirements. There are also obligations to report financial and stress-testing results on a quarterly basis. SFECC satisfied all reporting obligations during the assessment period.

A2. Financial Stability Standard for Securities Settlement Facilities

There are eight measures that the Reserve Bank considers relevant in determining whether a facility has met the Financial Stability Standard for Securities Settlement Facilities. The full text of the measures and associated guidance is available on the Reserve Bank's website. The following provides summary details of the information the Reserve Bank has used to assess ASTC and Austraclear against each of the relevant measures. This report updates the information presented in the Reserve Bank's 2006/07 assessment report, highlighting material changes in policies and procedures during 2007/08.

A2.1 ASX Settlement and Transfer Corporation (ASTC)

1. Legal framework

The securities settlement facility must have a well-founded legal basis.

ASTC Pty Limited is a wholly owned subsidiary of ASX Limited. It provides settlement services for ASX markets, as well as for a small number of transactions undertaken on the National Stock Exchange (NSX).

The legal basis for ASTC's operations is set out in its Settlement Rules. Under Section 822B of the Corporations Act, these rules have effect as a contract under seal between ASTC and each of its participants, and between each participant and each other participant. The Settlement Rules set out the rights and obligations of participants and ASTC, including in the event of default or suspension.

The netting arrangements undertaken by ASTC with respect to its participants' obligations have approval as a netting arrangement under Part 3 of the Payment Systems and Netting Act. This provides certainty for the netting process in the event of the insolvency of an ASTC participant or a payments provider.

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.

ASTC had 112 participants as at end June 2008. ASTC has objective and transparent participation requirements, which are publicly available and form part of the Settlement Rules and Procedures. The Settlement Rules also provide for an appeals process should an application for participation be rejected or a participant's access be terminated. Participation requirements address financial and business integrity issues, as well as operational and technical matters.

A participant who is not subject to prudential supervision (either as an ADI or as a clearing or market participant under ACH Clearing Rules or ASX Market Rules) must post a performance bond of $500,000. In addition, sponsorship bonds, also with a value of $500,000, must be lodged by sponsoring participants – i.e. those also acting in ASTC on behalf of non-participants – if they are not subject to prudential supervision and are not covered by the NGF compensation arrangements provided under the Corporations Act.

Performance and sponsorship bonds must be issued by an Australian bank or appropriately regulated insurance company. Funds held under a performance bond would be drawn upon by ASTC in the event that a loss was incurred due to that participant's breach of ASTC Settlement Rules. In a similar vein, funds held under a sponsorship bond would be drawn upon to meet any losses suffered by an issuer, participant-sponsored holder, or ASTC, arising from a rule contravention or offence. The monitoring, assessment and investigation of matters relating to financial requirements is dealt with by the capital- and liquidity-monitoring unit of ASX Markets Supervision, a separate subsidiary within the ASX group with its own board.

ASTC's Settlement Rules allow it to suspend or terminate a participant from its facility in the event of a failure to comply with the Settlement Rules, or where a payments provider fails to authorise a participant's payment for interbank settlement.

Some amendments were made to ASTC's disciplinary processes in March 2008, with a new single Disciplinary Processes and Appeals Rulebook introduced for all four licensed CS facilities in the ASX group. Furthermore, the ACH and ASTC Disciplinary Tribunals were integrated with SFECC's Business Conduct and Market Practices Committees and Austraclear's disciplinary framework to form a single ‘peer review’ disciplinary tribunal. Changes were also made to financial penalties applied in the event of a breach.

ASTC also levies fail fees on a participant that does not meet its settlement obligations on a timely basis. In its review of settlement practices, published in May 2008, the Reserve Bank recommended that ASTC strengthen its settlement fails regime. ASX was in parallel reviewing ASTC's regime for dealing with failed settlements and, with effect from 1 September 2008, announced an increase in the minimum and maximum fees applied in respect of fails, with the floor set at $100 and the cap at $5,000 (maintaining an ad valorem fee of 0.1 per cent). ASX also announced plans to require that participants close out any positions remaining unsettled on the fifth day after trade date (i.e. two days after the scheduled settlement date).

ASTC has also introduced a new benchmarking regime for settlement fail performance. The new regime makes use of peer-group benchmarking and provides a participant's compliance unit with a ranking of its settlement fails performance (based on the value of its trades which have failed to settle) against its market group peers. Additionally, the benchmarking reporting includes figures on total fail fees levied.

