Assessment of ASX Clearing and Settlement (CS) Facilities against the Principles for Financial Market Infrastructures (Principles) 2. Overview of the Clearing and Settlement Landscape

2.1 Clearing and Settlement in Australia

CCPs and SSFs are key components of the financial system, delivering services critical to the smooth functioning of securities and derivatives markets.

  • 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. Following novation, the exposure of all parties – whether it be for the few days until an equity trade is settled, or for the several years of payment flows under a longer-term interest rate swap contract – is to the CCP, rather than the bilateral counterparty in the original trade.
  • A SSF provides for the final settlement of securities transactions, executed either over the counter or on an exchange, and the maintenance of records of transfer of title. Settlement typically involves transfer of the title to the security and transfer of cash. These functions are linked via appropriate delivery-versus-payment (DvP) arrangements incorporated within the settlement process.

Well-designed and reliable CS facilities can be a source of both financial stability and operational efficiency. Indeed, this has been the experience in Australia and internationally. CS facilities act as a coordinating device in financial markets, bringing a network of counterparties together to support liquidity and the netting of exposures and settlement obligations. They also establish secure arrangements for the timely clearing and settlement of obligations between counterparties, assist institutions in the management of counterparty credit risks, and help to coordinate actions in the event of a market participant's default.

Many of these benefits derive from the size and breadth of the network that a CS facility controls. Accordingly, there is a tendency towards a single CS facility, or relatively few CS facilities, providing services in any given market. This is currently the case in Australia where, with the exception of CCP services in the market for OTC derivatives, only one CS facility operates in each product market.

Given their typically large size, their lack of substitutability in the markets they serve, and strong connections with banks and other financial institutions, CS facilities are generally systemically important. Indeed, this is the presumption in the PFMIs (PFMIs, p 12). Accordingly, it is critical that both CCPs and SSFs identify and properly control risks associated with their operations and conduct their affairs in accordance with regulatory standards that promote overall stability in the financial system.

Table 1 presents an overview of the systemically important CCPs and SSFs currently licensed to operate in Australia. Under the Corporations Act, these facilities are regulated jointly by ASIC and the Bank. The applicable regulatory regime is introduced in Section 2.2 below.

2.2 Regulatory Framework

Part 7.3 of the Corporations Act establishes a licensing regime for CS facilities in Australia. Licensing authority rests ultimately with the responsible Minister, with licence obligations specified in the Corporations Act – and in any supplementary licence conditions – administered by ASIC and compliance overseen jointly by ASIC and the Bank.

  • Under s 827D of the Corporations Act, the Bank may determine standards ‘for the purposes of ensuring that CS facility licensees conduct their affairs in a way that causes or promotes overall stability in the Australian financial system’. In accordance with this provision, the Bank has determined FSS, with which all the licensees listed in Table 1 must comply. The Bank also has responsibility to ensure that licensees take any other necessary steps to reduce systemic risk. The Bank carries out continuous oversight of CS facilities against the FSS, periodically conducting formal assessments of licensees' compliance and reporting its findings to the Minister. These formal assessments are published on the Bank's website.[1]
  • Under the Reserve Bank Act 1959, responsibility for the exercise of the powers granted to the Bank in the Corporations Act is assigned to the PSB. The PSB is tasked with ensuring that its powers are exercised in a way that ‘will best contribute to the overall stability of the financial system’. Also relevant to its responsibility for stability, the PSB has powers under the Payment Systems and Netting Act 1998 (PSNA) to ensure that settlement finality in approved payment, clearing and settlement systems and netting arrangements is legally certain (see Section 2.2.2, below). The PSB comprises the Governor as chair, one other Bank appointee, an appointee from the Australian Prudential Regulation Authority (APRA), and up to five other members.
  • Under the Corporations Act, ASIC is responsible for ensuring that CS facilities comply with all other obligations, including for the fair and effective provision of services. Together, the Corporations Act and the Australian Securities and Investment Commission Act 2001 (ASIC Act) give ASIC a range of inspection, investigation and enforcement powers. These enable ASIC to carry out its regulatory functions, including for licensed CS facilities.

    In the exercise of its regulatory functions and powers, ASIC considers whether a CS facility licensee is providing its services in a fair and effective manner such that it would meet the desired regulatory outcomes in Part 7.3 of the Corporations Act. These desired regulatory outcomes are elaborated in ASIC Regulatory Guide 211: Clearing and Settlement Facilities: Australian and Overseas Operators (RG 211).[2] The outcomes cover four key regulatory areas: CS facility stability; the clearing and settlement process; facility and participant supervision; and risk management. In considering whether a CS facility is meeting these regulatory outcomes, ASIC considers a range of matters, including the reliability of operations, the transparency of the clearing and settlement process, participants' confidence in the facility, the licensee's supervision of participants, and the facility's risk management.

