2012/13 Assessment of ASX Clearing and Settlement Facilities B1.1 ASX Clear

Standard 1: Legal Basis

A central counterparty should have a well-founded, clear, transparent and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions.

Rating: Observed

ASX Clear is a separate legal entity within the ASX Group that solely provides clearing services (CCP Standard 1.1). ASX Clear's legal basis is founded on clear and understandable rules that operate within the framework of relevant laws and regulations (CCP Standards 1.2, 1.3). The certainty of this legal basis in relevant jurisdictions is reinforced by supporting legislation, including ASX Clear's protection as a netting market under the Payment Systems and Netting Act 1998 (PSNA), and protection for settlements conducted via ASX Settlement and Austraclear under the same legislation, and is subject to periodic review by ASX Legal (CCP Standards 1.2, 1.5). ASX Clear has publicly outlined the key features of its legal basis on its website, and from time to time, for information, may provide legal opinions to participants or other stakeholders in respect of the legal basis of significant new services (CCP Standard 1.4). ASX has not identified any material risks arising from potential conflicts of law relating to the operations of ASX Clear (CCP Standard 1.6).

Based on this information, the Bank's assessment is that ASX Clear has observed the requirements of CCP Standard 1 during the 2012/13 Assessment period. The legal basis of ASX Clear is described in further detail under the following sub-standards.

1.1 A central counterparty should be a legal entity which is separate from other entities that may expose it to risks unrelated to those arising from its function as a central counterparty.

ASX Clear is a wholly owned subsidiary of ASX Clearing Corporation Limited, which is itself a wholly owned subsidiary of ASX Limited. As a separate legal entity, ASX Clear's central clearing activities are separate from the activities conducted by ASX's other clearing and settlement (CS) facilities and the rest of the ASX Group, notwithstanding the sharing of operational resources across multiple entities within the group.

ASX Clear's services are limited to CCP clearing of cash securities and derivatives transactions executed on the ASX and Chi-X markets, in accordance with the ASX Clear Operating Rules and Procedures. Accordingly, ASX Clear does not provide any services that have a distinct profile from, or pose additional risks to, its activity of operating a CCP.

1.2 The legal basis should provide a high degree of certainty for each material aspect of a central counterparty's activities in all relevant jurisdictions.

Legal basis

ASX Clear novates and nets transactions submitted for clearing by its participants. These activities require a high degree of legal certainty. Key components of the legal framework under which the CCP operates are:

  • ASX Clear holds a CS facility licence, under Part 7.3 of the Corporations Act 2001. This licence is administered by the Australian Securities and Investments Commission (ASIC) in consultation with the Bank, with the Minister acting as ultimate decision-maker on licensing matters.
  • ASX Clear has defined Operating Rules and Procedures. Under section 822B of the Corporations Act, these Rules and Procedures have effect as a contract under seal between: ASX Clear and each of its participants; each participant and each other participant; and each participant and each issuer.
  • Novation and the netting arrangements established under ASX Clear's Operating Rules are protected as a ‘netting market’ under Part 5 of the PSNA (see also CCP Standard 1.5).

The legal basis of ASX Clear's activities is reviewed by ASX Legal whenever there are material amendments to the Operating Rules or Procedures.

Rights and interests

The rights and interests of ASX Clear, its participants and, where relevant, its participants' customers in cleared positions and collateral are defined in ASX Clear's Operating Rules and Procedures.

The capacity to deal with collateral held by ASX Clear in circumstances of a participant default is an important risk protection. Recent amendments to Part 5 of the PSNA provide additional protections for the enforcement of security interests held by CCPs in the event of a participant default.

1.3 A central counterparty should have rules, procedures and contracts that are clear, understandable and consistent with relevant laws and regulations.

Section 822A of the Corporations Act establishes a framework to prescribe the matters that must be dealt with by Rules and those which may be considered under the Procedures. Rule changes are subject to a disallowance process.

The ASX Clear Operating Rules and Procedures are supplemented with explanatory material, published on ASX's public website and ASX's restricted participant website, to facilitate understanding by participants and prospective participants of the risks they face through participation in the system. Publicly available material includes high-level descriptions of ASX Clear's risk management framework, the CME SPAN and Cash Market Margining (CMM) margining methodologies, business continuity arrangements and the default management framework. Participants have access to additional manuals, reports and explanatory notes covering such topics as the application process for new participants, compliance, technical operational details, counterparty risk assessment and fees.

There is a clear process for changing ASX Clear's Operating Rules and Procedures. Proposed rule changes may be submitted informally to ASIC, which in consultation with the Bank will advise ASX of any regulatory concerns. Formal submission of the proposed changes to ASIC triggers a 28-day ‘disallowance’ period (referred to above), during which the Minister may choose to disallow the rule changes. The Minister considers a number of factors, including whether the proposed changes are consistent with the public interest. To assist the Minister in this process, ASIC provides detailed advice to the Minister, incorporating the views of the Bank as appropriate.

