Assessment of ASX Clearing and Settlement Facilities C2. Financial Stability Standards for Securities Settlement Facilities

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.

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 and Austraclear eliminate principal risk by ensuring that the settlement of securities delivery obligations occurs if and only if associated payment obligations are settled at the same time. ASX Settlement does so by performing both its cash and securities settlements in a multilateral net batch on a DvP Model 3 basis, while Austraclear settles securities transactions on a DvP Model 1 basis (see SSF Standard 10.2). Collateral substitutions instructed by ASX Collateral within Austraclear are settled on a DvD basis under the same arrangements as those for transfer of cash and securities. Where cash is used as a last resort, settlement is also on a DvP Model 1 basis.

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

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 C.2.1).

• 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 the assessment period, 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.

Failed settlements are removed from the multilateral net batch via the CHESS back-out algorithm, and for a securities shortfall rescheduled for settlement on the next day as long as the participant is not in default (see SSF Standard 11). The algorithm seeks to remove or reschedule as few transactions from the batch as possible, maximising settlement values and volumes, while minimising the knock-on effects to other participants. Transactions unrelated to novated settlement obligations would typically be backed out first. In the assessment period, 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 0.23 per cent of settlements rescheduled following the knock-on effects of the initial fails.

In the case of a failed settlement caused by a funds shortfall for a cleared trade, ASX Clear will inject funds into the settlement batch or enter into an OTA with sellers of affected securities to facilitate timely settlement (see CCP Standard 7.3). ASX Settlement's back-out algorithm is also used to identify transactions to be rescheduled or settled by means of OTAs.

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 the assessment period, the average value of individual gross settlement instructions in ASX Settlement (for both novated and non-novated transactions) was around $7,600. This compares with an average of $36.1 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 a daily average of $48 billion in debt securities transactions settled in Austraclear in the assessment period, 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.

Austraclear

Settlement of securities transactions in Austraclear (including the opening and closing legs of tri-party repo trades submitted by ASX Collateral) is on a DvP Model 1 basis. This entails that: there is a simultaneous transfer of cash and securities obligations between the buyer and seller on a transaction-by-transaction basis in real time; final settlement occurs if and only if both of the linked transfers are completed successfully; and if one transfer fails, the linked transfer will be cancelled.

To facilitate DvP settlement, Austraclear has a link with RITS, Australia's RTGS payments system (see SSF Standard 8). The settlement mechanism involves three main steps:

• Step 1: Once a transaction has been submitted to Austraclear, Austraclear will seek to lock down the securities in the delivering participant's account, preventing these securities from being transferred.
• Step 2: Once the securities have been locked down, Austraclear will send a message to RITS requesting that the payment be effected across the ESAs of the relevant participants or participating banks (see SSF Standard 8.3).
• Step 3: Once RITS has sent a confirmation to Austraclear that the payment has been effected, Austraclear will immediately effect the transfer of securities.

In the case of collateral substitutions initiated by ASX Collateral, the settlement mechanism in Austraclear requires that finality is achieved only when both linked securities deliveries have been successfully completed – that is, settlement occurs on a DvD basis. The design of Austraclear's systems further provides for the grouping of linked transactions to accommodate chains of substitutions where collateral has been re-used.

Although this design protects against principal risk, multiple substitutions in a long re-use chain may have implications for timely completion of transactions at the end of the day. To mitigate this risk and ensure that the potential for gridlock is no greater than under non-centralised collateral arrangements, participants engaging in the re-use of collateral may allow the use of cash as collateral of last resort. Substitutions involving the use of cash as collateral of last resort settle on a DvP Model 1 basis, consistent with the settlement of other transactions involving the exchange of securities for cash in Austraclear.