House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer and Minister for Financial Services, the Hon Stephen Jones MP)

Attachment 2: Impact Analysis - Competition in the clearing and settlement of cash equities

Competition in Clearing Australian Cash Equities: Conclusions, Council of Financial Regulators report (December 2012)

Introduction and Executive Summary

On 15 June, the Council of Financial Regulators (the Council) released a discussion paper on competition in the clearing and settlement of Australian cash equities. This work, carried out by the Australian Securities and Investments Commission (ASIC), the Reserve Bank of Australia (the Bank) and the Australian Treasury, in collaboration with the Australian Competition and Consumer Commission (ACCC) - collectively, the Agencies - arose out of the Council's broader review of financial market infrastructure regulation. The particular focus of the work has been the clearing of ASX-listed equities, reflecting interest emerging from several potential alternative providers in offering competing central counterparty (CCP) services in this market.

This paper presents the Agencies' conclusions from analysis of stakeholder responses to the discussion paper. Sixteen submissions were received from a range of stakeholders, including clearing and settlement infrastructure providers, service providers, industry associations and users of clearing and settlement services. Having analysed these submissions, the Agencies have held a number of meetings with both respondents and other interested stakeholders (including end-users of the financial markets and buy-side market participants) to explore several of the issues raised.

After first providing some background, the paper discusses messages from these submissions relevant to each agency's responsibilities. It draws out some key matters for consideration in understanding the implications of competition and assessing licence applications from competing providers of CCP services. Based on analysis of the issues raised, the paper makes recommendations to government on how to approach competition in clearing and settlement of the Australian cash equity market.

Stakeholders' Views on Competition in Clearing

Most respondents to the consultation viewed cash equity clearing as contestable, having seen competition emerge in Europe. Several were strongly in favour of competition in clearing, citing the following benefits:

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Lower clearing fees. According to an in-depth study of the European market conducted in 2011 by an economic consultancy, Oxera, clearing fees on a per transaction value basis fell for most CCPs. For those CCPs, the declines were between 7 and 59 per cent, and averaged more than 30 per cent.

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Increased innovation and user responsiveness. Those in favour of competition argued that it would encourage innovation. Several stakeholders also anticipated that competition would encourage enhanced user input to the ongoing development of the clearing and settlement infrastructure for the cash equity market. This would ensure that its design and functionality continued to meet participants' needs, including in response to global developments in messaging protocols and value-added services such as custody.

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Support for competition in trading. By providing an alternative to the vertically integrated incumbent, competition in clearing could improve the terms of access for competing trading platforms, increasing their viability and allowing the benefits of competition in trading to be more fully realised.

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Flow-on effects. The flow-on effects of competition in clearing to the market more generally are difficult to quantify, but to the extent that the combination of factors above lowered the costs of participating in the market, it was suggested that, over time, increased interest might emerge from international investors, contributing to deeper liquidity and tighter spreads.

Others were less convinced that competition in cash equity clearing would deliver a net benefit. While supportive of competition in principle, these respondents noted that a multi-CCP environment may entail additional costs to industry. A number of specific concerns were raised:

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The scale of the Australian market. To date, competition in clearing has been almost exclusively a European phenomenon, with the primary driver being greater integration of European markets. Some stakeholders questioned whether this experience was relevant to the Australian context, particularly since European markets are significantly larger in aggregate than the Australian market. Given that the total revenue from cash market clearing earned by the incumbent CCP, ASX Clear Pty Ltd (ASX Clear), was $46 million in 2011/12, a 30 per cent reduction in clearing fees (which is not implausible, given the experience in Europe) would yield aggregate direct savings for the industry of around $15 million.

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Operational costs. Respondents were concerned that there might be large up-front fixed costs associated with upgrades to connectivity, information technology or staff, and ongoing costs associated with duplication in processes and a loss of netting efficiencies. A particular concern was that such costs could fall on the industry as a whole, especially given the application of best execution rules.

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Costs of regulation. Partly informed by their perceptions of cost recovery for cross-market supervision, and in the absence of details of a prospective supervision model, participants were also mindful of a potential increase in regulatory costs in a multi-CCP scenario.

A clear theme from consultation with stakeholders was that currently difficult market conditions could exacerbate the impact of any operational and regulatory costs associated with the introduction of competition in equity clearing at this time. Stakeholders highlighted the presently low level of trading activity, the magnitude of regulatory reforms recently undertaken or still underway, and the consequent pressure on technology budgets and firm profitability. There was, therefore, little appetite and capacity in the industry to accommodate significant further change.

Safe and Effective Competition

Since the existing legislative framework envisages multiple providers of clearing services, the discussion paper took openness to competition as the starting point for its analysis. In particular, the paper considered how regulators could ensure that the benefits of competition could be realised without adverse implications for financial system stability or the effective functioning of financial markets.

In accordance with this approach, the Agencies have examined actions that might need to be taken, should competition emerge, to address the various issues identified in the discussion paper. Such actions may be cast in terms of 'minimum conditions' for safe and effective competition.

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Adequate regulatory arrangements. To ensure that competition did not compromise financial stability or market functioning, appropriate regulatory arrangements should be in place. In particular:

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All facilities, irrespective of their scale or domicile, should be rigorously overseen against new Financial Stability Standards (FSSs) determined by the Bank and other requirements, including licence conditions, under the Corporations Act 2001.

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The Council's framework for regulatory influence over cross-border clearing and settlement (CS) facilities should be applied. Recently, the Bank has released new FSSs and ASIC has updated its Regulatory Guide 211 Clearing and settlement facilities: Australian and overseas operators. These reflect new international standards developed by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO), as well as the Council's framework for cross-border regulatory influence. In accordance with this framework, if competition emerged from an overseas-based CCP and its market share reached a specified threshold, the CCP would be expected to establish a domestic legal and operational presence. Given the central role played by the cash equity market in the Australian financial system and a competing CCP's potential connections to other components of the domestic financial market infrastructure, this threshold would be set at a relatively low level.

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Ex ante wind-down plans should be established. These plans should be supported by a commitment to a notice period of no less than one year prior to any commercially driven exit, and additional capital sufficient to cover one year of operating expenses, calculated on a rolling basis. A competing CCP should also contribute to cross-market arrangements to ensure continued provision of clearing services for less liquid securities. Such measures would facilitate orderly exit should a commercial decision be taken to withdraw from the market.