3. Understanding risks

The securities settlement facility's rules and procedures must enable each participant to understand the securities settlement facility's impact on each of the financial risks the participant incurs through participation in the facility.

ASTC's Settlement Rules are comprehensive and publicly available. The Rules and Procedures explain the roles and responsibilities of each category of participant and ASTC. Substantial background information on ASTC's operations and risk management is also available on the ASX website.

ASTC must lodge any changes to its Settlement Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. ASTC consults with its participants on important rule changes, and notifies participants of all changes to the Settlement Rules or procedures.

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.

All securities held by ASTC are dematerialised and held in CHESS. Title is held in the name of clients of ASTC participants. The system does not record any details of encumbrances, other than collateral lodged in favour of ACH.

A CHESS sub-register forms part of the issuer's securities register. Maintenance and reconciliation of the complete register is the responsibility of the issuer or its appointed agent. Most ASTC participants settle across a centralised settlement account and subsequently allocate securities to end-clients in the CHESS sub-register. CHESS reports net movements on each CHESS sub-register to the holder of the issuer's complete register as part of its end-of-day process. Settlement participants utilise the centralised account under ‘trust’ provisions and are obliged to give irrevocable legal title to an end-client as long as that client has met all relevant conditions in respect of the settlement.

The transfer of title to securities in CHESS is effected by book entry, with ownership details updated electronically. Settlement occurs through a DVP process which is effected via a daily scheduled batch settlement cycle. ASTC's Settlement Rules also provide for transferring securities without payment, where required.

In the event of ASTC's insolvency, the rules and arrangements for title within ASTC provide a high degree of assurance that participants' securities will be immune from claims by ASTC's creditors. ASTC is not the legal owner of any participant or client assets, with these assets recorded in CHESS in the name of the participant or sponsored client.

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:

The operation of a securities settlement facility must eliminate principal risk between its participants and ensure that settlements, once completed, are final and irrevocable.
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.
Exposures between providers of cash settlement assets must be settled finally and irrevocably.

Settlement of securities transactions in ASTC occurs on a Model 3 DVP basis.^[7] This involves the simultaneous transfer of net payment and net securities obligations between buyers and sellers together at the end of the processing cycle. ASTC also provides for the settlement of cash obligations in relation to derivatives, which are also settled on a net basis. ASTC's Settlement Rules establish that settlement according to the terms of those rules is final and irrevocable. This is reinforced through legislation (see Measure 1).

Once a trade has been executed on the ASX market, a trade-related instruction is sent to CHESS. On T+1, CHESS generates a single net batch instruction reflecting the net position of each participant's novated trades in each line of stock. Between T+1 and T+3 participants can also instruct CHESS to include additional non-novated (off-market) transactions in the batch at T+3. During 2007/08, an average of around 67 per cent (by value) of net securities settled in the final batch were in respect of non-novated transactions. The majority of these transactions were related to the priming of clearing participants' accounts to facilitate settlement of novated trades (i.e. the transfer of securities to a clearing participant's securities account to ensure that they can be delivered in accordance with scheduled obligations).

By 8am on the settlement day, ASTC notifies each participant of its net cash and securities settlement obligations. Participants have until 10.30am to negotiate any additional non-novated trades necessary to ‘prime’ their accounts for settlement. After the cut-off for new instructions, transfer of securities positions is restricted in CHESS and participants' settlement banks are requested to authorise net funding demands.^[8] Once all cash authorisations have been received, the resulting interbank obligations are settled in RITS, typically by around noon. Securities positions are then updated at ASTC and participants are notified that the DVP transfer has been completed.

The finality of ASTC's settlement process is reinforced by its approval under Part 3 of the Payment Systems and Netting Act. In addition, the payments between payment providers as part of the multilateral net batch are protected by virtue of the approval of RITS as an RTGS system under Part 2 of the Payment Systems and Netting Act. This approval protects payments from being voided in the case of a payments provider entering external administration.

If, due to a shortfall of either securities or funds, a participant is unable to settle its scheduled obligations in the batch, ASTC's settlement rules allow for the transactions of the affected participant to be ‘backed out’. These transactions are then rescheduled for settlement on the next settlement day. The precise parameters of the back-out process depend upon whether or not the failing participant is in default. If the participant is in default, ACH may assume obligation for novated settlements as part of its default management process. ASTC's back-out algorithm seeks to remove as few transactions from the batch as possible, maximising settlement values and volumes, while minimising spillovers to other participants and minimising the potential injection of liquidity from ACH required in a default scenario. Non-novated trades are typically backed out first.

