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

Standard 9: Central securities depositories

A securities settlement facility operating a central securities depository should have appropriate rules and procedures to help ensure the integrity of securities issues and minimise and manage the risks associated with the safekeeping and transfer of securities. A securities settlement facility operating a central securities depository should maintain securities in an immobilised or dematerialised form for their transfer by book entry.

9.1 A securities settlement facility operating a central securities depository should have appropriate rules, procedures and controls, including robust accounting practices, to safeguard the rights of securities issuers and holders, prevent the unauthorised creation or deletion of securities, and conduct periodic and at least daily reconciliation of securities issues it maintains.

Through the CHESS sub-register, ASX Settlement operates a central securities depository that maintains a record of securities holdings and movements for ASX-quoted securities, and securities listed by AMOs and ALMOs. Securities registries maintain a separate record of holdings on behalf of issuers, using information on securities movements provided by CHESS.

Austraclear acts as central securities depository for the securities that it settles.

The ASX SSFs employ a range of controls designed to ensure the integrity of securities they hold. They maintain dual redundancy and a synchronous data update model which ensures that securities holding data are consistent across primary and backup data centres (see SSF Standard 14).

The ASX SSFs conduct periodic reconciliation of securities issues they maintain.

• At ASX Settlement, a monthly statement is sent to securities holders to report changes in their holdings of securities on the CHESS sub-register, and issuer registries are sent daily information on the movement of securities to enable them to accurately maintain company registers.
• Austraclear produces a daily report that reconciles opening and closing balances of holdings to transactions. This report is used to identify if a holding has not been accurately updated.

Annual audits of the controls used in ASX Settlement's and Austraclear's systems are conducted by an external auditor, with the resulting reports published on the ASX website. These audits assess controls over transaction processing, as well as change management, security protocols, technology operations and disaster recovery planning. The auditor's opinion is provided under the Australian Government Auditing and Standards Board standard ASAE 3402 – Assurance Report on Controls at a Service Organisation. Due to the coverage of these external audits, ASX Internal Audit performs additional risk-based audits of key ASX Settlement and Austraclear functions on an as needs basis.

These rules and procedures should:

1. identify the type of title or interest held by participants for particular securities, to the extent such title or interest is recognised by the facility's rules and procedures;

ASX Settlement

Securities settled by ASX Settlement are dematerialised (electronic) and held in CHESS. Title is held in the name of clients of ASX Settlement participants. Encumbrances are recorded by placing a holding lock on securities that have been pledged for collateral against margin obligations to ASX Clear, or are subject to participation in a buy-back or takeover, or are subject to actions such as court orders or bankruptcy proceedings. Sub-positions of securities pledged as collateral to ASX Clear are reconciled against records in ASX Clear's Derivatives Clearing System at least annually.

The CHESS sub-register forms part of an issuer's primary securities register. Maintenance and reconciliation of the complete register is the responsibility of the issuer or its appointed agent. Most ASX Settlement participants settle across a centralised settlement account and subsequently allocate securities to end-clients in the CHESS sub-register. As part of its end-of-day processes, CHESS reports net movements on each sub-register to the holder of the issuer's complete register (i.e. generally a share registry). Settlement participants utilise the centralised account under ‘trust’ provisions and are obliged to give irrevocable legal title to an end-client as long as that client has met all relevant conditions in respect of the settlement.

For securities for which CHESS is not the issuer central securities depository (e.g. Australian Government securities), ASX Settlement utilises the CHESS Depository Interest (CDI) structure. Under this structure, a related entity of ASX Settlement, CHESS Depository Nominees Pty Limited, or another nominee appointed by the issuer holds legal title to the security in the issuer central securities depository. A CDI is then created and maintained in CHESS; holders of CDIs have beneficial, but not legal, ownership of the underlying security.

Austraclear

Austraclear's Regulations identify title for three different classes of securities: Dematerialised Securities; Non-paper Securities and Euro entitlements; and Paper Securities.

• Dematerialised Securities are electronic securities that are registered in the Austraclear system rather than externally. They include electronic certificates of deposit, electronic promissory notes and electronic bank-accepted bills of exchange. A Dematerialised Security is held by a participant as a ‘chose in action’. This legal structure imposes rights and obligations that replicate the rights and obligations of a negotiable instrument.
• Non-paper Securities and Euro entitlements are electronic securities that are not registered within the Austraclear system. Non-paper Securities include Australian Government securities, registrable state and semi-government securities, and corporate debt. Euro entitlements are claims to investment-grade AUD-denominated securities issued in Europe that are deemed acceptable by Austraclear and are deposited in an account that Austraclear maintains at Clearstream (see SSF Standard 17.1). The entitlements remain within Austraclear and transfer of title occurs across these accounts, rather than offshore. In the case of Non-paper Securities and Euro entitlements, Austraclear holds legal title for the participant as nominee, while the participant retains beneficial title.
• Paper Securities are negotiable instruments and include some certificates of deposit, promissory notes and bills of exchange. Austraclear holds these securities for the participant as bailee, with the participant retaining legal and beneficial title (see SSF Standard 9.1(b)). There are currently no paper securities held in Austraclear.