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Appropriate safeguards in the settlement process. The cash equity settlement model in an environment with multiple CCPs should seek as far as possible to preserve the efficiencies of the existing settlement infrastructure, while affording materially equivalent priority to trades cleared through a competing CCP. It should also minimise financial interdependencies between the competing CCPs in the settlement process and facilitate appropriate default management actions. This would require significant modifications to the existing settlement model, although on the basis of preliminary discussions with stakeholders it should be feasible to develop a model with these characteristics.

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Access to the existing securities settlement infrastructure on non-discriminatory and commercial terms. Given that competition in the provision of settlement services is unlikely to emerge, a competing CCP would require access to the vertically integrated incumbent settlement facility, ASX Settlement Pty Limited (ASX Settlement). For competition to be effective, such access would need to be attainable on non-discriminatory and commercial terms. It is recognised that regulatory action might be necessary to fully achieve this.

The Agencies consider that establishing such minimum conditions is necessary to support policy objectives around financial stability, and the integrity and efficiency of financial markets. Outlining these conditions also provides guidance and certainty to potential new entrant CCPs on the regulatory requirements they will face. That is, providing a statement of these conditions should allow potential entrants to make commercial decisions on the economic viability of entry to the Australian market, and the nature of any service offerings.

The Agencies have also considered the implications of interoperability between CCPs. A number of respondents to the consultation agreed with the proposition in the discussion paper that giving participants of multiple trading venues a choice of clearing through a single interoperable CCP could be a means of mitigating some costs associated with a multi-CCP environment including the need to establish duplicate clearing connections. Implementing interoperability would, however, introduce costs and risks and take considerable time. As seen in European markets in which interoperability has emerged, the interests of the parties negotiating an interoperability agreement are unlikely to be aligned; it can therefore be difficult to reach mutually acceptable commercial terms without regulatory intervention. Given the associated complexities and risks, the case for any regulatory intervention to facilitate interoperability would need to be considered carefully and the implications fully understood by the Agencies.

Conclusions and Recommendations

As a matter of principle, the Agencies are open to competition in financial markets and would expect competition to deliver efficient outcomes in terms of pricing, innovation and user responsiveness. This reflects the existing legislative framework for clearing and settlement facilities in Australia, which sets out a licensing regime that contemplates multiple service providers. It also reflects a general, underlying policy position that competition is the most effective means of contributing to efficiency, innovation and productivity across the economy.

The Agencies have consulted widely and have listened to the views of stakeholders. While many stakeholders agreed that, in principle, competition for the clearing of cash equities could be expected to deliver benefits, there was also scepticism around whether those benefits would outweigh any associated costs. Perceptions about these costs and benefits have been influenced by recent experiences with the introduction of competition in the trading of ASX-listed securities, and the attendant changes to industry and regulatory arrangements. The Agencies are also aware that some views about the costs and benefits of CCP competition in the Australian market may reflect individual commercial interests in the outcomes of the Council's work.

The Agencies recognise that making changes in accordance with the minimum conditions to support CCP competition will involve costs, and that the benefits of competition in the clearing of cash equities may not be readily quantifiable. For instance, implementing safeguards in the settlement process would entail costs for both ASX Group (ASX) and participants, including due to flow-on changes to participants' internal processes and systems. Also, while the absolute direct benefits in terms of reductions in clearing fees alone may appear modest, it is more difficult to gauge the magnitude of other benefits such as from product or service innovation, or flow-on benefits to related markets.

These uncertainties are not, however, reasons to rule out the prospect of competition for the clearing of cash equities entirely. The current legislative settings contemplate competition, and a conclusion that CCP competition should not occur at all would represent a significant change in policy; the scope of the current work has not extended to considering such a fundamental reform.

At the present time, however, the Agencies acknowledge feedback from stakeholders that now may not be the appropriate time for changes that will have further cost implications for industry, especially given current market conditions and existing pressures on participants to cut costs. The Agencies also recognise the magnitude of regulatory changes already underway, not least in relation to Basel III and over-the-counter (OTC) derivatives clearing and trade reporting.

Recommendation 1: Taking these factors into account, the Agencies recommend that a decision on any licence application from a CCP seeking to compete in the Australian cash equity market be deferred for two years.

Deferring a decision on any licence application from a competing CCP recognises the legitimate industry concerns that have been raised. While it is recommended that a licence decision be deferred, the Agencies' work has nonetheless clarified minimum conditions for a new entrant CCP. The statement of these requirements should inform decision-making by a potential entrant about whether entry to the market is commercially viable.

Postponing CCP competition would, however, defer the benefits that the market might expect from competition in clearing Australian cash equities. For example, by perpetuating a de facto monopoly in cash equity clearing and settlement, alternative market operators have no choice of supplier for those essential inputs to their service. In other markets a regulated outcome is commonly sought in these circumstances. If a decision were taken to rule out entirely the prospect of competition for the clearing (or settlement) of cash equities, a presumption in favour of some form of regulation of ASX's CS facilities could arise.

At this point in time, however, the Agencies favour a mechanism that preserves the prospect of competition and/or further regulation in the future, while seeking to address the principal concerns raised by stakeholders in the near term.

Recommendation 2: The Agencies recommend that ASX work with industry stakeholders to develop a Code of Practice for Clearing and Settlement of Cash Equities in Australia (Code). Developing the Code would give industry stakeholders, including ASX, an opportunity to address the issues that have been raised during the Agencies' consultation. In the immediate term, prior to the establishment of the Code, there would be a strong case for ASX to commit publicly to the process by endorsing a set of principles developed by the Agencies to govern the conduct and organisation of its cash equity market clearing and settlement operations. These principles reflect merger conditions and access provisions that have been developed in recent years to govern the conduct of similar integrated market infrastructure providers in other markets, including Canada and Europe, and would form the basis for the Code.

Importantly, these arrangements would apply only in the case of the Australian cash equity market, and would not apply in relation to clearing and settlement services supporting either exchange-traded or OTC derivatives markets or OTC debt markets. Indeed, the Council reiterates its openness to the provision of OTC derivatives services by one or more domestic or overseas-based CCPs, subject to those CCPs meeting all regulatory requirements.

The Agencies see merit in setting ASX a clear timetable to implement the Code. It would seem reasonable to set an expectation that the terms of the Code be finalised within six months. This paper sets out some elements that the Agencies would, in accordance with the principles, expect to be included in the Code. It would be strongly preferred that ASX reach agreement on the Code with all relevant stakeholders prior to submission to the Council for approval. An appropriate mechanism would then be established by the Agencies to monitor ASX's adherence to the finalised terms of the Code.

