2015/16 Assessment of ASX Clearing and Settlement Facilities A1.2 ASX Clear (Futures) 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.

ASX Clear (Futures) is a separate legal entity within the ASX Group that solely provides clearing services (CCP Standard 1.1). ASX Clear (Futures)’ 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 protections afforded to ASX Clear (Futures) as a ‘netting market’ under the PSNA and the protection of money settlement finality through Austraclear under the same legislation. ASX Clear (Futures)' legal basis is subject to periodic review by ASX Legal (CCP Standards 1.2, 1.5). ASX Clear (Futures) 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 (Futures) (CCP Standard 1.6).In May 2016, Parliament passed the Resilience Act. Among other things, this Act amended the PSNA to enhance the protections afforded to netting markets, including ASX Clear (Futures), to protect the exercise of recovery powers and default fund contributions of participants should participants subsequently enter administration (CCP Standard 1.5). The amendments also provide additional legal certainty for RTGS systems approved under the PSNA, such as Austraclear.

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

ASX Clear (Futures)' services are limited to CCP clearing of futures and options products that are traded on the ASX 24 market and certain OTC derivatives, in accordance with the ASX Clear (Futures) Operating Rules and Procedures, the OTC Rules and the OTC Handbook. Accordingly, ASX Clear (Futures) 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 (Futures) 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 (Futures) holds a CS facility licence under Part 7.3 of the Corporations Act 2001. This licence is administered by ASIC in consultation with the Bank. The Minister acts as ultimate decision-maker on licensing matters, although this responsibility has been delegated to authorised ASIC officers since April 2016.
  • ASX Clear (Futures) has defined Operating Rules and Procedures. Under section 822B of the Corporations Act, these Rules have effect as a contract under seal between: ASX Clear (Futures) and each of its participants; and each participant and each other participant. The Operating Rules and Procedures set out the rights and obligations of participants and ASX Clear (Futures), including in the event of default or suspension.
  • ASX Clear (Futures) is protected as a ‘netting market’ under Part 5 of the PSNA (see also CCP Standard 1.5).

While ASX Clear (Futures) has been recognised as a third-country CCP by ESMA and has been exempted from registration as a Derivatives Clearing Organisation (DCO) by the Commodity Futures Trading Commission (CFTC) in the US, its legal basis is governed by Australian law. ASX Clear (Futures) has identified no legal risks arising from recognition or exemption in other jurisdictions.

The legal basis of ASX Clear (Futures)' activities is reviewed by ASX Legal whenever there are material amendments to the Operating Rules or Procedures. Five such reviews occurred for ASX Clear (Futures) during the Assessment period.

Rights and interests

The rights and interests of ASX Clear (Futures), its participants and, where relevant, its participants' customers in cleared positions and collateral are defined in ASX Clear (Futures)' Operating Rules and Procedures, OTC Rules and OTC Handbook. The OTC Handbook sets out the procedures, timings, contract terms and other details of the OTC derivatives clearing service. Customers of participants have a contractual right to deal directly with ASX Clear (Futures) in the event of the default of the direct participant that acts as their clearing agent (see CCP Standard 13.3). ASX Clear (Futures) has obtained legal advice confirming the enforceability of these arrangements and establishing that the arrangements do not interfere with protections for ‘close-out netting’ arrangements between participants and their customers under Part 4 of the PSNA.

The capacity to deal with cash or non-cash collateral held by ASX Clear (Futures) in circumstances of a participant default is an important risk protection. The ASX Clear (Futures) Operating Rules provide ASX Clear (Futures) with the right to deal with collateral of a defaulted participant to address losses or costs, or to meet other obligations arising from the default management process. Part 5 of the PSNA protects the enforcement of security interests held by CCPs in the event of a participant default (see also CCP Standard 1.5).

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 in the Operating Rules and those that may instead be considered under the Procedures. Operating Rule changes are subject to a Ministerial disallowance process, although the Minister's role in this process has been delegated to authorised ASIC officers since April 2016.[1] The Corporations Act also establishes how any inconsistency between the licensed facility's rules and applicable laws and regulations (in particular, derivative transaction rules and derivative trade repository rules) would be resolved.

