2015/16 Assessment of ASX Clearing and Settlement Facilities A2.1 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.

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 defaulted 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 in the event of 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).

ASX Settlement's default management arrangements are described in further detail in Section 4 and 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 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. Although ASX Settlement does not provide participants with any guarantee against credit or liquidity risk, the design of the system precludes principal credit exposures arising between participants. Settlement occurs on a DvP Model 3 basis, with contemporaneous multilateral net settlement of securities transfers in ASX Settlement and associated funds movements in RITS (see SSF Standard 10.2). Finality of settlement is protected by the approval of ASX Settlement's netting arrangements 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 the default 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, terminate or impose restrictions on participation. These include events of ‘non-compliance’ such as: entry or suspected entry into external administration; a failure to comply with participation requirements or other legal or regulatory obligations; or a failure or anticipated failure of a Payment Provider to authorise a participant's net payment obligation.

The formal Rules and Procedures form part of ASX's SSF DMF, a collection of internal and public documents that set out the guiding policies and procedures for managing a settlement participant default. This DMF includes an SSF Default Management Policy and associated Standards, which are applicable to both ASX Settlement and Austraclear. ASX Settlement also maintains documented procedures for dealing with the default of a participant, including back-out procedures to reconstitute the multilateral net batch. The default of a settlement-only participant would be managed by the PIRC, while the default of a settlement participant that is also a participant in ASX Clear would be managed by the ASX DMC in accordance with ASX Clear's default management framework (see Appendix A1.1, CCP Standard 12). The PIRC is chaired by the GE, Operations, and is made up of senior staff from relevant operational, risk management, compliance and legal departments.

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 Operating Rules and Procedures provide for the suspension or termination 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 to its knowledge, becomes subject to external administration or where it reasonably suspects that this may occur. A participants is also required to notify ASX if it has otherwise committed an event of non-compliance.

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 the ASX 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, terminate or impose restrictions on a participant in an event of non-compliance. ASX Settlement has also published a Guidance Note on the suspension and termination of ASX Settlement participants on its website.

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 Operating Rules allow for all or some of the participant's settlement instructions to be either ‘backed out’ or, in the case of transactions novated through ASX Clear, settled by means of an offsetting transaction (see Appendix A1.1, CCP Standard 7.3). If the failed instructions relate to a shortfall of securities, these are rescheduled for settlement on the next settlement day. If the failed instructions related to a shortfall of funds, the algorithm would remove instructions from the batch that reduced the participant's payment obligations to zero or a small receipt.

ASX Settlement's back-out algorithm is used to identify transactions to be rescheduled or settled by means of offsetting transactions. The back-out algorithm is designed to avoid increasing non-defaulted participants' net payment obligations, and seeks to remove or roll over as few instructions from the batch as possible, maximising settlement values and volumes, while minimising the spillover to other participants. Instructions unrelated to novated settlement obligations would typically be backed out first.

ASX Settlement's back-out algorithm is a key tool used in the management of ASX Clear participant default. In the event that the defaulted participant had a net payment obligation, ASX Clear would first consider injecting liquidity to facilitate the settlement of novated trades. If it was not possible or prudent to rely solely on available liquid resources, ASX would use the back-out algorithm to identify transactions to be settled by means of OTAs with participants due to deliver securities. These offsetting transactions would be scheduled for settlement on the next settlement day.

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. These fire drills focus on the more complex scenario of a clearing participant default, and only relate to ASX Settlement in that they involve the declaration of default if the clearing participant also participates 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. In the past, ASX Settlement has needed to use its default management procedures, most recently in response to the default of BBY Limited in May 2015.

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 Australian dollars. Accordingly, default management actions would be taken during the local time zone for all participants.