It is proposed that the principles, forming the basis for the Code, would include:

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User input to governance. To ensure responsiveness to users' evolving needs, a formal mechanism should be established within ASX's governance framework to give users a strong voice in strategy-setting and system design, and to make ASX's CS facilities for cash equities directly accountable to users. Users should be broadly defined to include not only clearing and settlement participants, but also end-users, alternative market operators, technology service providers and other relevant stakeholders. As part of this, ASX should engage with users to establish a clear and transparent medium-term program of investment in the core clearing and settlement infrastructure, including the Clearing House Electronic Sub-Register System (CHESS), that is directed towards users' needs and adopts (if not exceeds) relevant international best practice wherever practicable.

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Transparent and non-discriminatory pricing of clearing and settlement services. ASX should strengthen transparency in the pricing of its services by publishing detailed financial statements for its cash equity clearing and settlement subsidiaries. Further, all prices of individually unbundled clearing and settlement services, including rebates, revenue-sharing arrangements and discounts applicable to the use of these services, should:

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be transparent to all users of the services, including end-users and alternative market operators

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not discriminate between ASX-affiliated and other users of clearing and settlement services

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be made available to stakeholders in a form such that the impact of pricing changes can be readily understood, including the extent to which they have the potential to materially shift revenue streams between trading, clearing and settlement services.

Further, the Code should ensure there is a process for establishing an appropriate internal cost allocation model and policies to govern the allocation of costs or transfer of prices between ASX group entities. Compliance with these policies would be expected to be subject to internal audit review, as well as periodic external review.

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Access to clearing and settlement services. In the absence of alternative providers of cash equity clearing and settlement services, ASX should facilitate access to the CHESS infrastructure on non-discriminatory and transparent terms. In particular, ASX should adhere to a protocol for dealing fairly and in a timely manner with requests for access, including timeframes for responding to enquiries.

The Agencies acknowledge that ASX has recently made some advances in areas contemplated by these principles and has committed to considerable investment in its post-trade services. There has, for instance, been a high level of user engagement in ASX's development of its proposed clearing service for OTC interest rate derivatives and detailed fee schedules across ASX's businesses are already publicly available. Furthermore, notwithstanding some dissatisfaction with the length and nature of commercial negotiations around access for alternative market operators, and certain contractual terms, access has in practice been granted via ASX's Trade Acceptance Service (TAS). The Agencies, however, recommend seeking a public and transparent commitment to adhere to a Code which embeds and enhances these practices, in accordance with the principles.

Recommendation 3: It is proposed that, at the end of the two years, the Agencies carry out a public review of the Code's implementation and effectiveness, and ASX's adherence to it. At the same time, the Agencies would review the prospect of granting a licence to a competing CCP, or of pursuing other regulatory outcomes.

Without pre-judging outcomes (which may be influenced by a range of factors), possible recommendations from this review could be to maintain the Code for a further period, to propose alternative regulatory arrangements for ASX, or to propose granting a licence to a competing CCP. Experience and evidence gathered during the preceding two year period will be considered in determining the outcome.

Review of Competition in Clearing Australian Cash Equities: Conclusions , Council of Financial Regulators report (June 2015)

Introduction and Executive Summary

On 11 February 2015, the government announced that the Council of Financial Regulators (CFR) and the Australian Competition and Consumer Commission (ACCC) - together, the Agencies - would commence a review of the policy position on competition in clearing Australian cash equities (the Review).

The Agencies previously carried out a review of competition in this market in 2012 (the 2012 Review).1 In light of stakeholder feedback, the CFR recommended that a decision on any licence application from a competing cash equity central counterparty (CCP) be deferred for two years. In the meantime, ASX was encouraged to develop a Code of Practice for the Clearing and Settlement of Cash Equities in Australia (the Code).2 The government endorsed these recommendations in February 2013 and ASX published the Code in August 2013.3

Immediately following the announcement of the current Review, the Agencies released a consultation paper, seeking stakeholder views on a range of potential policy approaches.4

This paper presents the Agencies' conclusions from the Review. As in the 2012 Review, the particular focus of this work has been the clearing of ASX-listed cash equity securities (ASX securities). After first providing some background on the Review, the paper discusses key messages from the stakeholder consultation. Within the context of these messages, the paper goes on to present some analysis carried out by the Agencies on the costs, benefits and other implications of the alternative policy approaches of competition and monopoly.

The last section of the paper draws together the key messages from the consultation process and the Agencies' supporting analysis. The Agencies favour a policy approach that is open to competition, while at the same time deals with industry concerns around a continued monopoly, should competition not emerge. This approach is reflected in a series of recommendations to the government, along with a discussion of regulatory and legislative measures required to implement these recommendations.

Stakeholder Views and Analysis of Alternative Policy Approaches

The CFR received written submissions from 19 stakeholders, including a wide range of market participants and industry associations. Representatives of the Agencies also hosted bilateral discussions with 25 stakeholders. Respondents expressed mixed views on the appropriate policy approach, drawing out a number of issues that the Agencies had identified in their own analysis of the costs and benefits of the alternative policy options.

1 A paper outlining the issues for consideration was issued in June 2012: see CFR (2012), 'Competition in the Clearing and Settlement of the Australian Cash Equity Market: Discussion Paper', June. Available at

http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/Competition-in-the-clearing-and- settlement-of-the-Australian-cash-equity-market.

2 The CFR's advice on competition in clearing of the cash equity market and the final report of the 2012 Review are available at http://www.treasury.gov.au/PublicationsAndMedia/Publications/2013/competition-of-the-cash- equity-market>.

3 The government's response to the Agencies' recommendations is available at

http://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2013/022.htm

4 The consultation paper is available at http://www.cfr.gov.au/publications/cfr-publications/2015/review-of- competition-in-clearing-australian-cash-equities.pdf.

The case for competition

Consistent with the Agencies' analysis, most respondents acknowledged that competition in clearing could give rise to both benefits and costs. As in the 2012 Review, the main benefits cited were the prospect of lower clearing fees, improved product and service offerings, and the creation of a platform for broader financial market innovation. Unaffiliated market operators, in particular, saw competition in clearing as a prerequisite for vibrant competition at the trading level.5 Unaffiliated market operators also reported difficulties in negotiating clearing and settlement arrangements with ASX as a vertically integrated incumbent. Accordingly, some respondents were strongly in favour of lifting the moratorium on competition in the clearing of Australian cash equities immediately.

Others were in favour of competition in principle, but proposed a further deferral of competition for a period. This primarily reflected uncertainty about whether the benefits of competition would exceed the costs in this market. And a small number of respondents argued that a single provider was the best outcome for the Australian cash equity clearing market.