The Austraclear Regulations and Procedures provide the legal and operational basis for the transfer of title or interests between participants, including the timing of transfers and the role of pledges (encumbrances). Securities pledged in Austraclear require both the pledgor and pledgee to match a pledge request within the system. This places a lock on those securities until the pledgee accepts a request from the pledgor to release the lock.

Under the standard Austraclear account structure, participants can pledge securities to collateralise an exposure created outside the system without the transfer of title, or to exchange securities under repurchase agreements with the transfer of title. These securities may then be used by the collateral receiver without encumbrance (as long as the collateral giver has agreed that they may be re-used, which is standard practice).

The Austraclear Regulations also provide for account structures to support a CCMS. The accounts include collateral accounts to hold securities that have been given as collateral by way of outright transfer (Transferred Collateral Accounts) or security interest (Secured Collateral Accounts). These accounts are used only by users of the CCMS (who must be Full Participants) and are controlled by the Collateral Manager as their agent. A collateral receiver may re-use securities held by it in a Transferred Collateral Account (unless re-use has been restricted by agreement between the collateral giver and collateral receiver), but only within the CCMS and through the Collateral Manager as its agent. The collateral receiver may also instruct the Collateral Manager to transfer the securities to another account for sale or repo outside of the Collateral Management System, but only on condition that equivalent replacement securities are transferred into the collateral account. Austraclear also offers two types of accounts to hold securities to be lent or borrowed under securities lending agreements managed within a CCMS.

Settlement instructions for the CCMS are generated by an optimisation service operated by Clearstream based on exposure details provided by customers. The settlement instructions are given to Austraclear by the Collateral Manager, who is responsible for account and collateral management on behalf of its customers.

2. clearly identify the way in which the transfer of (or any other forms of dealing with) securities and related payments can be effected through the facility; and

The transfer of title to securities in CHESS and the Austraclear system is given effect by electronic book entry.

• In CHESS, settlement occurs via a DvP Model 3 process in a daily scheduled batch settlement cycle (see SSF Standard 10). The ASX Settlement Operating Rules and Procedures also provide for the free-of-payment transfer of securities, where required.
• In the Austraclear system, transfers of Dematerialised Securities are transfers of contractual rights within the system. Non-paper Securities are transferred through the passing of beneficial title from the seller to the buyer. Paper Securities are transferred through updates to participants' security records. Austraclear also uses allonges to record indorsements in respect of paper securities, maintaining the negotiability of these instruments. Austraclear retains legal title in the relevant registry. Settlement occurs via a DvP Model 1 process in real time on a gross basis (see SSF Standard 10). The Austraclear Regulations and Procedures also provide for the free-of-payment transfer of securities, where required.

3. ensure that, to the extent permissible by law, the creditors of the operator of the securities settlement facility have no claim over securities or other assets held, deposited or registered by participants in the facility.

In the event of ASX Settlement's or Austraclear's insolvency, the rules and arrangements for title within the ASX SSFs are designed to provide a high degree of assurance that participants' securities would be immune from claims by their respective creditors.

• ASX Settlement is not the legal owner of any participant or client assets; these assets are recorded in CHESS in the name of the participant, sponsored client or, in the case of CDIs, a nominee entity on behalf of the beneficial owner.
• Austraclear is not counterparty to any transactions settled in its system. Austraclear is not the legal owner of any Dematerialised Securities registered in the system; in the case of the other classes of securities, Austraclear holds the securities for a participant as either nominee (for Non-paper Securities and Euro entitlements) or bailee (for Paper Securities), while the participant retains beneficial title (and legal title in the case of Paper Securities).

9.2 A securities settlement facility operating a central securities depository should prohibit overdrafts and debit balances in securities accounts.

For ASX Settlement, CHESS does not allow the movement of securities from a holding that exceeds the available securities in the holding, preventing any potential debit balance in securities accounts.

