Alongside its work on access, pricing and competition in retail payment systems, the PSB has in recent years focused increasing attention on its responsibility to promote stability in the Australian financial system.

Recognising the systemic importance of FMIs (Financial market infrastructures), as described in Chapter 4, the reforms that followed the Wallis Inquiry gave the PSB (Payments System Board) responsibility for determining payments system policy so as to best contribute to controlling risk in the financial system. The reforms also gave the Bank a formal role, under Part 7.3 of the Corporations Act, in the regulation of licensed CCPs and securities settlement facilities (SSFs). In accordance with these responsibilities, the Bank has for more than a decade carried out rigorous oversight of FMIs.

Chapter 4 observed that shortcomings in the design of FMIs, or interruption to critical FMI services could have systemic implications. This section describes the FMI landscape in Australia and illustrates how sound regulation and oversight can help to ensure that FMIs are a source of stability rather than a source of systemic risk. It goes on to describe how the Bank executes its oversight role in respect of both high-value payments and CS facilities, before highlighting some important areas of focus for the PSB in recent years and identifying some regulatory challenges stemming from changes in the market environment.

The Bank has an oversight role in respect of three types of FMI that operate in Australia: high-value payment systems, CCPs and SSFs. High-value payment systems support wholesale funds transfers, while CCPs and SSFs – collectively known as CS facilities – clear and settle transactions in securities such as bonds and equities, and in derivative instruments such as options and futures.

High-value payment systems are systems that provide for the settlement of wholesale interbank payments. The principal domestic high-value payment system is the Reserve Bank Information and Transfer System (RITS). RITS, which is owned and operated by the Bank, sits at the heart of the Australian payments system (Section 8.2.2). The international foreign exchange settlement system, CLS, also plays an important role in Australia’s financial system.

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 swap contract – is to the CCP - Central counterparty, rather than the bilateral counterparty in the original trade.

These arrangements provide substantial counterparty risk management benefits to participants as well as greater opportunities for netting of obligations. At the same time, however, they result in a significant concentration of risk in CCPs. This risk would crystallise if a participant defaulted on its obligations to a CCP, since the CCP would have to continue to meet its obligations to all of the non-defaulting participants (Chapter 4). Accordingly, it is critical that CCPs identify and properly control risks associated with their operations and conduct their affairs in accordance with regulatory standards that promote the overall stability of the financial system.

Three CCPs (Central counterparties) are currently licensed under the Corporations Act to operate in Australia.

• ASX Clear Pty Limited (ASX Clear) provides CCP services for a range of financial products traded on the ASX and Chi-X Australia Pty Limited (Chi-X) markets, including cash equities, pooled investment products, warrants, certain debt products and equity-related derivatives.

• ASX Clear (Futures) Pty Limited (ASX Clear (Futures)) provides CCP services for derivatives traded on the ASX 24 market, including futures and options on interest rate, equities, energy and commodity products. In July 2013, ASX Clear (Futures) also began offering a clearing service for Australian dollar-denominated OTC interest rate derivatives.

• LCH.Clearnet Limited (LCH.C Ltd) was licensed in 2013 to provide CCP services for OTC interest rate derivatives and to act as the CCP for trades executed on a newly licensed derivatives exchange, FEX Global Pty Limited (FEX). FEX is not yet operational.

A SSF provides for the final settlement of securities transactions. Settlement involves transfer of the title to the security and transfer of cash. These functions are linked via appropriate delivery-versus-payment arrangements incorporated within the settlement process. Given their central role in the functioning of the markets they serve, it is critical that SSFs identify and properly control risks associated with their operations and conduct their affairs in accordance with regulatory standards.

18 There is also one other licensed SSF, IMB Limited, which operates a small SSF for settlement of its own securities.

19 ASIC rules implementing the PFMIs for trade repositories had not yet been finalised at the relevant assessment date.

• ASX Settlement Pty Limited (ASX Settlement) provides for the settlement of cash equities, debt products and warrants traded on the ASX and Chi-X markets. ASX Settlement also provides a settlement service for non-ASX listed securities.