As a general matter, the economics of central clearing favour the existence of relatively few CCPs in a market. Multiple CCPs are most likely to coexist where the market size is sufficiently large, where competing CCPs can leverage technology and operational capacity in other products or markets, where the market is segmented, or where netting benefits are preserved through interoperability. This is evidenced by the fact that to date, competition in clearing has been almost exclusively a European phenomenon, where it was primarily driven by the integration of multiple national markets.

A number of respondents also noted that the issue of competition should be considered in the context of the global financial system. Even if there was no competition within the Australian clearing market, these respondents considered that ASX would still be subject to competition from international cash equity markets.

Safe and effective competition

The Agencies have identified a number of implications that competition in clearing could have for financial stability, the functioning of markets and access. Stakeholders expressed a range of views about the potential costs and risks of a multi-CCP environment and how these might best be managed. The principal costs cited were fragmentation of liquidity, a loss of netting benefits and increased operational costs. Stakeholders also agreed that competition could give rise to potential financial stability risks, including instability in the event of a commercially driven exit of a CCP.

Many respondents felt, however, that the minimum conditions for safe and effective competition proposed by the Agencies in the consultation paper would be sufficient to address any concerns about financial stability and market efficiency in a multi-CCP environment. These minimum conditions related to: (i) adequate regulatory arrangements; (ii) appropriate safeguards in the settlement process; and (iii) access to existing settlement infrastructure on non-discriminatory and transparent commercial terms.

Consistent with the Agencies' analysis, many respondents agreed that interoperability between competing CCPs would be desirable as a means of mitigating some of the costs associated with a multi-CCP environment. In particular, since interoperability would permit participants to concentrate their clearing in a single CCP, participants may be able to avoid the potentially material costs of fragmentation, un-netting and duplicated operational connections.

5 Unaffiliated market operators include alternative listing markets and competing trading venues for ASX securities.

Prospect of competition

There was near consensus among stakeholders that, even if the moratorium were lifted, a competing CCP would be unlikely to emerge in the near term - if at all. Many stakeholders took the view that the proposed minimum conditions would materially increase the cost of establishing a competing CCP. In particular, the application of the CFR's framework for ensuring that domestic regulators retain sufficient regulatory influence over cross-border clearing and settlement (CS) facilities operating in Australia (the Regulatory Influence Framework) could be a barrier to entry. This framework imposes domestic location requirements where a CS facility is both systemically important and strongly domestically connected. In the case of the Australian cash equity market, a provider of clearing services would be required to incorporate domestically at a relatively low threshold of activity. Together with a number of other forces in favour of a single provider, including the relatively small scale of the Australian market, the domestic location requirements could make any business case for competition commercially unattractive, at least in the near term. Nevertheless, a number of respondents agreed that these requirements were necessary to manage potential financial stability risks, particularly in the event that an overseas CCP entered insolvency.

As in the 2012 Review, respondents to the consultation generally agreed that competition in the settlement space was unlikely to emerge.

Dealing with a continued monopoly

Since the threat of a competitor entering the clearing market could be weak, many respondents felt that some interim measures were required to deal with an ongoing monopoly until such time as competition emerged. Respondents that supported an extension to the moratorium similarly suggested that safeguards should remain in place for as long as ASX continued to operate as a monopoly provider of cash equity CS services. There was a wide range of views about the appropriate 'interim' measures for dealing with a continued monopoly in both clearing and settlement.

Respondents expressed mixed views about the effectiveness and usefulness of the existing Code. While some saw the Code as having been beneficial in improving transparency and user engagement, others questioned whether it had achieved its intended purpose. Notwithstanding that ASX has recently committed to upgrade the infrastructure supporting its cash equity CS facilities, a number of stakeholders considered that various initiatives taken by ASX under the auspices of the Code were just good business practice, and suggested that some of these should have been adopted earlier.

Many respondents also suggested that the Code did not go far enough to address the industry's concerns in the prolonged absence of competition. There was, for example, some support for greater independence and market user representation on the ASX Clear and ASX Settlement Boards. Unaffiliated market operators also called for 'open access' measures, with some wider support for structural, operational or at least deeper governance separation of the cash equity CS facilities.

There were mixed views about the appropriate level of direct regulatory intervention to enforce such interim measures. Many respondents suggested that some enforceable regulation or oversight would be necessary, and some acknowledged that this might require the use of legislative tools. Most respondents did not consider that a 'full regulation' approach would be necessary.

Conclusions from the Review

The Agencies have identified three core conclusions from the consultation process and their supporting analysis:

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The policy approach should be one of openness to competition. This policy stance would recognise the potential benefits of competitive discipline. It would also be consistent with the prevailing legislative settings in the Corporations Act 2001 that envisage competition, and the orientation towards competition in the 2014 Financial System Inquiry (FSI). Indeed, this policy approach would reflect the environment in which ASX operated until February 2013, when the government supported the CFR's recommendation to defer any consideration of competition in clearing cash equities. Taking the alternative path of prohibiting competition and establishing a statutory monopoly in cash equity clearing would be unprecedented internationally. To do so would require an unequivocal conviction that a single provider was the optimal market structure for cash equity clearing.

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Competition, even if permitted, may not emerge for some time, if at all. There remain strong forces in favour of a single provider of clearing services. A competing CCP may therefore never emerge (or at least not for some considerable time). This could weaken the discipline on ASX from contestability of clearing.

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The relevant regulators should have powers to deal with an ongoing monopoly. If the moratorium were lifted, ASX could choose to withdraw the Code. However, unless the threat of competition was sufficiently strong, market forces alone might be unable to discipline ASX's conduct. This suggests that the relevant regulators should be able to intervene as necessary to address industry concerns arising from a continued monopoly.

Reflecting these views, the Agencies have developed a number of recommendations. These include recommendations that the government implement legislative reforms that would give the relevant regulators rule-making and arbitration powers both to facilitate safe and effective competition in clearing, and to deal with the continued monopoly provision of cash equity CS services until such time as competition emerged.

Recommendation 1. Confirm a policy stance that supports openness to competition in the clearing market for ASX securities, and implement legislative changes to facilitate safe and effective competition in accordance with the Minimum Conditions.

The evidence from the Agencies' consultation and supporting analysis leads to a conclusion in favour of lifting the moratorium on consideration of a licence application from a competing CCP. A policy stance that supports openness to competition would recognise prevailing legislative settings in the Corporations Act as well as the potential benefits of competitive discipline.

