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.[5]
  • 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 Investments 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).[6] 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 CPSS-IOSCO 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:[7]

  • 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.[8] 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.[9] 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, Appendix A). Some Principles are relevant to both regulators and accordingly are jointly overseen.

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.[10]

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.

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’. 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/index.html>. [5]

ASIC's RG 211 is available at <http://www.ASIC.gov.au/rg>. [6]

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>. [7]

The Bank's FSS are available at <http://www.rba.gov.au/payments-system/clearing-settlement/standards/index.html>. [8]

The MOU between ASIC and the Bank is available at <https://www.rba.gov.au/media-releases/2002/mr-02-08.html#mou>. [9]

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>. [10]