2009/10 Assessment of Clearing and Settlement Facilities in Australia 5.3 ASX Settlement (formerly ASX Settlement and Transfer Corporation)

Background

ASX Settlement operates the securities settlement facility for cash equities and warrants traded on the ASX market.

ASX Settlement operates within a sound legal framework, based on its Operating Rules and Procedures (referred to as the ASTC Settlement Rules prior to August 2010). Under section 822B of the Corporations Act, these rules constitute a contract under seal between ASX Settlement and each of its participants, and between participants. Among other things, the rules set out the rights and obligations of ASX Settlement and each of its participants, including in the event of default or suspension. ASX Settlement's netting arrangements are approved 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 ASX Settlement participant or a payment provider.

ASX Settlement's securities settlement system is CHESS. Settlement risk in CHESS is mitigated by the use of a Model 3 DVP mechanism, whereby settlement of securities transfers and associated cash payments occurs in a multilateral net batch at around noon each day, with interbank cash payments made across Exchange Settlement (ES) accounts in the Reserve Bank's real-time gross settlement (RTGS) system, RITS. Securities title is updated upon confirmation of cash settlement from RITS.

Assessment of Developments in 2009/10

Following the disruption to the equity settlement process in January 2008, the Reserve Bank published a Review of Settlement Practices for Australian Equities and recommended that ASX Settlement consider a number of enhancements to its settlement arrangements.[1] After seeking participant feedback, ASX announced that it would implement a number of enhancements.[2] This implementation was the focus of the 2008/09 Assessment, with particular emphasis on improvements to the functioning of the batch-settlement model; and improving the transparency of securities-lending activity. Over 2009/10 the Reserve Bank continued its focus on ASX Settlement's progress towards implementation of these enhancements. During the period, ASX Settlement implemented additional improvements to the batch-settlement model, as well as continuing to improve transparency in the securities-lending market through implementation of the securities-lending disclosure regime.

Improvements to the batch-settlement model

The Reserve Bank's Review of Settlement Practices for Australian Equities recommended a number of potential enhancements to the functioning of the batch-settlement model following the significant delays to the completion of settlement in January 2008. In September 2009, after consultation with industry participants, ASX announced that it would implement a number of changes. While at the time of the announcement ASX had already implemented some changes to the batch-settlement model, a number of further improvements were identified.

These included:

  • An earlier deadline for the back out of settlement obligations: In the event that a participant fails to meet its payment obligations ASX may impose an earlier deadline for the back out of settlement obligations (although some flexibility will be retained in the event of operational problems). Had such arrangements been in place in January 2008, the back out of the troubled participant's settlement obligations and the recalculation of the batch could have been accelerated, reducing the overall length of the settlement delay, and mitigating the uncertainty that may affect the market at large.
  • Increasing ASX Settlement's powers to facilitate same-day settlement of backed-out settlement obligations: Since the incidence of batch recalculation could increase once an earlier deadline for the back out of settlement obligations has been imposed, ASX Settlement proposed to seek rules-based powers to require and facilitate the intraday settlement of certain backed-out settlement obligations if this was deemed necessary to avoid further disruption to the settlement process.
  • Removal of ASX Clear derivatives margins from the CHESS settlement batch: This ensures that ASX Clear's risk-management arrangements are not dependent on the completion of settlement in the cash equity market.
  • Amendment to the LEPO expiry settlement process: This addresses a potential principal risk to ASX Clear arising because of a mismatch between the nominal $0.01 option strike price and actual exposure.[3]
  • Development of standards for payment providers: ASX consulted on the possibility of pre-agreed settlement limits for payment providers (i.e., those settling payment obligations on behalf of settlement participants), so as to avoid delays associated with the approval of settlement obligations for their clients. Following the consultation process, rather than proceed with pre-agreed limits, ASX Settlement decided to work towards raising minimum standards for payment providers.

Over the assessment period ASX implemented a number of these enhancements. Starting February 2010 the payment of ASX Clear derivatives margins were removed from the CHESS batch. ASX also plans on making changes to remove netting between house and client margin payments in the settlement process during the next assessment period. ASX has implemented a temporary solution to mitigate risk around the LEPO expiry settlement process. A permanent solution will be considered as part of cash equity margining.[4]

In July 2010, ASX also clarified some aspects of the CHESS batch settlement processing cycle in a participant bulletin.[5] This bulletin set out the obligations of ASX Settlement and payment providers during the settlement cycle, including a timeline by which payment providers must confirm or reject their willingness to fund settlement participants' obligations. ASX will amend the formal agreements between payment providers and ASX Settlement, in consultation with the Australian Payments Clearing Association (APCA) and payment providers, to change the scheduled times in the formal agreements so that they better reflect current market practice, as well as providing clarity to payment providers as to their obligations.

With respect to the remaining enhancements, ASX has projects planned to increase ASX Settlement's powers to facilitate same-day settlement of backed-out settlement obligations. The Reserve Bank will continue to monitor developments in this area in the next assessment period.

Transparency of securities-lending activity

During the assessment period ASX completed the implementation of the securities-lending disclosure regime. The regime was the result of a recommendation by the Reserve Bank to increase transparency in the securities-lending market in the Review of Settlement Practices for Australian Equities. Since securities-lending transactions are currently settled in the CHESS settlement batch alongside equity trades that have been novated to ASX Clear, any disruption to their settlement can have spillover effects on settlement in the wider market. Indeed, the disruption to equity settlement in January 2008 arose, in part, from a participant's inability to meet obligations arising from securities-lending transactions. For this reason, the Reserve Bank saw a strong case for ASX Settlement, regulators and market participants to have access to data on activity in the securities-lending market, and the scale of outstanding positions. With this information, participants gain a better understanding of potential future settlement risks and the role of securities lending in broader market functioning. Transparency of this activity also improves the balance of information in the market; previously, only those directly involved in these transactions had access to such information.