In order to clarify how the relevant regulators would manage the potential costs and risks associated with a multi-CCP environment for clearing, the CFR would set out the minimum conditions for safe and effective competition in a publicly stated policy. Reflecting industry views and additional analysis carried out by the Agencies, these minimum conditions would extend beyond those articulated in the consultation paper to also require that appropriate interoperability arrangements be established prior to a competing cash equity CCP commencing operations (together, the Minimum Conditions). The Agencies anticipate publishing the stated policy in late 2015 or early 2016.

Since some aspects of the Minimum Conditions are not enforceable under the existing regulatory framework, the Agencies recommend implementing legislative changes that would allow the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (the Bank) (together, the Regulators) to implement and enforce the Minimum Conditions if and when a competitor emerged.

The Regulators would be unable to advise in favour of a competing cash equity CCP licence application until these measures had been implemented. The Agencies accept that this process could take some time. Consistent with the position of openness to competition, however, the Regulators would be prepared to engage with any potential entrant in the interim and commence consideration of a licence application, should one be submitted.

The proposed legislative framework to implement the Minimum Conditions would set out the relevant high-level requirements, and would empower the relevant regulators to make rules that impose specific obligations on CS facilities at a later stage through the use of rule-making powers. These rules would not be implemented until such time as a committed competitor emerged or was likely to emerge.

The Agencies recognise that the rule-making process and the need to make operational arrangements to support a multi-CCP environment would further extend the length of time between any submission of an application by a competitor and the commencement of operations. However, to implement the rules with a requirement that operational changes be made in advance would lead to redundant industry investment and regulatory cost should a competitor never emerge. This is particularly important given the rules will deal with matters such as interoperability and materially equivalent settlement arrangements between the emerging competitor and incumbent CCP, which could be costly to establish.

The Minimum Conditions would also need to be supported by an ACCC arbitration power to ensure that a competing CCP was able to access ASX monopoly settlement infrastructure on fair, transparent and non-discriminatory terms (see Recommendation 4).

Recommendation 2. The Agencies publicly set out regulatory expectations for ASX's conduct in operating its cash equity clearing and settlement facilities until such time as a competitor emerged.

Since the proposed legislative framework for safe and effective competition would not be in place for perhaps a number of years, and since competition might not emerge for some time even once the framework was in place, the effectiveness of the discipline from the competitive threat could be limited. Accordingly, the discipline from the competitive threat may need to be supplemented with other measures.

The Agencies would therefore publicly issue a set of regulatory expectations for the conduct of ASX's monopoly cash equity CS operations, in support of the long-term interests of the Australian market. It is anticipated that these expectations would be issued at the same time as the Minimum Conditions were set out as a publicly stated policy (see Recommendation 1). These expectations would apply to the cash equity clearing and settlement facilities (both of which are currently covered under the Code), and would remain in place for each of these facilities for as long as each remained a monopoly. The regulatory expectations would address the key governance, pricing and access matters currently dealt with under the Code, as well as some additional matters raised by stakeholders during the consultation and some of the new commitments proposed by ASX in its submission to this Review.

Recommendation 3. Implement legislative changes that would allow the relevant regulators to impose requirements on ASX's cash equity clearing and settlement facilities consistent with the regulatory expectations if these expectations were either not being met or were not delivering the intended outcomes.

As in the case of the Minimum Conditions, the regulatory expectations would not be legally enforceable under the existing regulatory framework. Since the threat of competition alone may not exert sufficient discipline on ASX, the Agencies consider it important not only that the regulatory expectations remain in place until the emergence of a competitor, but also that the relevant regulators would be able to impose enforceable requirements on ASX where the regulatory expectations were either not being met or not delivering the intended outcomes.

The Agencies therefore recommend further legislative change that would permit the use of rule- making powers. These powers would be used to impose specific obligations on ASX's cash equity CS facilities to act in accordance with the regulatory expectations. The powers would be held in reserve and would be expected to be used only in the event of a material deviation from the expectations or where ASX's conduct was generating undesirable outcomes for the market but was not sufficiently severe to trigger intervention by the ACCC under the Competition and Consumer Act 2010 (the CCA). The rule-making powers would be used to address systematic problems, rather than specific issues arising between particular parties.

Recommendation 4. Implement legislative changes to grant the ACCC an arbitration power to provide for recourse to binding arbitration in disputes about the terms of access to ASX's monopoly cash equity clearing and settlement services.

ASX will have incentives to discriminate in favour of its own operations when providing monopoly CS services to its competitors in related markets. To address this concern, the Agencies recommend legislative changes to implement an arbitration regime administered by the ACCC. The arbitration power would complement the rule-making powers proposed in Recommendations 1 and 3 by allowing for a more targeted regulatory response to specific access issues.

Arbitration would be available to parties requiring access to ASX's monopoly cash equity CS services in order to compete with ASX's operations in related markets; this would include unaffiliated market operators, CCPs and settlement facilities. The arbitration power would only be available for a material dispute where parties were genuinely unable to agree on terms of access to ASX's monopoly cash equity CS services through commercial negotiation. The arbitration power would provide an incentive for ASX to negotiate commercial and non-discriminatory terms of access, and would otherwise provide for timely resolution of access-related disputes.

The Agencies consider that the threat of arbitration by a regulator would be likely to provide an effective discipline on ASX. As the competition regulator, the ACCC would be well placed to assume an arbitration role in relation to disputes on the terms of access to ASX's monopoly CS services as a backstop to commercial negotiation. The Agencies consider that having the competition regulator assume this arbitration role would provide the greatest discipline on ASX and promote competition in related markets.

Safe and Effective Competition in Cash Equity Settlement in Australia: Response to Consultation

A Response to Consultation by the Council of Financial Regulators

September 2017

© Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury 2017. All rights reserved.

The contents of this publication shall not be reproduced, sold or distributed without the prior consent of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury.