The Principles have been implemented in Australia and are applied as regulatory standards jointly by ASIC and the Bank. Since both ASIC and the Bank are responsible for overseeing CS facility licensees under the Corporations Act, implementing the Principles in Australia involves coordination between the regulators. A statement issued by ASIC and the Bank in December 2012 (the Joint Statement) sets out the actions taken by the regulators to implement the Principles in Australia:[3]

  • ASIC revised its regulatory guidance on licensing and oversight of CS facility licensees in RG 211. The updated regulatory guidance incorporates the Principles that are relevant to ASIC's regulatory remit as matters it will consider in:
    • framing its advice to the Minister about any CS facility licence application
    • assessing a CS facility licensee's compliance with its ongoing obligations under the Corporations Act.
  • The PSB approved the determination of new FSS in November 2012.[4] These standards, which became effective from 29 March 2013, are aligned with the requirements in the Principles that address matters relevant to financial stability (see Section 2.2.1, below).

While the Bank has the power to set standards and assess licensees' compliance, enforcement powers rest with the Minister and ASIC. A failure to comply with licence obligations may be a trigger for the exercise of enforcement powers. The Minister or ASIC may take enforcement action independently or on the advice of the Bank. ASIC and the Bank have agreed an MOU, which is intended to promote transparency, help prevent unnecessary duplication of effort, and minimise the regulatory burden on CS facilities.[5] Further to these objectives, ASIC and the Bank have agreed on the appropriate division of each of the Principles between the two regulators, as published in Appendix 2 of RG 211 (see also Table A1 of Appendix A). Some Principles are relevant to both regulators and accordingly are jointly overseen. ASIC and the Bank have recently undertaken a joint Self-assessment against the Responsibilities that form part of the PFMIs.[6]

Following a request by the then Deputy Prime Minister and Treasurer in 2011, the Council of Financial Regulators (CFR, comprising the heads of regulatory authorities) consulted on a number of enhancements to the regulatory framework for FMIs. A number of recommendations were made to the government in February 2012. Some of these, relating to the application of ‘location requirements’ for FMIs operating across borders, were reflected in revisions to ASIC's RG 211 and the FSS in 2012. Other proposals are being developed by the CFR agencies, including in relation to special resolution arrangements for FMIs.[7]

2.2.1 The Bank's Financial Stability Standards

In accordance with its responsibilities under the Corporations Act, the Bank first determined FSS for licensed CCPs and SSFs in 2003. The standards were drafted at a high level, establishing an obligation for licensees to conduct their affairs ‘in a prudent manner’ so as to contribute to ‘the overall stability of the Australian financial system’. Each FSS was supported by a set of measures and guidance that the Bank would take into account in assessing a licensee's compliance. Minor variations were made to the FSS in 2005 and 2009.

As noted above, following the release of the Principles, the Bank updated its FSS to bring them into line with the stability-related Principles. The updated FSS also introduce some additional and varied requirements to reflect the Australian regulatory and institutional context. These include measures to ensure that regulators can maintain appropriate influence over cross-border facilities.

Consistent with the higher level of detail of the Principles relative to the previous international standards, the new FSS are specified at a more detailed level than the earlier standards. They cover matters such as legal basis, governance, credit and liquidity management, settlement models, operational resilience, and management of business and investment risks. Reflecting standards introduced in the Principles, the new FSS include more specific requirements for financial resources held to cover any losses incurred by CCPs in the event of a participant default, and a new requirement to develop a comprehensive and effective plan for the recovery or orderly wind-down of a CCP or SSF in the event that it experienced a threat to its continued viability.

2.2.2 The Payments Systems and Netting Act

The Bank, under the governance of the PSB, has powers under the PSNA to remove two important legal risks in the Australian payments system:

  • the risk that a court may apply the ‘zero hour’ rule and unwind any payments that have settled since midnight of the day preceding a bankruptcy order
  • the risk that a court may unwind net payment obligations, restoring gross obligations.

