2015/16 Assessment of ASX Clearing and Settlement Facilities A2.1 ASX Settlement Standard 10: Exchange-of-value settlement systems

If a securities settlement facility settles transactions that comprise the settlement of two linked obligations (for example, securities or foreign exchange transactions), it should eliminate principal risk by conditioning the final settlement of one obligation upon the final settlement of the other.

ASX Settlement eliminates principal risk in settlements involving the transfer of a security in exchange for cash by ensuring that delivery occurs if and only if the associated payment is settled at the same time (SSF Standard 10.1). ASX Settlement does this through the use of a DvP Model 3 settlement mechanism, which completes securities settlement via a multilateral net batch (SSF Standard 10.2).

ASX Settlement's arrangements for exchange-of-value settlements are described in further detail under the following sub-standards.

10.1 A securities settlement facility that is an exchange-of-value settlement system should eliminate principal risk by ensuring that the final settlement of one obligation occurs if and only if the final settlement of the linked obligation also occurs, regardless of whether the securities settlement facility settles on a gross or net basis and when finality occurs.

ASX Settlement eliminates principal risk by ensuring that the settlement of securities delivery obligations occurs if and only if associated payment obligations are settled. It does so by performing both its cash and securities settlements in a multilateral net batch on a DvP Model 3 basis (see SSF Standard 10.2).

10.2 A securities settlement facility that is an exchange-of-value settlement system should eliminate principal risk by linking the final settlement of one obligation to the final settlement of the other through an appropriate delivery versus payment (DvP), delivery versus delivery (DvD) or payment versus payment (PvP) settlement mechanism.

ASX Settlement links the final settlement of securities and payment obligations through a DvP Model 3 mechanism, where final securities and payments transfers occur contemporaneously on a multilateral net basis through a single batch of instructions. The settlement of securities via this mechanism involves several steps (including related steps taken for the clearing of novated transactions in ASX Clear and the ‘priming’ of settlement accounts) (Figure 1).

Step 1: Once a trade has been executed on either the ASX or an AMO's market, a trade-related instruction is sent to CHESS.
Step 2: Once CHESS validates these trades, they are novated in real time to ASX Clear and CHESS sends messages to the relevant clearing participants and the market on which the trade was executed, notifying them that the trade has been accepted and cleared. Trades that have the same clearing participant as buyer and seller, called clearing crossings, are not novated, netted or scheduled for settlement in the CHESS batch. To facilitate the remaining back-office processes for these trades, CHESS sends a single message to the clearing participant confirming the trade's details. The settlement of clearing crossings is negotiated bilaterally between brokers and their clients, and occurs when securities are transferred between broker and client settlement accounts.
Step 3: On the night of the trade date (T), CHESS generates a single net batch instruction reflecting the net position of each participant's novated trades in each line of stock. Before netting, clearing participants can mutually agree to block a transaction from netting, or delete or modify existing novated transactions. If matching instructions are sent from both clearing participants that are counterparties to a particular trade, CHESS sends messages to the clearing participants confirming that instructions for that trade have been processed.
Step 4: Between T+1 and T+2, participants can also instruct CHESS to include additional non-novated (off-market) transactions in the batch at T+2. Non-novated transactions mainly arise from three types of activities: pre-positioning transfers of securities across accounts; securities lending to cover a short sale or a shortfall in a participant's securities account; and off-market trades. Pre-positioning, or ‘priming’, involves transferring securities to a participant's entrepot settlement account, i.e. a centralised settlement account. Non-novated transactions also include trades in non-ASX-listed securities undertaken on trading platforms operated by ALMOs. During 2015/16, around 81 per cent of the value of net securities settled in the final batch was in respect of non-novated transactions.
Step 5: On the evening before settlement, ASX Settlement notifies each participant of its projected net cash payment obligations. Participants have until 11.30 am on T+2 to negotiate any additional non-novated transfers necessary to prime their accounts for settlement. After the cut-off for new instructions, transfer of securities positions by participants is stopped in CHESS until cash movements have been confirmed (Step 6), and participants' Payment Providers are requested to fund the net cash obligations of settlement participants.
Step 6: Payment obligations are settled between Payment Providers in RITS in a single daily multilateral net batch. Immediately upon confirmation from RITS that the funds transfers have been settled, ASX Settlement completes the net securities transfers in CHESS, thus ensuring DvP settlement. This typically occurs at around 12.30 pm. CHESS then notifies the participants that settlement has been completed successfully.
Step 7: At the end of the day, CHESS reports net movements on each sub-register to the holder of the issuer's complete register.