The key features of the disclosure regime, which was developed in consultation with ASX and market participants, are as follows:

  • Real-time tagging of all securities loan-related settlement instructions submitted to CHESS. These data are particularly useful for ASX Settlement as operator of the securities settlement facility, to give visibility of loan-related transactions submitted for settlement and allow settlement performance of such trades to be monitored effectively.
  • Daily reporting to ASX of settlement participants' outstanding on-loan and borrowed positions, by security. These data offer a gauge of outstanding loans which might be subject to recall, and allow for separate identification of chains of loans.
  • Quarterly reporting of the aggregate number of shares committed to lending programs by settlement participants.

On 2 November 2009, ASX started publishing daily reports containing the aggregate number and value of tagged transactions in the CHESS batch and the number of securities-lending transactions effected for each security. Since 14 December 2009, ASX has also published daily reports containing the value of outstanding securities-lending positions in each security. The value of securities committed to lending was added to these reports at the beginning of January 2010.

One issue with the disclosure regime is its coverage. Under ASX Settlement Operating Rules and Procedures, reporting is compulsory for settlement participants in ASX Settlement; firms active in the securities lending market, but who are not settlement participants, however, are not required to report. The incomplete coverage of the regime is evident from the discrepancy between the reported borrowed and loaned securities. To address this issue, the Reserve Bank has been working with ASX, industry participants and industry bodies to raise awareness of the regime and to secure voluntary commitments to provide similar data from non-settlement participants with a material presence in the Australian securities lending market. The Reserve Bank remains in dialogue with ASX and industry with regards to this issue, and if the current regime's reliance on voluntary reporting ultimately results in insufficient coverage, will consider changes to the regime to remedy this.

Operational performance

ASX Settlement's key system, CHESS, achieved a high level of operational reliability during the period, with just one short outage reported in January 2009; availability over the year was virtually 100 per cent. Capacity utilisation averaged 24 per cent during the assessment period, peaking at 50 per cent. Accordingly, ASX Settlement met both its targets of minimum availability of 99.8 per cent and capacity headroom of 50 per cent over peak utilisation.

ASX conducts business continuity tests of its key systems over two-year cycles. The testing program for 2010 and 2011 was finalised in early 2010, with CHESS scheduled for testing in May 2011. The last test of CHESS was conducted in September 2009, and did not reveal any problems. As noted in Section 5.1, ASX also updated its Business Continuity Management Policy during the year and has a number of improvements to arrangements planned in line with international best practice.

Trade acceptance service

In response to the prospect of AMOs entering the Australian market, ASX has announced the creation of a TAS, that will allow trades executed on AMOs' platforms to be cleared and settled through ASX Clear and ASX Settlement respectively. Details of the TAS are provided in Section 5.1.

Summary

It is the Reserve Bank's assessment that ASX Settlement complied with the Financial Stability Standard for Securities Settlement Facilities during the assessment period.

The Reserve Bank welcomes the enhancements to ASX Settlement's settlement arrangements, including the movement of margin payments from the CHESS batch to Austraclear, and clarifications around the CHESS batch processing cycle. The Reserve Bank encourages ASX Settlement to implement the other identified enhancements as soon as practicable and will monitor progress over the period ahead. The Reserve Bank also welcomes the implementation of the securities-lending disclosure regime and will continue to monitor the coverage of the regime.

Footnotes

The document ‘Review of Settlement Practices for Australian Equities’, is available at: <https://www.rba.gov.au/payments-and-infrastructure/financial-market-infrastructure/clearing-and-settlement-facilities/consultations/review-practices/>. [1]

In late 2008, ASX released a consultation paper, ‘Enhancing Australia's Equity Settlement System’. This document is available at: <http://www.asx.com.au/about/pdf/consultation_paper_enhancing_equity_settlement_system.doc>. In September 2009, ASX announced a number of enhancements to its equity settlement arrangements with input from the above consultation. The document ‘Enhancing Australia's Equity Settlement System: The Way Forward’ is available at: <http://www.asx.com.au/about/pdf/market_information_paper_enhance_equity_settle.pdf>. [2]

A LEPO is a European-style call option (i.e., can only be exercised on expiry date) with a strike price of one cent. There is no up-front option premium and both buyer and seller pay margins through the life of the LEPO. Upon exercise at expiry, the buyer pays premium and final margin payments to the seller (via ASX Clear) and the securities are transferred against consideration of just one cent. While the securities are transferred in conjunction with the CHESS batch, the final margin and premium payments may be settled in either Austraclear or the CHESS batch. Since the final margin and premium payments represent the full value of the securities, where these are not settled in the CHESS settlement batch, a daylight principal risk arises between the time at which they settle in Austraclear and the time at which securities are transferred in CHESS. [3]

The temporary solution involves ASX Clear withholding all outward margin payments until it has been confirmed that the CHESS batch has settled. The longer-term solution will involve settlement of securities delivered at expiry at the prevailing stock price, rather than the strike price of one cent. [4]

The bulletin is available at: <https://www.asxonline.com/intradoc-cgi/groups/clearing_and_settlement/documents/communications/asx_027540.pdf>. [5]