There was a delay to the settlement process in late January 2008 caused by a participant's inability to settle its obligations on time. In light of this disruption, the Reserve Bank undertook a review of equity settlement practices in May 2008. The Reserve Bank identified some possible modifications to the batch arrangements which might minimise the risk of one participant's settlement failure impacting settlement of the batch as a whole. These are discussed in Section 5.3.

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.

ASTC's Settlement Rules allow for the cancellation or suspension of a participant or a payment provider in the event that it becomes subject to external administration, or if it reasonably suspects that this may occur. Participants and payment providers are required to notify ASTC if they, or any other participant or payment provider, become subject to external administration or where they reasonably suspect that this may occur.

ASTC's Settlement Rules allow participants to nominate a new payment provider if their current provider is subject to, or is reasonably likely to become subject to, external administration.

ASTC's Settlement Rules allow it to remove transactions from batch settlement under certain circumstances, including where a participant is subject to external administration. ASTC has procedures and mechanisms in place to allow it to recast a batch ensuring that settlement can be carried out in a timely manner (see Measure 5).

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.

ASTC's key system is the Clearing House Electronic Sub-register System (CHESS).

CHESS has been highly reliable, with the system available for 99.99 per cent of the time over the period of this assessment. There was only one outage during the assessment period, with the system unavailable for a period of around 15 minutes. The system capacity of CHESS was upgraded in March 2008 to accommodate up to 1.1 million transactions per day. Average system utilisation during the assessment period was 33 per cent, with usage peaking at 62 per cent of capacity.

The security of the CHESS system is supported by access controls which are subject to external audit. The audit report for the assessment period was satisfactory. External penetration testing of CHESS is also conducted periodically. ASTC also has a fraud control policy in place which seeks to minimise the risk of fraud occurring within ASTC, as well as providing procedures for its timely identification and appropriate responses should it occur.

ASTC has arrangements in place to allow the timely recovery of its usual operations in the event of a contingency. It maintains an unmanned remote back-up facility which replicates the systems at the primary site. ASTC has detailed contingency procedures, which focus on the potential effects of a disruptive event. These contingency procedures are set down in ASTC's Incident Management Plan.

A test is completed annually to demonstrate that normal functions can be operated using systems located at the back-up site. ASTC also tests its ability to operate its primary systems from its back-up site monthly. A more extensive test, involving utilisation of back-up systems as the production environment for a day, took place in November 2007. Through its Settlement Rules, ASTC also requires its participants to have appropriate disaster recovery arrangements.

ASX Operations, a subsidiary of ASX Limited, is responsible for supplying ASTC and other ASX group companies with personnel and technological resources. ASTC has a written support agreement with ASX Operations which helps to ensure its access to these resources in the event of the external administration of ASX Operations, to the extent permissible by law.

8. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the relevant standard; breaches of risk-control requirements; and quarterly financial results. ASTC satisfied all reporting obligations during the assessment period.

A2.2 Austraclear

1. Legal framework

The securities settlement facility must have a well-founded legal basis.

Austraclear Limited is a wholly owned subsidiary of ASX Limited. It provides settlement services for the OTC debt market and for derivatives traded on the SFE and ASX markets.

The legal basis for Austraclear's operations is set out in its Regulations. Under Section 822B of the Corporations Act, these regulations have effect as a contract under seal between Austraclear and each of its participants, and between each participant and each other participant. The Regulations set out the rights and obligations of participants and Austraclear, including in the event of default or suspension.

The finality of settlements undertaken by Austraclear is reinforced by its approval as an RTGS system under Part 2 of the Payment Systems and Netting Act. This approval protects the finality of payments made through Austraclear in the event that a participant enters external administration.

Austraclear introduced an Electronic Conveyancing (EC) Settlement Facility during the assessment period. The EC Settlement Facility is not part of the operation of the licensed CS facility, but the Austraclear Regulations have been amended to incorporate these new arrangements. These Regulations therefore have effect as a contract between Austraclear participants. Settlement of the financial component of EC transactions occurs through the RITS Batch Facility. Austraclear has been approved as a Batch Administrator in the RITS Batch Facility.

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.

Austraclear had 735 participants as at end June 2008. Austraclear has objective and transparent participation requirements, which are publicly available and form part of the Regulations and Procedures. The Regulations also provide for an appeals process should an application for participation be rejected or a participant's access be terminated. Its participation requirements address financial and operational issues, such as capital adequacy, business integrity and business continuity arrangements.

