Assessment of ASX Clearing and Settlement Facilities – September 2019 Appendix C2. Financial Stability Standards for Securities Settlement Facilities

Standard 1: Legal basis

A securities settlement facility should have a well-founded, clear, transparent and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions.

1.1 A securities settlement facility should be a legal entity which is separate from other entities that may expose it to risks unrelated to those arising from its function as a securities settlement facility.

ASX Settlement and Austraclear are wholly-owned subsidiaries of ASX Settlement Corporation Limited, which is itself a wholly-owned subsidiary of ASX Limited (together referred to as the ASX Group). As separate legal entities, each of the ASX securities settlement facilities' (SSFs') securities settlement activities are separate from the activities conducted by each of the other ASX clearing and settlement (CS) facilities and the rest of the ASX Group, notwithstanding the sharing of operational resources across multiple entities within the group. Potential risks arising from the SSFs' reliance on financial resources held at the group level to cover general business risks are discussed under SSF Standard 12.2.

ASX Settlement's services are limited to: settlement services for the ASX market; settlement arrangements for Approved Market Operators (AMOs) through the Trade Acceptance Service (TAS); a DvP settlement service for transactions in non-ASX-listed securities undertaken on trading platforms operated by Approved Listing Market Operators (ALMOs) through the Settlement Facilitation Service; and the mFund Settlement Service for subscriptions and redemption transactions in unlisted managed funds. Accordingly, ASX Settlement does not provide any services that have a distinct profile from, or pose additional risks to, its activity of operating an SSF.

Austraclear provides settlement services and related depository services for debt securities, and settlement services for derivatives traded on the ASX 24 market and for payments to meet margin obligations arising in ASX Clear and ASX Clear (Futures), in accordance with the Austraclear Regulations and Procedures. ASX Collateral Management Services Pty Limited (ASX Collateral), a related legal entity within the ASX Group, and a wholly-owned subsidiary of ASX Operations Pty Limited, acts as a Special Purpose Participant in Austraclear. ASX Collateral operates a centralised collateral management service (CCMS) under which exchange of title to debt securities occurs in Austraclear.

Austraclear also offers settlement services for foreign currency payments and securities, currently covering payments denominated in RMB (see SSF Standard 8). The foreign currency settlement service is designed to operate independently from Austraclear's AUD services. Austraclear's ancillary services do not have a distinct profile from, or pose additional risks to, its activity of operating an SSF.

1.2 The legal basis should provide a high degree of certainty for each material aspect of a securities settlement facility's activities in all relevant jurisdictions.

Legal basis

ASX Settlement's settlement and netting arrangements and Austraclear's settlement arrangements for transactions entered into by their respective participants require a high degree of legal certainty. Key components of the legal framework under which the SSFs operate are listed below.

• The ASX SSFs each hold a CS facility licence under Part 7.3 of the Corporations Act 2001 (Corporations Act). This licence is administered by the Australian Securities and Investments Commission (ASIC) in consultation with the Bank. The Minister is the ultimate decision-maker on licensing matters, although this responsibility has been delegated to authorised ASIC officers since April 2016.^[3]
• ASX Settlement has defined Operating Rules and Procedures, and Austraclear has defined Regulations and Procedures. Under Section 822B of the Corporations Act, these Operating Rules and Regulations have effect as a contract under seal between: the relevant ASX SSF and each of its respective participants and issuers; each participant and each other participant; and each participant and each issuer. The Operating Rules, Regulations and Procedures set out the rights and obligations of participants and the relevant SSF, including in the event of default or suspension.
• The netting arrangements contained in ASX Settlement's Operating Rules are protected as an ‘approved netting arrangement’ under Part 3 of the Payment Systems and Netting Act 1998 (PSNA), and the finality of money settlements is supported by the approval of the Reserve Bank Information and Transfer System (RITS) as a ‘Real-time Gross Settlement (RTGS) system’ under Part 2 of the PSNA (see SSF Standard 1.5).
• ASX Settlement is a ‘prescribed CS facility’ for the purposes of Part 7.11, Division 4, of the Corporations Act. Section 1074D of the Corporations Act protects the validity of the transfer of a financial product effected through a prescribed CS facility in accordance with that facility's Operating Rules. Section 10 of the ASX Settlement Operating Rules specifies when transactions are taken to be settled.
• The finality of settlements undertaken by Austraclear is protected by its approval, and the approval of RITS, as an ‘RTGS system’ under Part 2 of the PSNA (see SSF Standard 1.5).