ISBN 978-0-6480470-4-9 (Online)

Introduction and Background

In March 2016, the Government endorsed the recommendations of a 2015 review of competition in clearing cash equities in Australia (the Review), conducted by the Council of Financial Regulators (CFR) in collaboration with the Australian Competition and Consumer Commission (ACCC) (together, the Agencies).1 In October 2016 the Agencies released two policy statements: Regulatory Expectations for Conduct in Operating Cash Equity Clearing and Settlement Services in Australia (Regulatory Expectations); and Minimum Conditions for Safe and Effective Competition in Cash Equity Clearing in Australia (Minimum Conditions (Clearing)).2

These policy statements were developed based on the assumption that the prevailing market structure in settlement (in which ASX Settlement Pty Limited (ASX Settlement) is the sole provider of settlement services) would continue, at least for the foreseeable future. However, the Agencies are aware that industry developments (such as the emergence of new technologies) may challenge the previous assumptions regarding the future market structure for settlement services. In addition, the statutory framework (Part 7.3 of the Corporations Act 2001 (Corporations Act)) applies to both clearing and settlement. This has prompted the Agencies to consider the need for specific policy guidance in respect of competing securities settlement facilities (SSFs).3

In March 2017, the Agencies released the consultation paper: Safe and Effective Competition in Cash Equity Settlement in Australia (the Consultation Paper), which sought views on whether the prospect of competition in the settlement of cash equities in Australia may have increased, and invited feedback on the development of policy guidance for such competition.4 The Consultation Paper did not review the policy case for competition in settlement, noting that the Government has endorsed a position of openness to competition.5

The Consultation Paper defined settlement as the transfer of securities in exchange for payment (i.e. the delivery-versus-payment (DvP) process). The paper also acknowledged that there are a range of services that are ancillary to settlement, and sought feedback on the contestability of these services. The Consultation Paper discussed a number of potential implications of competition in settlement, including for the efficient functioning of markets, financial stability and access. It also presented some potential controls to support safe and effective competition, should it emerge. In developing these potential controls, the Agencies had regard to the structure of the Minimum Conditions (Clearing).

1 See Review of Competition in Clearing Australian Cash Equities: Conclusions, A Report by the Council of Financial Regulators, June 2015 available at:

http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Review-of-competition-in-clearing- Australian-cash-equities.

2 The Regulatory Expectations apply to the Australian Securities Exchange's (ASX) engagement with, and provision of services to, users of its monopoly cash equity clearing and settlement services, for both ASX-listed and non-ASX-listed securities. The Minimum Conditions (Clearing) establish a set of minimum conditions to support safe and effective competition should a competing provider of clearing services emerge. These policy statements establish a flexible policy framework so that if competition in clearing were to emerge, the Minimum Conditions (Clearing) would apply while the Regulatory Expectations would continue to apply to the provision of ASX's ongoing monopoly settlement service. The policy statements are available at: http://www.cfr.gov.au/media-releases/2016/mr-16-02.html>.

3 The Agencies' consideration of the need for specific policy guidance was limited to the circumstance when trades in the same listed cash equity security could be settled in more than one SSF. The Agencies did not consider the need for policy guidance on the potential emergence of competition in the settlement of other listed or unlisted products.

4 The Consultation Paper is available at: https://www.cfr.gov.au/publications/consultations/safe-and-effective- competition-in-cash-equity-settlement-in-australia/pdf/consultation-paper.pdf.

5 The media release announcing the Government's openness to competition is available at:

http://sjm.ministers.treasury.gov.au/media-release/034-2016/.

This response to consultation summarises the key feedback from stakeholders (Section 2) and the Agencies' views on how this feedback should be addressed within the policy framework (Section 3). Where a summary of industry feedback is provided, the views presented are those of industry.

In line with this, the Agencies have published the Minimum Conditions for Safe and Effective Competition in Cash Equity Settlement in Australia (Minimum Conditions (Settlement)), which provide a set of controls for competition in settlement of cash equities in Australia.6 Similar to the Minimum Conditions (Clearing), the Agencies would expect to periodically review the Minimum Conditions (Settlement), including in the event of material changes to the operating environment or market structure, such as the emergence of a competing SSF. In light of this work, the Agencies have also reviewed the Regulatory Expectations and Minimum Conditions (Clearing) and made some minor consequential changes to ensure consistency of the language used across the policy statements.

Overview of Consultation Responses

The Agencies received 13 written responses to the Consultation Paper and held nine bilateral meetings with stakeholders. These stakeholders included licensed market operators, brokers, custodians, prospective providers of settlement services, share registries and industry bodies.

Stakeholder feedback to the consultation focussed on four main themes:

•

the likelihood of competition in settlement (and the associated potential risks and costs);

•

competition in services ancillary to settlement;

•

existing barriers to entry (including access to services (including data)); and

•

the proposed controls to support safe and effective competition should it emerge.

These four themes are discussed further below.

Likelihood of Competition in Settlement

Most stakeholders agreed that the prospect of competition in settlement has increased since the Agencies completed the Review in 2015. A majority of respondents attributed this to developments in technology, in particular, the emergence of distributed ledger technology.

Almost all stakeholders were concerned about the potential risks and inefficiencies that could arise from a market structure with competing SSFs. For example, some stakeholders expressed concerns regarding the duplication of effort required to process and reconcile information across multiple SSFs. Other concerns related to the additional costs and risks of connecting to more than one SSF.

Most responses also suggested that the potential for shortened settlement cycles and, particularly, differing settlement cycles across competing SSFs may increase operational risks and costs.7 Approximately half of the respondents questioned whether potential benefits of competition, such as lower prices, would be outweighed by additional costs associated with increased complexity. However, almost half felt that competition was desirable provided adequate regulatory safeguards were in place.

6 The Minimum Conditions (Settlement) are available at https://www.cfr.gov.au/publications/cfr- publications/2017/minimum-conditions-safe-effective-competition/pdf/policy-statement.pdf.

7 The risks arising from real-time settlement and the optionality of shorter settlement timeframes are not unique to a market structure with competing SSFs, but would also arise in the event that a single SSF sought to offer such optionality. The concerns expressed by stakeholders related to market fragmentation as a result of these differing timeframes and are discussed further in section 2.4.

Some responses indicated it was possible competition would emerge for a subset of settlement services. This may include the DvP settlement function of title transfer or other Clearing House Electronic Sub- register System (CHESS) services which occur in connection with this function, including corporate actions processing, sub-registry services and payment facilitation.

Competition in Ancillary Services

The Consultation Paper noted that there are a number of services ancillary to settlement, such as asset registration, safekeeping, issuer services (e.g. corporate actions) and investor services. The respondents provided a range of comments on these services, especially on their contestability and the interdependence with a DvP settlement service. Most respondents believed a competing SSF would need to provide at least some ancillary services in order to effectively provide a DvP settlement service. However, some suggested that as long as a competing SSF had access to the data held on the CHESS sub- register (or its replacement), it could effectively provide DvP settlement without also providing ancillary services.8

Some respondents noted that the range of ancillary services provided by ASX Settlement on a monopoly basis is limited, and that many ancillary services are already offered through the registries on a competitive basis. There were mixed views on whether competition has been beneficial for the provision of ancillary services. For example, several submissions noted that each of the registries use different processes and systems and that this results in some inefficiencies due to a lack of standardisation and automation (e.g. corporate actions processing). On the other hand, other stakeholders felt that competition among the registries had encouraged innovation - a primary example being the provision of securities holding statements in electronic form. At the same time, some submissions noted that competitive pressures had led to pricing benefits for certain services offered by the registries.

