2012/13 Assessment of ASX Clearing and Settlement Facilities B2.1 ASX Settlement

Standard 11: Participant Default Rules and Procedures

A securities settlement facility should have effective and clearly defined rules and procedures to manage a participant default. These rules and procedures should be designed to ensure that the securities settlement facility can take timely action to contain losses and liquidity pressures and continue to meet its obligations.

Rating: Observed

ASX Settlement has powers under its Operating Rules and Procedures to manage a participant default, and has documented procedures setting out how to manage a default. Powers available to ASX Settlement include powers to suspend or terminate the participant status of a defaulting participant (SSF Standards 11.1, 11.2). Participants are also required to report default events or an expected default to the SSF. ASX Settlement sets out its default management powers in its Operating Rules and Procedures (SSF Standard 11.3). Given that ASX Settlement is not exposed to financial loss on a participant default, its handling of a default situation is largely procedural in nature (SSF Standard 11.4). ASX Settlement's default management arrangements are designed for the particular characteristics of its activities, and take into account potential impacts on Australian markets (SSF Standard 11.5).

Based on this information, the Bank's assessment is that ASX Settlement has observed the requirements of SSF Standard 11 during the 2012/13 Assessment period. ASX Settlement's default management arrangements are discussed in further detail under the following sub-standards.

11.1 A securities settlement facility should have default rules and procedures that enable the securities settlement facility to continue to meet its obligations in the event of a participant default and that address the replenishment of resources following a default. A securities settlement facility should ensure that financial and other obligations created for non-defaulting participants in the event of a participant default are proportional to the scale and nature of individual participants' activities.

ASX Settlement does not provide participants with a guarantee against credit or liquidity risk; however, the design of the system precludes principal credit exposures arising between participants. ASX Settlement is not exposed to risk as a participant and has no settlement obligations arising from its role as a provider of a settlement facility including in the event of a default. Settlement occurs in central bank money on a DvP model 3 basis with money settlement in RITS as a single multilateral batch. Finality of settlement is protected by ASX Settlement's approval as a netting arrangement under the PSNA. The default of a participant in ASX Settlement would not require the SSF to meet obligations on its behalf, although it could alter the obligations of non-defaulting participants if it resulted in the reconstitution of ASX Settlement's multilateral net batch prior to settlement (see SSF Standard 11.3).

Section 12 of the ASX Settlement Operating Rules sets out the circumstances in which ASX may suspend or impose restrictions on participation. These include events of ‘non-compliance’, such as entry or suspected entry into external administration or the failure to comply with participation requirements, a failure or anticipated failure of a participant's Payment Provider to authorise its net payment obligation, or a failure to comply with legal or regulatory obligations. ASX Settlement maintains documented procedures for dealing with the default of a participant, including in respect of back-out procedures to reconstitute the multilateral net batch. The default of a settlement-only participant would be managed by the Participant Incident Response Committee (PIRC), while the default of a settlement participant that is also a participant in ASX Clear would be managed by the ASX Default Management Committee in accordance with ASX Clear's Default Management Framework (see Appendix B1.1, CCP Standard 12). The PIRC is chaired by the EGM, Operations, and is made up of senior staff from operational, risk management, compliance and legal units.

11.2 A securities settlement facility should be well prepared to implement its default rules and procedures, including any appropriate discretionary procedures provided for in its rules. This requires that the securities settlement facility should:

1. require its participants to inform it immediately if they:
   1. become subject to, or aware of the likelihood of external administration, or have reasonable grounds for suspecting that they will become subject to external administration; or
   2. have breached, or are likely to breach, a risk control requirement of the securities settlement facility; and
2. allow for the cancellation or suspension of a participant or commercial settlement bank from the securities settlement facility:
   1. if the participant or commercial settlement bank is in external administration; or
   2. if there is a reasonable suspicion that the participant or commercial settlement bank may become subject to external administration; and
3. allow participant users of a commercial settlement bank which becomes subject to external administration, or which is reasonably likely to become subject to external administration, to quickly nominate a new commercial settlement bank.

ASX Settlement's Rules and Procedures allow it to cancel or suspend the participation of a participant or a Payment Provider in the event that it becomes subject to external administration, or if ASX Settlement reasonably suspects that this may occur. A participant or a Payment Provider is also required to notify ASX Settlement if it, or any other participant or Payment Provider, becomes subject to external administration or where it reasonably suspects that this may occur.

The ASX Settlement Operating Rules and Procedures allow a participant to nominate a new Payment Provider if its current provider is subject to, or is reasonably likely to become subject to, external administration.

11.3 A securities settlement facility should publicly disclose key aspects of its default rules and procedures. Where a securities settlement facility settles via a multilateral net batch, arrangements for dealing with any unsettled trades of a defaulting participant that are not guaranteed by a central counterparty, such as reconstituting the multilateral net batch excluding the settlement obligations of the defaulting participant, should be clear to all its participants and should be capable of being executed in a timely manner.

ASX Settlement's Operating Rules and Procedures are published on ASX's public website. These include requirements for participants to give notice of insolvency or the reasonable possibility of insolvency and the rights of ASX Settlement to suspend or terminate participant status in an event of non-compliance.

If, due to a shortfall of either securities or funds, a participant is unable to settle its scheduled obligations in the batch, ASX Settlement's rules allow for all or some of 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 (i.e. has a shortfall of funds). If the participant is in default, ASX Clear may assume an obligation for novated settlements in accordance with its default management arrangements. ASX Settlement's back-out algorithm seeks to remove as few transactions from the batch as possible, maximising settlement volume, while minimising the spillover to other participants. Transactions unrelated to novated settlement obligations are typically backed out first. ASX consulted in July 2013 on a proposal to amend the way that it would deal with a shortfall of funds related to novated transactions. Under this proposal, ASX Clear would meet any payment obligations to allow securities delivery transactions to settle as intended, with participants providing the funds for settlement via separate repurchase transactions for the same stock to settle at a later date (see Appendix B1.1, CCP Standards 7.3 and 7.9 for further details). The net economic and operational effect of these transactions on non-defaulting participants would be equivalent to the current back-out arrangements.

ASX Settlement's back-out arrangements are described in Rule 10.11 of the ASX Settlement Operating Rules, as well as in related Procedures available to participants.

11.4 A securities settlement facility should involve its participants and other stakeholders in the testing and review of the securities settlement facility's default procedures. Such testing and review should be conducted at least annually and following material changes to the rules and procedures to ensure that they are practical and effective.

ASX conducts regular in-house default management ‘fire drills’ to test default procedures as they would apply to participants across one or more of the ASX CS facilities. While the focus of the fire drills is on the more complex scenario of a clearing participant default, procedures for managing the default of an ASX Settlement participant are also tested to the extent that clearing participants also participate in ASX Settlement. Settlement-only aspects of default management are less complex, and ASX has determined that its testing of default procedures in the context of a clearing participant default is sufficient to ensure that ASX Settlement's default procedures are practical and effective.

11.5 A securities settlement facility should demonstrate that its default management procedures take appropriate account of interests in relevant jurisdictions and, in particular, any implications for pricing, liquidity and stability in relevant financial markets.

Participants include both Australian and overseas brokers with a significant domestic presence, including subsidiaries of Australian and overseas banks. Products settled by ASX Settlement are traded on Australian markets and denominated in AUD. Accordingly, default management actions would be taken during the local time zone for all participants.