The legal basis of the ASX SSFs' activities is reviewed by ASX Legal as part of business-as-usual processes, such as contract execution and admission of participants domiciled in foreign jurisdictions, and change management processes, such as considering the impact of the introduction of new legislation or launch of new products. Input from ASX Legal is sought as part of internal processes for rule amendments and changes to procedures and guidance notes. ASX also undertakes either a general or targeted consultation with market participants when considering rule amendments. Through these processes, ASX seeks to maintain clear and understandable rules, procedures and contracts that are consistent with relevant industry standards and market protocols. However, ASX Legal does not periodically conduct general reviews to assess whether incremental changes to rules and procedures over time might reduce their clarity and understandability.

The legal basis for the operation of the CCMS in Austraclear and the status of ASX Collateral as a Special Purpose Participant is set out in the Austraclear Regulations. Legal arrangements between ASX Collateral and customers of the CCMS (which must be Full Participants) are set out in standard-form Collateral Management Service Agreements. The standard-form Service Agreements specify the nature of services that the Collateral Manager provides to users. These agreements are between ASX Collateral and users of the collateral service; Austraclear is not a party to these contracts.

The Austraclear Regulations provide for settlement instructions to be submitted to Austraclear by a Collateral Manager admitted as a Special Purpose Participant and acting as agent for its customers, which must be admitted as Full Participants.

Rights and interests

The rights and interests of ASX Settlement, its participants and, where relevant, its participants' customers in securities held in CHESS are defined in ASX Settlement's Operating Rules and Procedures (see SSF Standard 9).

Similarly, the rights and interests of Austraclear, its participants and, where relevant, its participants' customers in securities deposited with Austraclear are defined in Austraclear's Regulations and Procedures (see SSF Standard 9).

1.3 A securities settlement facility should have rules, procedures and contracts that are clear, understandable and consistent with relevant laws and regulations.

Section 822A of the Corporations Act establishes a framework to prescribe the matters that must be dealt with in ASX Settlement's Operating Rules, Austraclear's Regulations and those that may instead be considered under their Procedures. Operating Rule changes are subject to a Ministerial disallowance process, although the Minister's role in this process is delegated to authorised ASIC officers.

ASX Settlement's Operating Rules and Procedures and Austraclear's Regulations and Procedures are published on the ASX public website and the Customer Portal, ASX's restricted participant website. These documents are supplemented with explanatory material to support participants' (and prospective participants') understanding of the risks they face through participation in the system. In addition to the Operating Rules, Regulations and Procedures, publicly available material includes high-level descriptions of both SSFs' operations and settlement processes, business continuity arrangements, fees and charges and ASX Clear's Default Management and Recovery Framework (DMRF) (as it applies to ASX Settlement participants that also participate in ASX Clear).

There is a clear process for changing ASX Settlement's Operating Rules and Procedures and Austraclear's Regulations and Procedures. In practice, proposed changes to Operating Rules or Regulations are submitted informally to ASIC. In consultation with the Bank, ASIC considers the proposed changes and advises ASX of any regulatory concerns. Once such concerns are satisfactorily addressed, ASIC invites formal submission of the proposed Operating Rule or Regulation changes, which triggers a 28-day disallowance period (referred to above), during which the Minister may choose to disallow the Operating Rule or Regulation changes. The Minister or delegate must consider a number of factors when deciding whether to disallow Operating Rule or Regulation changes, including whether the proposed changes are consistent with the public interest.^[4] In addition, the Minister or delegate must ensure that there has been adequate consultation with the Bank when deciding whether to disallow Operating Rule or Regulation changes, and consider any advice and recommendations from the Bank and ASIC staff.^[5] If changes to the Operating Rules or Regulations are not disallowed by the Minister or delegate, they are notified to participants via the ASX website.

1.4 A securities settlement facility should be able to articulate the legal basis for its activities to the Reserve Bank and other relevant authorities, participants and, where relevant, participants' customers, in a clear and understandable way.

The legal basis for the activities of ASX Settlement and Austraclear and the protections afforded by the approval of each facility under the relevant parts of the PSNA (see also SSF Standard 1.5) are described in the Disclosure Framework document available on ASX's public website. This document sets out in detail how each CS facility meets the requirements of each Principle within the Principles for Financial Market Infrastructures (PFMI) developed by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) (see SSF Standard 18.4).^[6]

On behalf of each licensed entity within the ASX Group, including all ASX CS facilities, ASX Limited submits an annual report to ASIC under section 792F of the Corporations Act that is shared with the Bank. This report sets out the extent to which each licensee has complied with its obligations under Chapter 7 of the Corporations Act.