1.4 A central counterparty should be able to articulate the legal basis for its activities to the Reserve Bank and other relevant authorities, participants and, where relevant, participants' customers, in a clear and understandable way.

The legal basis for the activities of ASX (Clear) and the facility's protection as an approved netting market under the PSNA – see also CCP Standard 1.5 – are described on the ASX public website in its Disclosure Framework document (see CCP Standard 20.5).[1]

ASX Limited on behalf of each licensed entity within the ASX Group, including all CS facilities, submits an Annual Group Licence Report to ASIC and the Bank. This report sets out the legal basis for the CS facilities' activities under its licence obligations, and is used by ASIC in the preparation of ASIC's Market Assessment Report for the ASX Group.

For significant new services, ASX Clear may seek independent legal opinions in respect of relevant aspects, or any implications their introduction may have for the legal basis of existing functionality. These opinions may, in some circumstances, be shared with participants or other stakeholders for their information, particularly to demonstrate the legal efficacy of new Operating Rules.

1.5 A central counterparty should have rules, procedures and contracts that are enforceable in all relevant jurisdictions. There should be a high degree of certainty that actions taken by the central counterparty under such rules and procedures will not be voided, reversed or subject to stays, including in the event that the central counterparty enters into external administration or that one or more of its participants defaults or is suspended.

Since ASX is a vertical exchange, there is a certain degree of overlap in how aspects of the service are linked in conducting trading, clearing and settlement, although trades may also enter at the clearing level via the Trade Acceptance Service. ASX Clear's Operating Rules establish the point at which trades are novated and the risk controls that apply to manage clearing exposures. Such risk controls are calibrated to participants' net obligations to the CCP. Unlinked payment obligations arising from clearing are settled in Austraclear, and the point at which settlement is final and irrevocable is established in Austraclear's Regulations. Securities transfers and related payment obligations arising from clearing are settled in ASX Settlement, and the point at which settlement is final and irrevocable is established in ASX Settlement's Operating Rules

Novation and netting

Part 5 of the PSNA provides protections for approved ‘market netting arrangements’ (i.e. the function of a CCP) against claims that might otherwise be upheld in insolvency proceedings. It covers several areas relevant to CCPs. In particular, it provides protection for:

  • novation, the process whereby matched trades between participants are replaced by separate contracts between the buyer and the CCP and the seller and the CCP
  • the process of reducing each participant's contracts to a net exposure (reflecting the exposure to the participant's portfolio of contracts)
  • the CCP's rules covering default, such that future exposures may be terminated and a net payout obligation calculated
  • payments made on a net basis, by protecting against the voiding of net payments in the event of insolvency of a participant.

Settlement finality

Payment-only obligations are settled in Austraclear and securities-related obligations are settled in ASX Settlement. Settlement finality is protected by approvals of Austraclear and ASX Settlement under Part 2 and Part 3 of the PSNA respectively. Part 2 protects against exercise of the so-called ‘zero-hour rule’ in insolvency law, whereby transactions occurring after the point at which an insolvency is legally determined to have started could potentially otherwise be reversed. Part 3 protects the finality of settlements in ASX Settlement's multilateral net batch. Any interbank transactions arising from these settlements are settled in real time in the Reserve Bank Information and Transfer System (RITS), across Exchange Settlement Accounts (ESAs) held with the Bank. Finality of funds transfers in RITS is again supported by the approval of RITS under Part 2 of the PSNA.

Assumption of risk

Through novation, the obligations of ASX Clear are to each participant as principal – irrespective of whether that participant is acting on behalf of a client. Equally, participants' obligations are to ASX Clear for all transactions that have been novated (i.e. both proprietary and client transactions).

Importantly for the legal protections provided under the PSNA, as noted above, the point of novation is established by ASX Clear's Operating Rules. In respect of exchange-traded transactions, ASX Clear's Operating Rules specify that a transaction on the ASX or Chi-X markets is novated immediately upon the matching of a bid and offer, while for over-the-counter (OTC) equity options, novation occurs upon acceptance and registration of that transaction within the clearing system.

Enforceability of ASX rules while under external administration

ASX Legal has analysed the legal enforceability of ASX Clear's Operating Rules upon the CCP's entry into external administration, and has identified no material legal risk to enforceability.

1.6 A central counterparty conducting business in multiple jurisdictions should identify and mitigate the risks arising from any potential conflicts of law across jurisdictions. A central counterparty should provide the Reserve Bank with a legal opinion that demonstrates the enforceability of its rules and addresses relevant conflicts of law across the jurisdictions in which it operates. This should be reviewed on a periodic basis or when material changes occur that may have an impact on the opinion, and updated where appropriate.

Although participants of ASX Clear include Australian-domiciled subsidiaries of entities that are based in foreign countries, the Operating Rules are governed by Australian law and require that all participants submit to the exclusive jurisdiction of New South Wales courts. ASX Legal's analysis of potential conflicts of law across jurisdictions has identified no material legal risks.

Footnote

Available at <http://www.asxgroup.com.au/media/pfmi_disclosure_framework.pdf>. [1]