The ASX Clear (Futures) Operating Rules and Procedures, OTC Rules and OTC Handbook are published on the ASX public website and the Customer Portal, ASX's restricted participant website. These documents are supplemented with explanatory material, to support participants' (and prospective participants') understanding of the risks they face through participation in the system. In addition to the Operating Rules and Procedures, publicly available material includes high-level descriptions of ASX Clear (Futures)' risk management framework, the SPAN margining methodology, business continuity arrangements and the CCP DMF. Participants have access to additional manuals, reports and explanatory notes covering such topics as the application process for new participants, compliance, technical and operational details, counterparty risk assessment, and fees.

There is a clear process for changing ASX Clear (Futures)' Operating Rules and Procedures. Proposed rule changes may be submitted informally to ASIC. In consultation with the Bank, ASIC considers the changes and advises ASX of any regulatory concerns. Once such concerns are satisfactorily addressed, ASIC invites formal submission of the proposed Operating Rule changes, which triggers a 28-day ‘disallowance’ period (referred to above), during which the Minister may choose to disallow the Operating Rule changes. The Minister or delegate must consider a number of factorswhen deciding whether to disallow Operating Rule changes, including whether the proposed changes are consistent with the public interest.[2] In addition, the Minister or delegate must ensure that there has been adequate consultation with the Bank when deciding whether to disallow Operating Rule changes, and consider any advice and recommendations from the Bank and ASIC staff. If changes to the Operating Rules are not disallowed by the Minister or delegate, they are notified to participants via the ASX website.

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 (Futures) and the facility's protection as an approved netting market under the PSNA (see also CCP Standard 1.5) are described on ASX's public website in its Disclosure Framework document, which sets out in detail how each CS facility meets the requirements of each Principle within the PFMI developed by CPMI and IOSCO (see CCP Standard 20.5).[3]

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

ASX Clear (Futures) may seek independent legal opinions on relevant legal matters relating to significant new services, including any implications that 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 that new Operating Rules will have the intended legal effect.

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.

The ASX Clear (Futures) Operating Rules and Procedures, OTC Rules and OTC Handbook set out how the CCP assumes risk in relation to its participants, arrangements for netting offsetting exposures and obligations of participants, and the risk controls that apply in respect of participants' net exposures. Payment obligations arising from clearing, including those related to margin obligations, are settled in Austraclear. The point at which settlement of these obligations is final and irrevocable is established in Austraclear's Regulations. Measures that contribute to ensuring a high degree of certainty in respect of these aspects of ASX Clear (Futures)' activities are detailed below.

Settlement finality

Payment obligations arising between ASX Clear (Futures) and its participants are settled in Austraclear. The legal certainty of settlement finality is supported by Austraclear's approval as an RTGS system under Part 2 of the PSNA. This approval provides protection against application of the so-called ‘zero-hour rule’ in insolvency law, whereby transactions settled after the point at which an insolvency is legally determined to have started could potentially otherwise be reversed. Any interbank transactions arising from these settlements are settled in real time in RITS, across 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. NZD obligations are settled through NZClear, with the finality of settlement protected under Part 5C of the Reserve Bank of New Zealand Act 1989 (NZ) (see CCP Standard 8.1).

In May 2016, Parliament passed the Resilience Act. The Resilience Act amends the PSNA to provide additional legal certainty for RTGS systems that have been approved under the PSNA, such as Austraclear and RITS. The amendments facilitate the ongoing participation by institutions in ‘non-terminal’ external administration (e.g. statutory management) by clarifying that the protections under the PSNA continue to apply.

Netting

Part 5 of the PSNA protects the effectiveness of ‘market netting contracts’, including contracts entered into in accordance with the rules of a netting market. ASX Clear (Futures) is an approved netting market. Part 5 provides protection for several aspects of the netting of exposures and payments under the ASX Clear (Futures) Operating Rules:

  • the process of reducing each participant's contracts to a net exposure (reflecting the CCP's 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.

Assumption of risk

ASX Clear (Futures) assumes risk on cleared trades through the process of novation, whereby matched trades between participants are replaced by separate contracts between the buyer and the CCP, and the seller and the CCP. Through novation, the obligations of ASX Clear (Futures) are to each participant as principal, although client clearing arrangements also establish a legal relationship between clients and the CCP (see CCP Standard 13). Equally, participants' obligations are to ASX Clear (Futures) for all transactions that have been novated (i.e. both proprietary and client transactions).