• Austraclear Limited (Austraclear) offers securities settlement services for trades in debt securities, including government bonds and repos.

Both in Australia and internationally, FMIs were a source of stability during the global financial crisis, operating reliably throughout this period. In part reflecting significant enhancements to the design of FMIs in the two decades prior to the crisis, market participants retained confidence in the infrastructure, allowing financial trading to continue even in an environment where financial institutions were reluctant to assume exposures to each other. Nevertheless, this period shone a light on potential issues that could arise in extreme stress. Accordingly, work on the international and domestic standards applying to CCPs and other FMIs has continued since the crisis, including on measures to ensure continuity of critical services in circumstances in which an FMI faces a threat to its ongoing financial viability.

Regulation and oversight promote the sound design of FMIs, helping to ensure that they act to mitigate systemic risk (Chapter 4). The Australian regulatory framework for FMIs is summarised in Sections 8.6.3 and 8.6.4, focusing primarily on the Bank’s role and the standards to which it holds FMIs. These standards have drawn, after extensive consultation, on the international framework set out by the Principles for Financial Market Infrastructures (CPSS-IOSCO 2012; the PFMIs), which were published in April 2012 by the international standard-setters, CPSS and IOSCO (Chapter 3).

To ensure continuity of critical FMI services, even in the event of extreme financial shocks, international regulators are developing guidance for the recovery and resolution of FMIs (Chapter 3; Section 8.6.4).

Both the guidance on recovery planning and that on FMI resolution are close to being finalised.

Internationally, regulation and oversight of FMIs have delivered significant enhancements to their design and operation over the past two decades. These enhancements, promoted by international policy and standard-setting bodies such as CPSS and IOSCO, were instrumental in ensuring that by the time of the global financial crisis, participants were confident in FMIs’ settlement models, risk management frameworks, and operational arrangements. Importantly, they regarded them as sources of stability rather than systemic risk.

A key element of the PSB’s responsibility for the safety and stability of payment systems in Australia is oversight of systemically important payment systems. To date, RITS is the only domestic system identified by the Bank as warranting oversight as a systemically important payment system. This reflects the fact that RITS is the principal system in Australia (by aggregate value of payments), mainly settles high-value and/or time-critical payments, and is used to effect interbank settlements arising in other FMIs (Section 8.6.2).

As part of its oversight of RITS, the Bank periodically conducts self-assessments of RITS against relevant international standards. These self-assessments are reviewed by the PSB and published on the Bank's website. Prior to the publication of the PFMIs, the relevant standards were the CPSS Core Principles for Systemically Important Payment Systems. Following the release of the PFMIs, the Bank committed to carrying out annual self-assessments against the PFMIs. In the most recent self-assessment, published in December 2013, the Bank concluded that RITS observed all of the relevant standards and committed to continuing work to ensure that RITS’s operations remain in line with international best practice (RBA 2013b). The PSB also reviews any material developments occurring between assessments.

The Bank has also identified CLS as a systemically important international payment system. CLS is chartered in the United States and is regulated and supervised by the Federal Reserve. The Federal Reserve has established a cooperative oversight arrangement for CLS, in which the Bank participates.

8.6.3.1 ESA access

20 The Bank’s Exchange Settlement Account Policy is available at <http://www.rba.gov.au/payments-system/esa/>.

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

Practically, this is achieved through the Bank having the power to ‘approve’ an 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 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 RITS and Austraclear, and

six multilateral netting arrangements, including all of the retail payments clearing streams and the CHESS batch.

The Corporations Act establishes conditions for the licensing and operation of CS facilities in Australia and gives the Bank powers and responsibilities relating to these facilities. These powers are exercised under the governance of the PSB. The Bank and ASIC have joint responsibility for CS facilities under the Corporations Act, and have worked effectively together since the introduction of the regime. The regulators’ respective roles under the Corporations Act are well defined and understood both by the regulators themselves and CS facility licensees.