In Austraclear, any instruction to move securities from a participant's securities in excess of available securities remains in a ‘not ready’ status until sufficient securities are received into that account. If the instruction remains outstanding at the end of the day, it will move to a ‘failed’ status and automatically be removed from Austraclear. This removes the possibility of a debit balance in securities accounts.

9.3 A securities settlement facility operating a central securities depository should maintain securities in an immobilised or dematerialised form for their transfer by book entry. Where appropriate, a securities settlement facility operating a central securities depository should provide incentives to immobilise or dematerialise securities.

Securities held in CHESS are dematerialised; securities underlying a CDI are immobilised and held by a nominee on behalf of the beneficial owner (see SSF Standard 9.1).

The securities maintained in Austraclear are either paper or dematerialised (see SSF Standard 9.1). Paper Securities are immobilised and held by Austraclear as bailee for the owner.

9.4 A securities settlement facility operating a central securities depository should protect assets against custody risk through appropriate rules and procedures consistent with its legal framework.

ASX Settlement and Austraclear have identified potential custody risks arising from negligence, misuse of assets, fraud, poor administration, or inadequate record-keeping. Operational controls to mitigate these risks include segregation of duties, access restrictions and authorisation checks.

• ASX Settlement's Operating Rules allow ASX Settlement to give advice to a participant or issuer to correct an error that it has caused. If ASX Settlement causes an error in its securities holdings, it is responsible for correcting that error.
• Austraclear's Regulations require that Austraclear provide safekeeping for Paper Securities, and do all that is in its power to replace the security if it becomes lost, stolen, destroyed or damaged. If Austraclear were liable to a participant due to the loss or destruction of a Paper Security, its liability could extend to the face value of the security. The Austraclear Regulations also include specific warranties and indemnities by participants to limit potential liabilities arising from custody risk.

The ASX SSFs are covered by the ASX Group general and professional indemnity insurance policy for civil liabilities arising from their central securities depository activities. Where losses are the result of employee wrongdoing or a computer manipulation, the ASX SSFs are covered by the ASX Group comprehensive Crime Policy.

9.5 A securities settlement facility operating a central securities depository should employ a robust system that ensures segregation between its own assets and the securities of its participants, and segregation among the securities of participants. Where supported by the legal framework, a securities settlement facility operating a central securities depository should also support operationally the segregation of securities belonging to a participant's customers on the participant's books and facilitate the transfer of customer holdings.

ASX Settlement

ASX Settlement is not the legal owner of any participant or client assets; these assets are recorded in CHESS in the name of the participant, sponsored client or, in the case of CDIs, a nominee entity on behalf of the beneficial owner. CHESS provides an account structure that is designed to ensure the legal and operational segregation of participants' securities in CHESS and the segregation of clients' securities from those of participants. Under this account structure, securities are held against a unique Holder Identification Number for each client or participant.

However, during the settlement cycle there is a period in which securities have to be transferred into a separate ‘entrepot’ settlement account with no operational segregation between participant and client securities (reflecting the account structure at ASX Clear – see Appendix C.1, CCP Standard 13; see also SSF Standard 10.2). Prior to transfer to the settlement account, client securities may be temporarily placed in an ‘accumulation’ account in the name of the participant. Even if this were to occur, the client remains the beneficial owner of securities in the accumulation account until the point of transfer to the settlement account. Participants are also required to fund any transfer of securities beneficially owned by clients into their settlement account, by depositing the net sale proceeds into the client trust account concurrent with the CHESS batch settlement process. In combination, these arrangements aim to ensure that clients remain beneficially in possession of their securities or corresponding funds for all but a brief window during the settlement period (see SSF Standard 10.2 and Appendix C.1, CCP Standard 13).

Austraclear

Austraclear segregates its own assets and securities from those of its participants. Participant holdings are legally and operationally segregated within participant accounts. Participants have the further option to segregate client holdings by adopting sub-accounts. Austraclear does not mandate the segregation of client holdings; however, this may be required by regulatory regimes governing participants.

9.6 A securities settlement facility operating a central securities depository should identify, measure, monitor and manage its risks from other activities that it may perform; additional tools may be necessary in order to address these risks.

Neither ASX Settlement nor Austraclear performs any ancillary activities that may pose a risk to the operation of their central securities depository function. In particular, they do not provide a centralised securities lending facility or act as a principal in securities lending transactions. Austraclear does offer paying agent services to issuers of debt securities. This service is governed under a service agreement and documented terms and conditions, which are available on the ASX public website. The service is subject to the same operational risk framework that is applied across all ASX facilities (see SSF Standard 14). Austraclear's liability from this activity is limited under the service agreement.