Practically, this is achieved through the Bank having the power to ‘approve’ a real-time gross settlement (RTGS) system or a netting arrangement. Any RTGS system approved under the PSNA is protected from zero hour risk, while any netting arrangement approved under that Act is protected from both zero hour risk and the possible unwinding of netting. In assessing an application for approval, the PSNA sets out a number of tests including that, without such approval, the bankruptcy of a participant could cause systemic disruption.

To date, the Bank has approved three RTGS systems, including the Reserve Bank Information and Transfer System, in which all CS facilities ultimately settle in central bank money, as well as Austraclear. The Bank has also approved a number of multilateral netting arrangements, including the multilateral net settlement batch for cash equities operated by ASX Settlement.

Separately, the Commonwealth Treasury has responsibility for approving market netting arrangements under the PSNA. Approval provides legal certainty in respect of a number of matters relevant to CCPs, particularly in the event that a participant becomes insolvent. These include arrangements for novation and netting, and dealing with securities posted as collateral by participants.

2.3 ASX Clearing and Settlement Facilities

The ASX Group operates four CS facilities: two CCPs and two SSFs. Each of these facilities holds a CS facility licence, and each is required under the Corporations Act to comply with applicable FSS determined by the Bank and to do all other things necessary to reduce systemic risk. The ASX CS facilities are currently the only facilities of significant size incorporated and based primarily in Australia, and hence for which ASIC and the Bank are the authorities responsible for primary oversight in respect of the Principles (Table 1). LCH.Clearnet Limited, a third licensed CCP, operates under an overseas CS facility licence; its primary regulator is the Bank of England.

2.3.1 ASX Group Structure

All four CS facilities are part of the ASX Group (ASX). In the ASX corporate structure, the two central counterparties (CCPs) – ASX Clear and ASX Clear (Futures) – are subsidiaries of ASX Clearing Corporation Limited (ASXCC), while the two securities settlement facilities (SSFs) – ASX Settlement and Austraclear – are subsidiaries of ASX Settlement Corporation Limited (Figure 1). ASXCC and ASX Settlement Corporation Limited are in turn subsidiaries of the ASX Group's parent entity, ASX Limited. ASX Limited is the licensed operator of the ASX market, while another subsidiary, Australian Securities Exchange Limited, is the licensed operator of the ASX 24 market. The ASX market provides a trading platform for ASX listed securities and equity derivatives, while ASX 24 is an exchange for futures products. ASX Clear and ASX Settlement provide clearing and settlement services for the ASX market, and ASX Clear (Futures) provides clearing services for the ASX 24 market.[8]

ASX Limited is a listed company. The ASX Limited Board is responsible for overseeing the processes for identifying significant risks to ASX and ensuring that appropriate policies as well as adequate control, monitoring and reporting mechanisms are in place. In addition, ASX Limited's Board assigns certain responsibilities to subsidiaries within the group, including the boards of the four CS facilities (the CS Boards). The CS Boards are responsible for managing the particular clearing and settlement risks faced by each respective CS facility, including through compliance with the FSS. The CS Boards are subject to common governance arrangements with high-level objectives set out in the CS Boards' Charter. A majority of the directors on the CS Boards are common to the boards of all four CS facilities; however, one of the directors on the ASX Clear and ASX Settlement Boards does not sit on the ASX Clear (Futures) and Austraclear Boards, and two of the directors on the ASX Clear (Futures) and Austraclear Boards do not sit on the ASX Clear and ASX Settlement Boards.

ASX Clearing Corporation Limited (ASXCC) is a wholly owned subsidiary of ASX Limited. ASXCC is the holding company for and manages the financial resources of the two CCPs. It invests these resources according to a treasury investment policy and investment mandate approved by the CS Boards.

The CS facilities rely in the delivery of their services on group-wide operational and compliance resources that reside in ASX Operations Pty Limited, which is a wholly owned subsidiary of ASX Limited.

  • ASX Operations Pty Limited (ASX Operations) provides most operational resources required by the CS facilities, including services to enable ASX Compliance to perform its services.
  • ASX Compliance Pty Limited (ASX Compliance) provides compliance services to the licensed entities of the ASX Group, including monitoring and enforcing participants' compliance with the Operating Rules of the CS facilities.

ASX has adopted a group-wide organisational structure to manage the business operations of its various entities, including the CS facilities. Its business units are organised into nine main divisions:

  • Office of the Chief Executive Officer (CEO)
  • Risk
  • Operations
  • Technology
  • Business Development
  • ASX Compliance
  • Office of General Counsel and Company Secretariat, Regulatory Policy and Regulatory Assurance
  • Chief Financial Officer (CFO) Office
  • Human Resources.

