Assessment of ASX Clearing and Settlement (CS) Facilities against the Principles for Financial Market Infrastructures (Principles) 1. Introduction and Executive Summary

The Principles for Financial Market Infrastructures (the PFMIs), published by the Committee on Payment and Settlement Systems (CPSS, now the Committee on Payments and Market Infrastructures (CPMI)) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) in April 2012,[1] establish a set of international standards for financial market infrastructures (FMIs). The principles within the PFMIs consist of 24 headline ‘Principles’, each supported by one or more ‘Key Considerations’ containing more detailed requirements for FMIs. The scope of the Principles includes central counterparties (CCPs) and securities settlement facilities (SSFs) – collectively, clearing and settlement (CS) facilities – as well as systemically important payment systems and trade repositories.[2]

This report presents the joint Assessment of the Australian Securities and Investments Commission (ASIC) and the Reserve Bank (the Bank) as to how well the four licensed CS facilities in the ASX Group (ASX) – the two CCPs, ASX Clear Pty Limited (ASX Clear) and ASX Clear (Futures) Pty Limited (ASX Clear (Futures)); and the two SSFs, ASX Settlement Pty Limited (ASX Settlement) and Austraclear Limited (Austraclear) – observed the requirements of the Principles as at 30 June 2014 (the PFMI Assessment). Consistent with their international responsibilities, ASIC and the Bank have committed to periodically carry out PFMI Assessments of licensed domestic CS facilities.

The PFMI Assessment draws heavily on the Bank's assessment of the ASX CS facilities against Financial Stability Standards (FSS) determined by the Bank, which is published alongside this report (the FSS Assessment).[3] The FSS are fully aligned to requirements in the Principles and associated Key Considerations that address matters relevant to financial stability. They do not, however, incorporate several Principles and Key Considerations that are solely relevant to ASIC's regulatory remit. In addition, the FSS contain several more detailed requirements that go beyond the minimum standard set out in the Principles. This report therefore repackages the material in the FSS Assessment, principally for an international audience, and adds information relevant to ASIC's responsibilities so as to cover the full range of relevant Principles. Also published alongside this report is a Self-assessment of ASIC's and the Bank's regulation and oversight of CS facilities against the Responsibilities for central banks, regulators and other relevant authorities for financial market infrastructures (the Responsibilities), which also form part of the PFMIs.[4]

This report has been produced by ASIC's Financial Market Infrastructure Stakeholder Team and the Bank's Payments Policy Department. It is expected that this report will be an input into ongoing work of the CPMI and IOSCO to monitor implementation of the PFMIs across jurisdictions, including Australia.

The Assessment concludes that the ASX CS facilities either observe or broadly observe all relevant Principles. ASIC and the Bank have nevertheless made a number of recommendations to further strengthen the ASX facilities' observance of requirements under the Principles. Some recommendations have also been made to encourage continuous improvement, even where relevant requirements have been observed.

1.1 Background

The Corporations Act 2001 establishes conditions for the licensing and operation of CS facilities in Australia and gives ASIC and the Bank powers and responsibilities relating to these facilities. These powers are exercised under the governance of ASIC's Commission and the Bank's Payments System Board (PSB), respectively. The regulators' respective roles are defined in the Corporations Act.

  • The Bank is responsible for ensuring that CS facilities comply with FSS that it determines, and that facilities take any other necessary steps to reduce systemic risk.
  • ASIC is responsible for ensuring that CS facilities comply with all other obligations under the Corporations Act, including the fair and effective provision of services.

The Bank has determined two sets of FSS relevant to its oversight of CS facilities: one which applies to CCPs (CCP Standards), and another which applies to SSFs (SSF Standards).

ASX operates four licensed CS facilities: two CCPs and two SSFs.

  • CCPs. A CCP acts as the buyer to every seller, and the seller to every buyer in a financial market. It does so by interposing itself as the legal counterparty to all purchases and sales via a process known as novation:
    • ASX Clear provides CCP services for cash equities, debt products and warrants traded on the ASX and Chi-X markets, and equity-related derivatives traded on the ASX market.
    • ASX Clear (Futures) provides CCP services for futures and options on interest rate, equities, energy and commodity products traded on the ASX 24 market, as well as Australian dollar-denominated over-the-counter (OTC) interest rate derivatives.
  • SSFs. A SSF provides for the final settlement of securities transactions and the maintenance of records of transfer of title:
    • ASX Settlement provides SSF services for cash equities, debt products and warrants traded on the ASX and Chi-X markets; ASX Settlement also provides SSF services for non-ASX listed securities.
    • Austraclear provides SSF services for trades in debt securities, including government bonds and repurchase agreements.

1.2 Assessment

This Assessment was conducted as at the end of June 2014. Consistent with the division of responsibilities for oversight of CS facilities under the Corporations Act, ASIC and the Bank have allocated responsibility for the assessment of each of the Principles between the two authorities (see Section 2.2 and Table A1 in Appendix A). On the basis of the evidence presented in this report, ASIC and the Bank have concluded that the ASX CS facilities either observe or broadly observe all relevant Principles. The areas in which the ASX facilities have been found to broadly observe the requirements of the Principles relate to the CCPs' model validation framework and investment policy, as well as three areas in which the Bank granted transitional relief from the corresponding requirements of the FSS: recovery planning; segregation and portability; and liquidity risk management.