Austraclear's Regulations allow it to suspend or terminate a participant from its facility in the event of a breach of its Regulations. Clearing and Settlement Operations monitors participants' operational processing performance.

Some amendments were made to Austraclear's disciplinary processes in March 2008, with a new single Disciplinary Processes and Appeals Rulebook introduced for all four licensed CS facilities in the ASX group. Furthermore, Austraclear's disciplinary framework was integrated with SFECC's Business Conduct and Market Practices Committees and the ACH and ASTC Disciplinary Tribunals to form a single ‘peer review’ disciplinary tribunal. Changes were also made to financial penalties applied in the event of a breach.

3. Understanding risks

Austraclear's Regulations and Procedures are comprehensive and publicly available. The Regulations and Procedures explain the roles and responsibilities of each category of participant and Austraclear. Background information on Austraclear's operations, technical arrangements and risk management is also available on ASX's website.

Austraclear must lodge any changes to its Clearing Rules with ASIC. Under Section 822E of the Corporations Act, the Minister has 28 days to consider, and potentially disallow, any rule changes made by a licensed CS facility. Austraclear consults with its participants on important rule changes. Announcements affecting participants are issued as ‘SFE Notices’ which are targeted to participants and market users.

4. Certainty of title

Austraclear's Regulations identify title for three different classes of securities: paper securities, non-paper securities and dematerialised securities.

Paper securities are negotiable instruments and include some certificates of deposit, promissory notes and bills of exchange. Austraclear holds these securities for the participant as bailee. The participant retains legal and beneficial title. Non-paper securities are electronic securities which are not registered within the Austraclear system. They include Commonwealth Government securities, registrable state and semi-government securities and corporate debt. In each of the registries, Austraclear holds legal title for the participant as nominee. The participant retains beneficial title. Dematerialised securities are electronic securities which are registered in the Austraclear system rather than externally. They include electronic certificates of deposit, electronic promissory notes and electronic bank-accepted bills of exchange. A dematerialised security is held by a participant as a ‘chose in action’.^[9] This legal structure imposes rights and obligations which replicate the rights and obligations of a negotiable instrument.

The transfer of title to securities in the Austraclear system is effected by book entry. Paper securities are transferred through updates to participants' security records. Austraclear also uses ‘allonges’ which maintain the negotiability of paper securities.^[10] Non-paper securities are transferred through the passing of beneficial title from the seller to the buyer. Austraclear retains legal title in the relevant registry. Transfers of dematerialised securities are transfers of contractual rights within the Austraclear system.

In the event of Austraclear's insolvency, the rules and arrangements for title within Austraclear provide a high degree of assurance that participants' securities will be immune from claims by Austraclear's creditors. Austraclear is not counterparty to any transactions settled in its system.

5. Settlement

The operation of a securities settlement facility must eliminate principal risk between its participants and ensure that settlements, once completed, are final and irrevocable.
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.
Exposures between providers of cash settlement assets must be settled finally and irrevocably.

Settlement of securities transactions in Austraclear occurs on a Model 1 DVP basis. This involves the simultaneous transfer of payment and securities obligations between the buyer and seller on an item-by-item basis through the settlement cycle. Austraclear also provides for one-way cash transfers between participants, which are also settled on an item-by-item basis. Austraclear's Regulations establish the basis for settlement of transactions entered into the system. By volume, DVP settlements account for around 43 per cent of total settlements and one-way cash transfers around 57 per cent. There is also a small volume of free-of-payment securities transfers (less than 0.5 per cent). By value, however, DVP payments predominate, accounting for 76 per cent of total transfers.

‘Participating banks’ hold ES accounts at the Reserve Bank and act on behalf of other Austraclear participants. 56 participating banks were operating in Austraclear as at 30 June 2008. Settlement of payment obligations occurs between participating banks across ES accounts on a RTGS basis. As such, settlement occurs in central bank money. Austraclear is notified immediately upon settlement of the payment leg of a securities trade, allowing for the immediate transfer of securities title so as to ensure DVP settlement.

The finality of Austraclear's settlement process is reinforced by its approval as an RTGS system under Part 2 of the Payment Systems and Netting Act. In addition, the payments between participating banks are protected by virtue of the approval of RITS under Part 2 of the Payment Systems and Netting Act.

6. External administration

Austraclear's Regulations allow it to cancel or suspend a participant or a participating bank that becomes subject to external administration, or if it reasonably suspects that this may occur. A participant or a participating bank is also required to notify Austraclear if it becomes subject to external administration or where it reasonably suspects that this may occur.

