2007/08 Assessment of Clearing and Settlement Facilities in Australia 3. Developments in the Clearing and Settlement Industry in 2007/08

The past 12 months have seen a substantial increase in volatility and traded volumes and values in a number of markets served by Australia's clearing and settlement facilities. There have also been financial problems with a small number of brokers, and on two occasions in January there were significant delays in the batch settlement of equities. Also during this period, three new platforms have applied for licences to operate market venues for the trading of ASX-listed equities. These applications have raised the issue of how the new platforms will link into the established clearing and settlement infrastructure, which is currently integrated with the incumbent exchange.

Activity in the Licensed CS Facilities

Over 2007/08, volumes and values passing through the licensed CS facilities continued to increase, though in some cases less rapidly than in the preceding period. The most notable growth was in cash equities volumes, which rose by 86 per cent, outstripping growth of 22 per cent in values traded. Reflecting the faster growth in volumes than values, the average transaction size has continued to fall (Graph 1). This is partly the result of more widespread application of automated trading strategies and other mechanisms to split large orders and release them gradually into the market.

As traded values have grown, the average settlement value on each side of the daily net CHESS settlement batch has also increased, rising by 20 per cent over the year to approximately $630 million (Graph 2). The peak value of settlements during the year was $3.7 billion, on 25 September 2007.

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

The average daily settlement of debt securities through Austraclear, comprising outright purchases and sales of debt securities and repos, increased significantly over the year, rising by 27 per cent to $42.2 billion.

Risk Management in the Licensed Central Counterparties

As values traded have risen, exposures faced by the central counterparties, ACH and SFECC, have grown. On average, 73 per cent of cash equities and warrants traded on the ASX market were novated to ACH during the year to June 2008. The resultant exposure faced by ACH can be captured by the sum of participants' settlement obligations to ACH in respect of their trades. Over the year, ACH's average exposure from a single day's trades increased by 36 per cent to $610 million. Taking into account the three-day settlement cycle, ACH's total exposure rose by a similar percentage, to $1.3 billion per day. ACH does not routinely levy margins in respect of participants' cash equity positions, but has recently introduced a regime whereby participants are required to post collateral to cover large exposures.

ACH and SFECC manage the risk associated with participants' derivatives positions partly via the imposition of initial margins. For ASX-traded derivatives, the aggregate of initial margins held during the assessment period rose by 44 per cent to an average of almost $730 million. This reflected both the rise in notional values traded and higher market volatility, which led to an increase in margin rates. By contrast, on the SFE market, where clearing participants scaled back their open positions markedly, initial margins posted to SFECC peaked at $4.7 billion at the end of the previous assessment period and declined through the remainder of 2007 to be within a $2 to $3 billion range during most of the first half of 2008 (Graph 4). The average for 2007/08 as a whole was approximately $3 billion, similar to the previous year.

Delay to Equity Settlement in January 2008

During the first half of 2008, a number of brokers experienced financial difficulties. Where these brokers were either clearing or settlement participants, the licensed CS facilities had to take action to manage both direct counterparty risk exposures and potential spillovers to other participants through the clearing and settlement process. The assessments in Section 5 describe some of the measures taken.

On two days in late January 2008, the inability of one broker to meet its obligations in the daily net batch settlement process run by ASTC led to significant delays in the settlement of Australian equities. While settlement is typically completed at around noon, the batch did not settle until around 4.30pm on 29 January and around 2.30pm on 30 January. Further to these events, the Reserve Bank undertook an extensive review of settlement practices in the Australian equity market, publishing its findings in May 2008.^[1] The main findings of this review are outlined in Section 5.3.

Prospective Changes in the Clearing And Settlement Landscape

During the assessment period, ASIC launched two public consultations on the implications of competing trading platforms for ASX-listed equities.^[2] Three companies have applied for market licences to provide platforms in direct competition with the ASX market, currently the sole provider. In March 2008, ASIC gave advice to the Minister for Superannuation and Corporate Law on the regulatory framework for these new trading platforms; the Minister is currently considering that advice.

The Reserve Bank's interest is in the nature of arrangements to be put in place to enable the new trading platforms to clear and settle via ACH and ASTC. The Reserve Bank has been in close dialogue with ASX and ASIC on these matters. On 19 March 2008, ASX issued a high-level public consultation document, laying out the relevant issues to be addressed in establishing access to its CS facilities. This was followed by the publication of issues papers for industry consultation on 11 April 2008 and 24 July 2008.

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

Footnotes

The report is available at: <https://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/consultations/review-practices/> [1]

CP86: Competition for Market Services – trading in listed securities and related data (July 2007) and CP95: Competition for Market Services – response to CP86 and further consultation (November 2007). [2]