The ASX SSFs may seek independent legal opinions on relevant legal matters relating to significant new services, including any implications that their introduction may have for the legal basis of existing functionality. These opinions may, in some circumstances, be shared with participants or other stakeholders for their information, particularly to demonstrate that new Operating Rules or Regulations will have the intended legal effect.

1.5 A securities settlement facility should have rules, procedures and contracts that are enforceable in all relevant jurisdictions. There should be a high degree of certainty that actions taken by the securities settlement facility under such rules and procedures will not be voided, reversed or subject to stays, including in the event that the securities settlement facility enters into external administration or that one or more of its participants or a settlement bank defaults or is suspended.

Settlement finality

The finality of ASX Settlement's settlement process, which is established in the ASX Settlement Operating Rules, is protected by:

• the approval of its netting arrangements under Part 3 of the PSNA; this approval ensures that netting in accordance with ASX Settlement's Rules and Procedures is legally certain.
• its designation as a ‘prescribed CS facility’ for the purposes of Part 7.11, Division 4 of the Corporations Act, in relation to the transfer of financial products effected through the settlement facility.

The finality of Austraclear's settlement process, which is established in the Austraclear Regulations, is protected by its approval as an ‘RTGS system’ under Part 2 of the PSNA. With this approval, a transaction settled in Austraclear at any time on the day on which a participant enters external administration has the same effect as if the participant had gone into external administration on the next day (in the case of a winding up) or as if the participant had not gone into external administration (in the case of other forms of external administration). Accordingly, in the event of insolvency, all transactions settled on the day of the insolvency are irrevocable and cannot be unwound simply because of the event of external administration (i.e. they are protected from the ‘zero-hour’ rule).

In addition, to the extent that settlement in ASX Settlement or Austraclear depends on the settlement of interbank obligations in RITS, this is also protected from the zero-hour rule by the approval of RITS as an ‘RTGS system’ under Part 2 of the PSNA (see SSF Standard 8).

ASX has satisfied itself on the finality of settlement in both SSFs.

Enforceability of rules under external administration

ASX's processes for review of legal risks have identified no material legal risk to enforceability of ASX Settlement's Operating Rules and Austraclear's Regulations should the SSFs enter into external administration.

1.6 A securities settlement facility conducting business in multiple jurisdictions should identify and mitigate the risks arising from any potential conflicts of law across jurisdictions. A securities settlement facility should provide the Reserve Bank with a legal opinion that demonstrates the enforceability of its rules and addresses relevant conflicts of law across the jurisdictions in which it operates. This should be reviewed on a periodic basis or when material changes occur that may have an impact on the opinion, and updated where appropriate.

Although the ASX SSFs' operations are based in Australia, participants of ASX Settlement and Austraclear include subsidiaries and branches of entities that are domiciled in foreign countries. ASX Settlement's Operating Rules and Austraclear's Regulations are governed by Australian law and require that all of their respective participants submit to the jurisdiction of New South Wales courts. During the assessment period, each of the ASX SSFs took steps consistent with this Standard to satisfy itself that the laws of jurisdictions outside Australia do not impact its analysis of core legal risks, including matters covered under SSF Standards 1.2 and 1.5.

ASX Legal reviews existing legal opinions on a case-by-case basis when there are changes to legislation covered by the opinions, material changes to the Operating Rules or Regulations of the ASX SSFs, or new business initiatives that may impact the scope of the opinions. In addition, senior staff in ASX Legal periodically meet to assess whether any changes in law or business activities mean that existing legal opinions should be updated.

Footnotes

While the Minister has delegated responsibility for certain decisions under Chapter 7 of the Corporations Act to authorised ASIC officers, the Minister may still exercise the powers delegated by ‘calling up’ the matter. [3]

Section 827A of the Corporations Act sets out the matters the Minister must have regard to, available at <http://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s827a.html>. [4]

For more information see ‘Guidelines for the Exercise of Powers Delegated to ASIC under Chapter 7 of the Corporations Act 2001’, available at <https://treasury.gov.au/publication/guidelines-for-the-exercise-of-powers-delegated-to-asic-2016/>. [5]

Available at <http://www.asx.com.au/documents/asx-compliance/pfmi-disclosure-framework.pdf>. Prior to 1 September 2014, CPMI was known as the Committee on Payment and Settlement Systems (CPSS). [6]