Some stakeholders noted that ASX's ongoing issuance of securities holding statements in hard copy was evidence of a lack of innovation. Some stakeholders also considered the fees charged for these statements to be excessive.

Several responses argued that, in order to improve the provision of ancillary services, promoting competition in ancillary services independently of competition in DvP settlement should be a priority.

Barriers to Entry - Access to Services (including data)

A large majority of stakeholders raised concerns over perceived barriers to entry for a competing SSF. The two main themes across the submissions centred on access to the data in the CHESS sub-register and concerns around ASX's vertically integrated market structure. Some respondents also noted practical and commercial considerations such as the small scale of the Australian cash equities market and the significant costs of developing a settlement system.

Almost all respondents expressed the view that, for competition in settlement to be effective, any competing SSF would need to be able to access data in the CHESS sub-register or its replacement (e.g. holder identification and securities holdings data).9 Access to other ASX monopoly services deemed necessary for competition was also mentioned by a majority of stakeholders. This may be required, for

8 Most corporate actions are currently performed by the registries and facilitated by access to information contained in the CHESS sub-register. Examples of corporate actions performed by registries include dividend payments, rights issues, share buy backs and capital reconstructions. The Agencies acknowledge that the ASX project to replace CHESS may impact competition in clearing and settlement. This is provided for in the Regulatory Expectations.

9 The listed cash equities supply chain begins with the issuer-requested registration of a cash equity on an approved listing market and continues through the trading, clearing and/or settlement functions, ending with the final registration of the (new) owner of the cash equity on the CHESS sub-register (which subsequently updates the registries' records).

example, to ensure legal certainty of settlement. Such services may include securities conversions and transfers between the CHESS and issuer sub-registries, and the issuance of CHESS holding statements.

Some respondents also argued that the data currently held in the CHESS sub-register should be provided by an independent utility service, in order to better facilitate competition across the Australian cash equities market. Some respondents suggested that settlement services more broadly (including DvP settlement) should be provided by an industry utility.

A second theme that emerged from a majority of the responses was concern around the current interdependency of the ASX Group's vertically integrated structure, which provides listing, clearing, settlement, CHESS sub-registry and other ancillary services. These submissions argued that this structure inhibited competition and encourages anti-competitive behaviour.

One submission suggested that, to facilitate genuine competition, the ASX Group should be operated as distinct functional entities (e.g. one for each of trading, clearing, settlement, registration) to address concerns around its vertically integrated structure.

Proposed Controls to Support Safe and Effective Competition

Stakeholder feedback generally supported the policy controls proposed in the Consultation Paper to support fair and effective competition in settlement. However, some respondents also argued the controls may need to go further. The majority of submissions commented that establishing appropriate links between competing SSFs would be required for effective competition. Some respondents argued that any policy guidance needs to make appropriate arrangements for a set of common principles for SSF rule-making, for instance to ensure certainty and integrity of legal title.

There were mixed opinions on whether new policy is needed to deal with default management where, for example, a defaulting entity may be a settlement participant in competing SSFs. While some respondents thought it was important that regulators be involved, some instead considered default management to be primarily the responsibility of the central counterparty. Some of the submissions highlighted the difficulty in determining 'fair and reasonable pricing', and one wanted explicit regulatory oversight of pricing. Another also specifically suggested a review of ASX's pricing policies for non-Clearing and Settlement services.

The Consultation Paper asked for feedback about the potential effects of a competing SSF providing the choice of settlement timeframe and/or SSF as part of contract formation on a licensed market. Specifically, the Australian Securities and Investments Commission (ASIC) had concerns that this model may fragment market liquidity (e.g. from retail investors, institutional investors and proprietary traders), based on preferences of settlement timeframe, and/or SSF. A majority of submissions agreed with this concern.

More broadly, some stakeholders suggested that real-time settlement may only be particularly beneficial for retail clients (who typically pre-deliver securities and cash to their broker before placing orders). Stakeholders also broadly accepted that institutional clients (particularly overseas clients) would prefer a longer settlement cycle due to their trade netting and settlement matching needs. In contrast, one stakeholder thought that, although fragmentation of liquidity is more likely in a competitive post-trade environment, technology could overcome this problem with improved reporting and system interoperability.

There were also some different views over whether settlement timeframes and changes to other market infrastructure arrangements should move on a whole-of-market basis or in a more fragmented manner driven by individual SSFs. In a similar vein, there were differing views over which entities in the investment chain should make the choice of which SSF to use and, potentially, the resultant settlement period.

Other Issues

A number of other issues were raised by stakeholders:

•

Almost half of the submissions made comments related to the CHESS replacement project. For instance, there were some concerns the CHESS replacement project will further entrench the monopolistic vertically integrated structure currently in place.

•

One stakeholder called for the Agencies to expand the scope of the current consultation to include an end-to-end review of competition throughout the equities market (from listing, through trading, clearing and settlement, to registration).

•

Some submissions commented on current registry arrangements, for example, noting the costly nature of the fragmented sub-register system. In addition, one respondent argued to change the Australian 'name-on-register' model to a central securities depository model) - although other submissions supported the current model.

•

Some respondents expressed concerns that the Corporations Act and Corporations Regulations 2001 (Regulations) need to be amended to allow the licensing of an entrant SSF given the legacy references to ASX Settlement and Transfer Corporation Pty Limited or ASTC (the former name of ASX Settlement) in these instruments.

•

Some respondents were concerned about the perceived suggestion in the Consultation Paper that the Agencies were considering the mandatory imposition of clearing for all markets. The Agencies would like to make clear that they do not propose to impose mandatory clearing requirements for listed securities over and above existing regulatory obligations for the clearing and settlement of these securities.

•

One submission suggested that licence conditions be imposed on ASX to enforce compliance with the Regulatory Expectations and the Minimum Conditions or, failing this, fast tracking the legislative amendments recommended to the Government, in order to grant rule-making and arbitration powers to the relevant Agencies.