As cross-border provision of FMI services becomes more widespread, it will be increasingly important for regulators in different jurisdictions to work effectively together. Bilateral and multilateral cooperative oversight arrangements are important vehicles for host authorities to exert regulatory influence over FMIs that provide systemically important services in their jurisdictions. The Bank has established bilateral cooperative arrangements with the Bank of England to support its oversight of LCH.C Ltd, and sits on a Bank of England-led multilateral oversight group.

The remainder of this sub-section provides an overview of how the PSB has exercised its responsibilities as overseer of these facilities.

In accordance with its responsibilities under the Corporations Act, the Bank first determined FSS for licensed CCPs and SSFs in 2003. The 2003 FSS 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.

Following the release of the PFMIs, the Bank updated its FSS to bring them into line with the stability-related PFMIs, and ASIC took steps to implement measures relevant to its mandate (ASIC and RBA 2013). The new FSS also include 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 (Section 8.6.5).

Consistent with the higher level of detail of the PFMIs 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 PFMIs, the new FSS include enhanced requirements for financial resources held to cover any losses incurred by CCPs in the event of a participant default, and a 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.

The Bank assesses CCPs and SSFs annually against the FSS. Given the growing systemic importance of these facilities, the Bank strongly supports high standards for the design and risk management of CS facilities operating in Australia. International consistency is also essential in light of the increasing cross-border provision of FMI services; cross-border recognition of regulatory rules is important where domestic institutions participate in overseas FMIs and where international institutions participate in Australian FMIs. Acknowledging the importance of international consistency, while at the same time recognising the need to ensure that regulatory settings fit the Australian context, the Bank continues to contribute to the development of relevant international standards and guidance through its representation on the CPSS.

To date, the Bank’s oversight of CS facilities has focused on the four licensed domestic CS facilities in the ASX Group. These facilities have been operated by the ASX Group since the merger of ASX and the Sydney Futures Exchange in 2006. The Bank carries out ongoing monitoring and assessment of these facilities through regular meetings and the collection of data and other information on the facilities’ activities. Since 2006/07, the Bank has published its annual assessment of each licensed CS facility against the applicable FSS.

The first assessments against the new FSS were approved by the PSB in August 2013, and published in September 2013 (RBA 2013a). All four ASX facilities were found to have either observed or broadly observed all relevant requirements under the standards in the assessment period. The Bank did, however, make a number of recommendations to strengthen the ASX facilities' observance with the relevant standards and encourage continuous improvement. During the assessment period, the Bank also examined closely two new services introduced by ASX: a new OTC derivatives clearing service launched by ASX Clear (Futures) and a centralised collateral management service, ASX Collateral.

The PSB also carries out specific reviews from time to time, reflecting live issues in the operation of the facilities, specific requests from government, or developments in underlying markets. In the past few years, such reviews have considered the appropriate level of participation requirements for Australia’s licensed clearing facilities, settlement practices in the Australian equities market, and disclosure of equities securities lending. Some of the design and risk management enhancements arising from the Bank’s oversight of domestic CS facilities are described in ‘Box 8E: CS Facility Oversight’.

21 These measures would apply both where an overseas-based facility sought to provide its services in Australia and where a domestic facility sought to outsource certain operations offshore.

One such additional measure is to require that any systemically important CCP use an ESA at the Bank to manage its Australian dollar-denominated obligations, and also that it maintain a portion of its liquid assets in Australian dollar-denominated liquid assets. A holder of an ESA with the Bank is entitled to central bank liquidity against eligible collateral assets, which may be important in some market circumstances.

Additional requirements would apply where a facility was not only systemically important, but also had a strong domestic connection. Such a facility would be required to incorporate locally and hold a domestic licence, such that:

The policy is flexible and allows triggers for particular measures to be set on a case-by-case basis. It has already been applied in the case of LCH.C Ltd, and it will need to be applied in considering the appropriate regulation of any future cross-border licence applicant.

Importantly, however, there is at present no specific legal provision for imposing a requirement that a licensee incorporate locally and transition from an overseas to a domestic licence. Further to the CFR’s recommendations to the government arising from the review of FMI regulation in 2011, a working group of the CFR has developed legislative proposals to remove this impediment. The Bank strongly encourages the government to progress these alongside proposals to introduce an FMI resolution regime.