2012/13 Assessment of ASX Clearing and Settlement Facilities B2.2: Austraclear

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

Austraclear has powers under its Operating Rules and Procedures to manage a participant default, and has documented procedures setting out how to manage a default, including in respect of special purpose participants that are collateral managers. Powers available to Austraclear 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. Austraclear sets out its default management powers in its Regulations and Procedures (SSF Standard 11.3). Since Austraclear 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). Austraclear's default management arrangements are designed for the particular characteristics of its activities, and take into account potential impacts on relevant markets (SSF Standard 11.5).

Based on this information, the Bank's assessment is that Austraclear has observed the requirements of SSF Standard 11 during the 2012/13 Assessment period. Austraclear'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.

The default of a participant in Austraclear does not require the SSF to meet obligations on its behalf; nor does it create additional obligations for non-defaulting participants. Steps taken by Austraclear to manage a participant default are therefore largely procedural in nature. Participant defaults may result from insolvency events or a failure to comply with the requirements of the Austraclear Regulations, and are dealt with under Regulations 3.10 to 3.14 and under the ASX Enforcement and Appeals Rulebook. Austraclear maintains an internal checklist setting out actions to be taken by relevant business units within ASX in managing a participant default. The default of an Austraclear participant would be managed by the Participant Incident Response Committee (PIRC). The PIRC is chaired by the EGM, Operations, and is made up of senior staff from operational, risk management, compliance and legal units.

ASX Collateral

The introduction of the collateral management service does not alter existing default rules and procedures under the Austraclear Regulations. In the normal course, an event of default in Austraclear involves suspension or termination of the defaulting participant in accordance with Austraclear Regulations. For the collateral management service, the intent is to preserve contractual default arrangements set out in Principal Agreements. These arrangements entitle the collateral receiver to treat collateral held as owned on an outright basis, and include clauses permitting either counterparty to terminate a future obligation to return collateral or cash where the counterparty has suffered an event of default.

Upon notification of a default under a Principal Agreement, ASX Collateral would act as the collateral receiver's agent and, upon instructions from the collateral receiver, instruct Austraclear to transfer collateral held from the receiver's Collateral Account to its Source Account or Austraclear trading account.

A collateral receiver would issue such instructions through a notice of default to ASX Collateral. The default notice must be signed by two authorised signatories of the collateral receiver. The notice would be in two parts.

• Part 1 would notify ASX Collateral of the default and identify the specific account, contract and exposure that are the subject of the default. Upon receipt of this part, ASX Collateral would effectively freeze the account. Until Clearstream's Collateral Management Exchange (CmaX) is updated with the account status, any recommended settlement instructions from CmaX relating to that account would not be executed.
• Part 2 of the default notice would authorise ASX Collateral to instruct Austraclear to transfer the collateral securities to an account controlled and operated by the collateral receiver.

Nothing in the arrangements requires ASX Collateral to enquire into the validity of any matters in connection with Principal Agreements, including in relation to actions taken in a default event. Any dispute over actions taken is a matter for parties to the Principal Agreement. ASX Collateral is not a party to the Principal Agreement and its role as agent is strictly limited. Equally, Austraclear is not party to the Principal Agreement; Austraclear's role in the process is to act on the instructions of ASX Collateral. Nevertheless, the Austraclear Regulations provide an indemnity to Austraclear against any loss or claim arising from its actions in accordance with instructions from ASX Collateral.

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.

Austraclear's Regulations and Procedures allow it to cancel or suspend the participation of 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 and Procedures on a participant changing its Participating Bank, including the case where that Participating Bank is insolvent.

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.

Austraclear's Regulations 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 Austraclear to suspend or terminate participant status in a default event.

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 Austraclear participant are also tested to the extent that clearing participants also participate in Austraclear. As neither Austraclear nor its participants is exposed to financial obligations created by the default of a participant in respect of Austraclear transactions (a participant may be impacted by the default of another participant if it has outstanding unsettled bilateral transactions with the defaulting participant), the management of a settlement-only participant default situation is generally procedural in nature. Austraclear has on occasion had need to employ its default management procedures, most recently to address the appointment of an external administrator to a participant in July 2013.

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.

All products settled by Austraclear are AUD-denominated (including Euroentitlements) and Austraclear's operations are conducted domestically. Key participants generally have a significant domestic presence; for example, Participating Banks must be domestically licensed ADIs with an ESA at the Bank. As Austraclear's default management procedures do not place financial obligations on participants, there would be expected to be minimal potential impacts on market pricing, liquidity and stability stemming from these procedures.