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

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 Austraclear
Observed Observed

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 and Austraclear are not exposed to financial risk from the settlement process since these SSFs do not provide participants with any guarantee against credit or liquidity risk. As a result, neither SSF assumes settlement obligations, including in the event of a clearing participant default or settlement participant's payment failure. The use of a DvP settlement mechanism in ASX Settlement and Austraclear, or DvD in the case of collateral management transactions in Austraclear, also precludes settlement risk arising between participants (see SSF Standard 10.2).

Default rules and procedures

If a SSF participant experienced an event of non-compliance, including a payment failure, ASX would have the discretion to suspend, terminate or restrict the participant's access to the relevant settlement system. This power applies to settlement participants in both SSFs, as well as payment providers and participating banks. A suspended participant would no longer be able to settle transactions through the relevant facility, and ASX may cancel any of its outstanding non-novated instructions scheduled for settlement. Following termination, all access to the SSF would be removed. Neither suspension nor termination would affect the participant's outstanding obligations to the ASX SSFs or CCPs.

Proportionality

Following a payment failure, ASX Settlement's Operating Rules allow for all or some of the participant's non-novated transactions to be either ‘backed out’ or, in the case of transactions novated through ASX Clear, settled by means of funds provided by ASX Clear or through an OTA (see Appendix C.1, CCP Standard 7.3). ASX Settlement's back-out algorithm is used to identify transactions to be removed or settled by means of OTAs.

Since transactions in ASX Settlement settle on a multilateral net basis in a batch, the backing out of a defaulter's transactions could also have an impact on the ability of other transactions which the defaulter was not a counterparty to settle.[15] 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.

In Austraclear, the impact of any cancellation of a defaulter's existing non-novated transactions would only fall on the defaulter's counterparties since transactions settle on a gross individual basis.

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.

Notification requirements and policies and procedures

Participants, payment providers (in the case of ASX Settlement) and participating banks (in the case of Austraclear) are required to notify the relevant ASX SSF of a non-compliance or insolvency event (as appropriate), or if there is a reasonable possibility of these events occurring. Similar requirements apply to Foreign Currency Settlement Banks with respect to Austraclear. In the context of ASX Settlement, participants and payment providers are also required to notify ASX Settlement if they become aware that any other participant or payment provider becomes subject to external administration or they have reasonable grounds to suspect that this may occur.

The formal ASX Settlement Rules and Procedures and Austraclear Regulations form part of ASX's SSF DMRF, a collection of internal and public documents that set out the guiding policies and procedures for managing a settlement participant default. The DMRF helps ensure that the SSFs are well prepared to implement its default rules and procedures.

The DMRF includes an SSF Settlement Failure 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. In addition, Austraclear also maintains an internal checklist setting out actions to be taken by relevant business units within ASX in managing a participant default. The default of a settlement-only participant at ASX Settlement or an Austraclear participant would be managed by the PIRG, while the default of an ASX Settlement participant that is also a participant in ASX Clear would be managed by the ASX Default Management Committee (DMC) in accordance with ASX Clear's default management framework (see Appendix C.1, CCP Standard 12). The PIRG is chaired by the Executive General Manager, Operations, and is made up of senior staff from relevant operational, risk management, compliance and legal functions.

Cancellation and suspension

The rules of ASX Settlement and Austraclear give the ASX SSFs the power to suspend, terminate or impose restrictions on participation under certain circumstances.

  • ASX Settlement. Under Section 12 of the ASX Settlement Operating Rules, these circumstances 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.
  • Austraclear. The relevant provisions of the Austraclear Regulations are sections 3.9 to 3.14. Under the regulations, Austraclear may suspend or terminate a participant or participating bank that has become subject to an ‘insolvency event’ – which includes the entry or likely entry into insolvency or external administration – or otherwise fails to comply with the regulations. Similar powers apply to Foreign Currency Settlement Banks in Austraclear.

These powers extend to payment providers in ASX Settlement and participating banks in Austraclear.

Switching of settlement banks

The ASX Settlement Operating Rules and Procedures explicitly 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. The Austraclear Regulations and Procedures do not restrict a participant changing its participating bank, including in 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.

Both ASX SSFs disclose their default rules and procedures on the ASX's public website. Both SSFs have further published guidance notes on the suspension and termination of a participant on ASX's website. Austraclear's Guidance Note was first published in March 2017. At the same time, ASX Settlement released an updated version of its Guidance Note. An overview of the default management process for participants in ASX Settlement and Austraclear was added to the ASX website during the assessment period.

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. 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 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.

ASX Settlement's back-out arrangements are described in Rule 10.11 of the ASX Settlement Operating Rules and related Procedures, as well as in its Guidance Note. These documents are 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. During the assessment period, ASX conducted a fire drill focusing on the default of a settlement participant. Previous fire drills had focused on a clearing participant default, and only related to ASX Settlement and Austraclear to the extent that the clearing participant also participated in the ASX SSFs. In light of this experience, ASX is enhancing its fire drills to consider interactions between clearing and settlement participants within the one scenario. For example, the ASX Clear fire drill considered the knock on effects of the default of a participant across ASX Clear, ASX Settlement and Austraclear, and in doing so tested the default procedures of the two ASX SSFs

The default management arrangements at both SSFs have been used in recent times. ASX Settlement needed to use its default management procedures, most recently in response to the default of BBY Limited in May 2015. Austraclear has also periodically needed to employ its default management procedures over the past few years, including to respond to the appointment of external administrators to a number of participants, most recently in March 2017.

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.

Both the ASX SSFs primarily settle products denominated in Australian dollars and traded on Australian markets, and their participants currently all have a domestic presence. Austraclear offers a foreign currency settlement service, currently covering payments and securities denominated in RMB, although the value of payments settled using this service is currently very low. Consequently, the ASX SSFs' default management procedures are designed to suit the Australian market.

Footnote

Since transactions in Austraclear settle on a gross individual basis, there is no need for such arrangements. [15]