There is no restriction within the Austraclear Regulations on a participant changing its participating bank, including where that entity is insolvent.

As a facility supporting bilateral agreements negotiated on an OTC basis, without the presence of a central counterparty, Austraclear does not have centralised arrangements for dealing with the unsettled transactions of its participants. Consequently, replacement risk for any trade left unsettled due to the insolvency of a participant is borne directly by trade counterparties. By virtue of the application of a Model 1 DVP arrangement, unsettled trades do not give rise to principal risk.

7. Operational risk

Austraclear's key system is EXIGO. In April 2008, Austraclear assumed responsibility for all first- and second-level computer system support and business continuity arrangements in respect of the EXIGO system. Only the support provided by OMX's system developers remains outsourced.

During the assessment period EXIGO was available for 99.95 per cent of the required time. Austraclear's availability target for EXIGO is 99.8 per cent. There were three outages during the assessment period, for a total of 147 minutes. The first two outages occurred in late 2007: trades were matching successfully, but not settling. A short-term workaround was established on both occasions. A more permanent solution was affected in February 2008 by amending the relevant computer code. The third outage occurred in May 2008: live series were incorrectly deleted in SECUR, causing an outage in EXIGO. ASX updated its operational procedures to address the problem and has asked OMX to amend the relevant computer code.

Average capacity utilisation for EXIGO was 32 per cent during the assessment period, and peak capacity utilisation was 57 per cent.

The security of the EXIGO system is supported by access controls which were subject to external audit in April 2008. In response, Austraclear is taking steps to address some administrative issues highlighted. Austraclear also has a fraud control policy in place which seeks to minimise the risk of fraud occurring within Austraclear, as well as providing procedures for its timely identification and appropriate responses should it occur.

Austraclear has arrangements in place to allow for the timely recovery of its usual operations in the event of a contingency. These contingency procedures are set down in Austraclear's Incident Management Plan. ASX consolidated SFE's back-up facilities (including Austraclear's back-up facilities) to its group back-up site during the assessment period.

Austraclear tests back-up arrangements quarterly and carries out connectivity and procedural testing on a monthly basis. Austraclear utilised its back-up systems as part of the production environment several times during 2007. Through its Regulations, Austraclear also requires that its participants have appropriate disaster recovery arrangements.

8. Regulatory reporting

CS facility licensees are required to meet certain reporting obligations to the Reserve Bank under the Financial Stability Standards. These obligations include the reporting of: breaches of the relevant standard; breaches of risk-control requirements; and quarterly financial results. Austraclear satisfied all reporting obligations during the assessment period.

Footnotes

Under the net tangible asset regime, participants must hold a minimum of $5 million in net tangible assets. [1]

As noted, interbank transactions arising from settlements in ASTC and Austraclear are settled in RITS across ES accounts held with the Reserve Bank. RITS is also approved under Part 2 of the Payment Systems and Netting Act. [2]

Recent procedural changes were announced by ACH whereby a participant wishing to withdraw a bank guarantee lodged as collateral will be unable to do so until alternate cover has been lodged with ACH. Also, all bank guarantees are now required to be withdrawn at least one business day prior to their specified expiry date. [3]

ACH would suspend discounting if the exponentially-weighted moving average (EWMA) of SPI volatility was 30 per cent higher than historical volatility. ACH uses seven years of daily SPI movements for both volatility measures. [4]

With the exception of electricity contracts which will be subject to a monthly review. [5]

SFECC applies discounts only under normal market conditions. It will suspend discounting – thereby reverting to full collateralisation of AIMs – if exponentially-weighted moving average (EWMA) volatility is 30 per cent higher than historical volatility. SFECC uses seven years of daily SPI movements for both volatility measures. [6]

There is provision for DVP to occur on a trade-by-trade basis using CHESS RTGS, but this option has yet to be used. [7]

‘Payment providers’ hold ES accounts at the Reserve Bank and act on behalf of ASTC settlement participants. There were 12 payment providers operating in ASTC as at 30 June 2008. [8]

A legal right to intangible property. It allows the holder (in this case, the relevant Austraclear participant) to direct Austraclear to deliver to it securities of a specified description and number. [9]

‘Allonges’ are separate sheets of paper attached to a bill of exchange for the purpose of documenting endorsements. As a bill of exchange is transferable through endorsement, the allonge attached to the bill acts as a legal extension of the document. [10]