There is considerable activity in the hours prior to the 11.30 am cut-off for settlement instructions as participants arrange to lend and transfer securities in order to prime their settlement accounts. Settlement participants may wait until the morning of T+2 to complete the priming of their accounts, partly due to the need to wait for final matched settlement instructions from offshore clients. As a consequence, fails in delivery of securities are a daily occurrence, although fail rates are relatively low by international comparison. The failure of a participant to meet payment obligations is a much rarer occurrence and may be indicative of problems that are not merely operational.

If a participant is unable to settle its scheduled obligations in the batch due to a shortfall in either securities or funds, ASX Settlement's rules allow for all or some of the transactions of the affected participant to be either ‘backed out’ or settled by means of an offsetting transaction (see Appendix A1.1, CCP Standard 7.3). If the failed transactions relate to a shortfall of securities, these are rescheduled for settlement on the next settlement day. If the failed transactions related to a shortfall of funds, ASX Clear would, as part of its default management strategy, consider injecting liquidity to ensure the settlement of novated trades. If this did not occur, ASX Clear would settle novated trades by entering into OTAs with participants due to deliver securities. These offsetting transactions would be scheduled for settlement on the next settlement day.

In March 2016, ASX transitioned from a three-day to a two-day settlement cycle for cash equities (see Section 3.5.7). In recognition of the potential impact of a shortened cycle on participant arrangements to process and pre-position securities for settlement, ASX extended the cut-off for batch settlement instructions to 11.30 am from 10.30 am as part of the transition.

ASX Settlement's back-out algorithm is used to identify transactions to be rescheduled or settled by means of offsetting transactions. The algorithm seeks to remove or roll over as few transactions from the batch as possible, maximising settlement values and volumes, while minimising the spillover to other participants. Transactions unrelated to novated settlement obligations would typically be backed out first. In 2015/16, an average of 0.04 per cent of settlement transactions were recorded as ‘initial fails’ (where a participant has insufficient securities on the day of settlement), with an average of 0.25 per cent of settlements rescheduled following the knock-on effects of the intitial fails.

Since the transition to the T+2 settlement cycle, the settlement fail rate remained broadly in line with nine-month period before the transition. Both initial fails and rescheduled settlements during the Assessment period were slightly lower as a proportion of total settlements than in 2014/15.

The use of the DvP Model 3 settlement mechanism described above is acceptable for ASX Settlement given the relatively low average value of securities transactions involved. In 2015/16, the average value of individual gross settlement instructions in ASX Settlement (for both novated and non-novated transactions) was around $9 600. This compares with an average of $35.3 million for an individual DvP settlement instruction for debt securities in Austraclear.

The average daily value of Australian Government securities settled in the CHESS batch has remained less than $1 million, since ASX Settlement began settling them in 2014. This compared with $43.3 billion in debt securities transactions settled in Austraclear in 2015/16, suggesting that there has been no significant movement of wholesale Australian Government securities transactions into the CHESS batch. Settlement values from ASX Settlement's mFund service (for payments related to unlisted managed funds) have been small relative to the size of the gross value of settlements in the CHESS batch. While neither the settlement of Australian Government securities or mFund transactions within the CHESS batch currently pose significant risks to the batch process, the Bank will continue to monitor the use of both services.