Model validation

During 2013/14, ASX significantly enhanced its model validation approach, including by:

  • implementing substantial enhancements to the backtesting and sensitivity analysis of margin models
  • introducing reverse stress testing
  • engaging external experts for a three-year period to undertake a comprehensive validations of all key risk models.

As a result of ASX's progress in this area, the Bank's assessment is that both ASX Clear and ASX Clear (Futures) have observed most relevant model validation requirements under the Principles. Aside from a specific recommendation around liquidity stress testing at ASX Clear (see below), it is expected that both CCPs will fully observe all relevant requirements once the first year of the independent external model validation program has been completed. The CCPs are also encouraged to continually refine and enhance their margin backtesting, sensitivity analysis and reverse stress-testing methodologies and their integration into existing risk management processes.

Investment risks

In its recent assessments of the ASX CCPs against the FSS, the Bank has expressed the concern that the ASX CCPs' treasury investment policy allows relatively large and concentrated exposures to a small number of domestic banks. In response, ASX has lowered the limits on its unsecured exposures to the large domestic banks, and taken steps to improve its capacity to both make secured investments and invest with a broader range of high-quality counterparties. While the Bank welcomes the steps taken to date, it expects further progress before the ASX CCPs will be deemed to have fully observed the relevant Principle. The Bank has opened a dialogue with ASX on the detail of its expectations around credit limits on unsecured exposures to non-government-related entities and the liquidity profile of the investment portfolio. This dialogue will reveal any practical issues or implementation challenges. It will also clarify a reasonable time frame over which a transition should be achieved.

FSS transitional relief

A small number of CCP and SSF Standards that were previously subject to transitional relief came into effect at end March 2014. ASX has made a number of enhancements to rules and processes relevant to the CS facilities' observance of the corresponding requirements of the Principles. Some of this work is, however, ongoing. It is expected that the relevant ASX facilities will fully observe these requirements once the remaining work is completed (in most cases during the coming year).

  • Recovery planning.[5] While final CPSS-IOSCO guidance on recovery planning has still not yet been published, in early 2014 ASX developed a basic recovery plan based on the facilities' existing powers under their Operating Rules. ASX has also formulated a plan to enhance those rules in order to be able to fully address any uncovered credit losses and liquidity shortfalls and replenish financial resources following a participant default. It plans to consult on its proposed recovery approach in the second half of 2014.
  • Segregation and portability. In accordance with requirements of the Principles, ASX Clear (Futures) has introduced individual client segregation within its account structures for both OTC derivatives and exchange-traded futures. Sitting alongside the pre-existing omnibus client account structure for exchange-traded products, the new arrangements give clients a choice in the level of protection they receive and the likelihood that positions and associated collateral could be transferred to an alternative participant in the event of a clearing participant default. ASX Clear has also implemented the first of two phases of enhancements to its cash market arrangements to provide clients with equivalent protection to house/client omnibus segregation. Implementation of the second phase will be required for ASX Clear to fully observe the relevant Principle.
  • Liquidity risk. Both CCPs' prefunded liquid resources are currently considered to be sufficient to meet the required level of cover for liquidity exposures arising from derivatives transactions. However, ASX Clear's prefunded liquid resources may not be sufficient to cover extreme but plausible payment obligations arising from the settlement of cash equity transactions. In April 2014, ASX introduced changes to its Operating Rules whereby participants commit to provide liquidity to ASX Clear to address any funding shortfall. Under these arrangements, ASX Clear would settle transactions by entering into ‘offsetting transaction arrangements’ with participants that were due to deliver securities to the defaulted participant. The Bank considers these arrangements to be consistent with the relevant Principle. ASX plans to make enhancements to ASX Clear's liquidity stress testing, including to routinely provide more information to management and the Bank on the degree of contingent reliance on offsetting transaction arrangements. The Bank will monitor these enhancements and discuss further with ASX how such information might best be disseminated to participants to support their liquidity management and planning.

The remainder of this report is structured as follows. Section 2 provides an overview of the clearing and settlement landscape in Australia, while Section 3 summarises the conclusions and recommendations arising from ASIC's and the Bank's detailed assessment of each ASX CS facility against the Principles. Finally, the detailed assessments of the ASX CS facilities against the Key Considerations for each Principle are set out in Appendix A.

Footnotes

The Principles are available at <http://www.bis.org/publ/cpss101.htm>. [1]

In this report, ‘clearing and settlement facility’ is defined as in Part 7.1, Division 6 of the Corporations Act 2001. [2]

The FSS Assessment is available at <http://www.rba.gov.au/payments-system/clearing-settlement/assessments/2013-2014/>. [3]

The Self-assessment against the Responsibilities is available at <http://www.rba.gov.au/payments-system/policy-framework/principles-fmi/responsibilities-of-authorities.html>. [4]

Recovery refers to steps taken by an FMI to respond to a threat to its continued viability; the related concept of resolution refers to steps taken by public authorities to restore an FMI in distress to viability or wind it down. [5]