Risk contains a number of departments that play key roles in the management of risks faced by the CS facilities:

  • Clearing Risk Strategy and Policy – develops and maintains policies and standards related to CCP risk management, with a focus on longer term strategic initiatives.
  • Clearing Risk Quantification – maintains and validates CCP risk and pricing models.
  • Clearing Risk Management – implements CCP risk management policies and standards, and maintains effective procedures for carrying out those policies and standards.
  • Enterprise Risk – responsible for enterprise-wide risk management, including general business risk.
  • Portfolio Risk Management – responsible for managing investment and liquidity risks associated with ASXCC's investment portfolio.
  • Internal Audit – conducts risk-based reviews of internal controls and procedures across ASX. Internal Audit reports to the Chief Risk Officer for administrative purposes only.

ASX's clearing risk policy framework also sets out roles for a number of internal committees that bring together decision makers and experts from departments across the group:

  • Clearing Risk Policy Committee (CRPC) – reviews policies and standards prior to CS Board submission.
  • Capital and Liquidity Committee (CALCO) – advises on changes to clearing risk policies and standards related to capital, liquidity and balance sheet management.
  • CCP Risk, Operations and Compliance Committee (CROCC) – discusses and shares information across relevant operational, compliance and risk management departments.
  • Enterprise Risk Management Committee (ERMC) – reviews and approves enterprise risk management policy and related reporting prior to Board submission.
  • Risk Quantification Group (RQG) – responsible for quantitative risk management matters.
  • Default Management Committee (DMC) – coordinates ASX's response to a clearing participant default, and conducts the review and testing of the CCPs' default management approach.

ASX's settlement risk policy framework sets out roles for a number of additional internal committees:

  • Settlement Risk Policy Committee (SRPC) – reviews policies and standards prior to CS Board submission.
  • SSF Risk, Operations and Compliance Committee (SROCC) – discusses and shares information across relevant operational, compliance and risk management departments.
  • Participant Incident Response Committee (PIRC) – coordinates ASX's response to a settlement participant incident, and provides input into policy determinations and settings as necessary in response to such incidents.

2.3.2 ASX central counterparties

The ASX Group includes two CCPs that are required to conduct their affairs in accordance with the Principles. Primary responsibility for the design and operation of a CCP in accordance with the Principles lies with a CS facility licensee's board and senior management.

  • 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, as well as Australian dollar-denominated OTC interest rate derivatives.

2.3.3 ASX securities settlement facilities

The ASX Group includes two SSFs that are required to conduct their affairs in accordance with the Principles. Primary responsibility for the design and operation of an SSF in accordance with the Principles lies with a CS facility licensee's board and senior management.

  • 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.

Footnotes

The Bank has set out its policy on frequency of formal assessments of CS facilities, confirming that systemically important facilities will be assessed annually: see ‘Frequency of Regulatory Assessments of Licensed Clearing and Settlement Facilities’, available at <http://www.rba.gov.au/payments-system/policy-framework/frequency-of-assessments.html>. The Bank's assessments of CS facility licensees have been published on the Bank's website since 2007. Annual assessments of the CS facilities under the ASX group are available at <http://www.rba.gov.au/payments-system/clearing-settlement/assessments/2012-2013/>. [1]

ASIC's RG 211 is available at <http://www.ASIC.gov.au/rg>. [2]

A policy statement setting out how the Principles have been implemented in Australia is available at <http://www.rba.gov.au/payments-system/policy-framework/principles-fmi/implementing-principles-australia.html>. [3]

The Bank's FSS are available at <http://www.rba.gov.au/payments-system/clearing-settlement/standards/>. [4]

The MOU between ASIC and the Bank is available at <http://www.rba.gov.au/media-releases/2002/mr-02-08.html#mou>. [5]

The Self-assessment is available at <http://www.rba.gov.au/payments-system/policy-framework/principles-fmi/responsibilities-of-authorities.html>. [6]

The Council of Financial Regulators' recommendations to the Deputy Prime Minister and Treasurer are available at <http://www.treasury.gov.au/∼/media/Treasury/Consultations%20and%20Reviews/Consultations/2012/CFRWG%20on%20Financial%20Market%20Infrastructure%20Regulation/Key%20Documents/CoFR_Letter_to_Deputy_PM.ashx>. [7]

ASX Clear and ASX Settlement also provide clearing and settlement services for markets other than ASX; these are noted in Section 2.3.2. [8]