Review of Settlement Practices for Australian Equities Executive Summary

On 29 and 30 January 2008, there were significant delays in the settlement of Australian equities. As a result of these delays, the Payments System Board of the Reserve Bank has undertaken an extensive review of settlement practices in the Australian equity market.

Settlement of most equities transactions in Australia occurs in a single daily batch process run by the Clearing House Electronic Sub-register System (CHESS), which is owned and operated by ASX. This batch process, which typically settles at around noon, reduces all scheduled securities transfers, including both novated and non-novated transactions, to a single net transfer per line of stock for each participant. Settlement occurs on a delivery-versus-payment basis, with associated interbank payment flows settled across Exchange Settlement accounts at the Reserve Bank, also on a net basis. Netting reduces the amount of equities and funds that need to change hands, providing benefits to participants.

In late January, the inability of a participant to meet its payment obligations resulted in the batch being delayed on two occasions. Despite the delays, there was never any doubt that the central counterparty for equity transactions, the Australian Clearing House (ACH), would be able to meet its obligations.

As part of the Review, the Reserve Bank has considered possible fundamental changes to current settlement arrangements. One option would be to split the current batch into two parts: one for transactions that are novated to ACH, and one for non-novated transactions. The Bank does not support this option, given that there are often close connections between novated and non-novated transactions. Another option would be to move to a system in which settlement occurs on a trade-by-trade basis. The Bank's view is that this type of settlement arrangement represents the first-best outcome from a pure risk-control perspective and that there is a strong case for moving to such a system over the medium term.

In the meantime, the Bank has identified some possible modifications to the current batch settlement process for settling equities that might improve the robustness of the settlement process and improve market functioning. These include:

• the introduction of an explicit window for completion of settlement – perhaps 12.30 pm to 2.30 pm;
• clarification of lines of communication and deadlines for decisions, including by settlement banks;
• an amendment to the cut-off time for new settlement instructions, so as to allow more time prior to the batch for participants to ensure that securities and funds are in place;
• changes to the settlement fails regime, including an increase in the fees applying to failed trades; and
• an increase in the transparency of securities lending activity.

The Bank will be working with ASX and industry participants over coming months to assess whether, and how, these changes might be implemented.