The point of novation is established by ASX Clear (Futures)' Operating Rules and OTC Rules. For exchange-traded derivatives, ASX Clear (Futures)' Operating Rules specify that a transaction on the ASX 24 market is novated upon the registration of a matched trade by the market, which occurs in ASX 24's SYCOM system. Likewise, ASX 24's Operating Rules state that trades executed on the trading platform are extinguished and replaced by contracts with ASX Clear (Futures) upon registration of the trades with ASX Clear (Futures). Non-market trades are novated once their details have been approved and registered by ASX Clear (Futures). Acceptance rules for registration of OTC derivatives trades are set out in the OTC Rules. Requirements include, for example, that the OTC transaction has been submitted in accordance with procedures and eligibility criteria in the OTC Handbook, that participants are authorised and not in default, and that the transaction passes limit checks. If an OTC transaction satisfies the requirements and is accepted by ASX Clear (Futures) for registration, the transaction is novated with effect from the time at which the transaction details were received by ASX Clear (Futures).

Part 5 of the PSNA protects the effectiveness of the process of novation outlined in the ASX Clear (Futures)' Operating Rules and OTC Rules, by virtue of ASX Clear (Futures)' status as an approved netting market.

Enforceability of rules under external administration or recovery

The enforceability of ASX Clear (Futures)' Operating Rules (including the OTC Rules) in circumstances when a participant has entered external administration is protected by Part 5 of the PSNA. This protection ensures that ASX Clear (Futures) can enforce key rights under its Operating Rules (including netting or termination of obligations and enforcement of security) in relation to a participant in external administration, despite any provision of insolvency law that might otherwise interfere with such rights. The Resilience Act amended the definition of external administration in Part 5 of the PSNA to explicitly cover resolution measures for bank and non-bank financial institutions.

ASX Legal has analysed the legal enforceability of ASX Clear (Futures)' Operating Rules upon the CCP's entry into external administration. ASX Clear (Futures) has also obtained legal advice to confirm the enforceability under Australian law of Operating Rules under which novated contracts may be closed out in the event that ASX Clear (Futures) was subject to an insolvency event. No material legal risks to enforceability have been identified. The ASX Clear (Futures) Operating Rules give participants the right to terminate novated contracts in the event that ASX Clear (Futures) defaulted on its obligations, with calculation of a net obligation to or from each participant on termination (i.e. ‘close-out netting’ rights). The rules do not interfere with ASX Clear (Futures)' proposed arrangements for addressing a liquidity shortfall (see CCP Standard 7.9). The continued appropriateness of close-out netting rights will need to be assessed in light of future developments in FMI resolution.

ASX Legal has carried out analysis on the legal basis of tools available under ASX Clear (Futures)' recovery plan (see CCP Standards 3.5, 4.8, 7.9 and 14.3). This analysis has not identified any material legal risk to enforceability of these tools or the application of protections under Part 5 of the PSNA to payment haircutting, termination powers or the allocation of investment losses.

The Resilience Act enhances the protections afforded to ASX Clear (Futures) as a netting market. In particular, the changes protect the exercise of recovery powers and default fund contributions of participants should participants subsequently enter administration.

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.

Participants of ASX Clear (Futures) include Australian subsidiaries and branches of entities that are domiciled in foreign countries (including France, Germany, Hong Kong, Switzerland, United Kingdom and United States), as well as one participant clearing remotely from the United Kingdom. However, the Operating Rules are governed by Australian law and require that all participants submit to the exclusive jurisdiction of New South Wales courts. ASX has obtained an external legal opinion in relation to foreign participation that has identified no material legal risks.

Footnotes

While the Minister has delegated responsibility for certain decisions under Chapter 7 of the Corporations Act to authorised ASIC officers, the Minister may still exercise the powers delegated by ‘calling up’ the matter. [1]

For more information see ‘Guidelines for the Exercise of Powers Delegated to ASIC under Chapter 7 of the Corporations Act 2001’, available at: <http://treasury.gov.au/~/media/Treasury/Publications%20and% 20Media/Publications/2016/Guidelines%20for%20the%20exercise%20of%20powers%20delegated%20to%20ASIC/ Downloads/PDF/Guidelines_ASIC_ch7.ashx>. [2]

Available at <http://www.asx.com.au/documents/asx-compliance/pfmi-disclosure-framework.pdf>. Prior to 1 September 2014, CPMI was known as the Committee on Payment and Settlement Systems (CPSS). [3]