Response to Consultation Feedback

Given strong stakeholder support for the development of policy guidance on the possible emergence of competition in settlement, the Agencies have decided to extend the existing policy framework for competition in clearing. Consequently, the Agencies have published the Minimum Conditions (Settlement), to support safe and effective competition in the settlement of cash equities, should it emerge.

Relatedly, as a result of the substantive feedback from stakeholders, the Agencies also reviewed the Regulatory Expectations and Minimum Conditions (Clearing) to assess whether any consequential changes were required to address the potential emergence of a competing SSF. Minimal changes were made to these policy statements, including noting the increased likelihood of competition in settlement.

Similar to the Minimum Conditions (Clearing), the Minimum Conditions (Settlement) aim to give prospective providers of settlement services sufficient clarity as to the measures that ASIC and the Reserve Bank of Australia would require be taken before they could advise in favour of a licence application.

The Minimum Conditions (Settlement) build off the controls proposed in the Consultation Paper. In response to consultation feedback, the Agencies have amended the controls as initially proposed, to incorporate a clarification and two additions, as follows:

•

Access on transparent, non-discriminatory, and fair and reasonable terms: The Agencies acknowledge that in order to offer safe and effective settlement services, competing SSFs are likely to require access to the data of other Clearing and Settlement (CS) facilities. The Minimum Conditions (Settlement) specifically address stakeholder concerns about access to certain data necessary for the provision of settlement services by a competing SSF. CS service providers will be required to facilitate access to their respective services (including data) on a transparent and non- discriminatory basis, with terms and conditions, including price, that are fair and reasonable. The Agencies note that the Government is implementing legislative changes that will grant the ACCC power to arbitrate disputes about the terms of access, including pricing. The Agencies recognise that certain ancillary services are necessary to support the provision of DvP settlement. Those ancillary services necessary to DvP settlement will ultimately be a function of each SSF's business model, and may change over time (including due to ASX's CHESS replacement project).

•

Appropriate arrangements for certainty of securities transfer and administration: An additional control has been included to address concerns regarding certainty of securities transfer and administration. There may be circumstances under which registries, acting on behalf of issuers, receive conflicting instructions from competing SSFs, related to the same listed security. The registry will need to determine how to prioritise those instructions to ensure the resulting change of title to the securities is legally certain. Accordingly, the Agencies consider there is a case, if required, for regulatory arrangements to support certain aspects of the legal relationship between competing SSFs, registries and issuers.

•

Appropriate regulatory arrangements for oversight of primary and secondary markets: This additional control recognises ASIC's strong regulatory interest in the potential impact on price formation, liquidity and fragmentation in markets where there is a choice offered between settlement timeframes at the point of trade execution. The purpose of the control is to alert potential entrant SSFs that including a choice of settlement timeframe in their business case may have implications for any CS facility licence application. ASIC would therefore have a regulatory role in any proposal in which the choice of settlement timeframe and/or SSF might have potential market impacts.

Regarding stakeholder feedback on default management arrangements, the Agencies' expectation is that application of the existing regulatory framework for CS facilities in a multi-SSF environment should be sufficient to address any additional risks.

Stakeholder feedback suggests it is possible that competition could emerge from either a competing full service SSF or from a facility which provides a select number of settlement services only. In the latter case, the Regulatory Expectations will continue to apply to the remaining subset of monopoly CS services. Complementing this, the Minimum Conditions (Settlement) will apply to the contested settlement services.

Other Issues

As noted above, stakeholders also raised several broader points in their responses to the consultation. The Agencies' responses are outlined below.

•

Appropriate market structure for settlement services: Consistent with the conclusions drawn from the Review, the Agencies consider that the most appropriate market structure for SSF services should be determined by the market. Comments related to current registry arrangements were considered by the Agencies but remain outside the scope of the policy aims of the consultation.

•

Broader review on competition in listed cash equities markets: The Agencies' view is that a broader end-to-end review on competition in listed cash equities markets (i.e. from listing through trading, clearing and settlement, to registration), is not in the scope of the current consultation. ASIC has completed significant work on the structure of cash equity markets in Australia, including the development and implementation of ASIC rules to preserve market integrity following the introduction of competition between market operators. ASIC's policy work in cash equity market structure, including competition, is ongoing. This work, together with the Agencies' published policy framework for competition in clearing and the proposed Minimum Conditions (Settlement) effectively establishes a policy framework for safe and effective competition in the listing, trading, clearing and settlement of cash market equities in Australia. ASIC and the ACCC will discuss stakeholder feedback relevant to the equity market structure in Australia, and the potential for future policy collaboration on competition.

•

Data access issues for settlement services: In its consideration of data access issues, the Agencies were mindful of the recently released Productivity Commission Inquiry Report on Data Availability and Use.10 The Agencies will give consideration to the investor and market infrastructure data implications with respect to future developments in the Government's data policy.

•

Productivity Commission Inquiry: The Productivity Commission is also currently conducting a broader inquiry into competition in the Australian financial system, having released a consultation paper on 6 July 2017. The Productivity Commission has announced its intention to avoid overlap with other active reviews. The Agencies will engage with the Productivity Commission on the CFR's established policy framework on competition in clearing and settlement for Australian cash equities and the Government's announced reform package.

•

CHESS replacement project: The Agencies acknowledge that ASX's CHESS replacement project may have a significant impact on the market, and may interact with the issues discussed in the Consultation Paper. The Regulatory Expectations, which apply to ASX's engagement and provision of services to users of its monopoly cash equity CS services, establish the Agencies' expectation that ASX will provide commercial, transparent and non-discriminatory access to its monopoly CS services.

•

References in the Act and Corporations Regulations to ASX Settlement and Transfer Corporation Pty Ltd: Treasury will consider changes to amend legacy references (such as ASTC) in the Corporations Act and Regulations as part of the development of draft legislation to implement the Government's announced reform package.

Next Steps

Along with this response to consultation, the Agencies have concurrently published the Minimum Conditions (Settlement), consequential amendments to the Regulatory Expectations and the Minimum Conditions (Clearing).

The Agencies will work with the Government on the development of draft legislation to fully implement the policies set out in the Regulatory Expectations, the Minimum Conditions (Clearing) and the Minimum Conditions (Settlement). The draft legislation will incorporate changes to the Corporations Act to implement rule-making powers for the relevant Agencies and an arbitration power for the ACCC.

As noted above, the Agencies will engage with the Productivity Commission on the Government's announced reform package to regulate both the ongoing provision of ASX's monopoly CS facilities services for Australian cash equities, and the potential emergence of competition in these services.

10 The Productivity Commission's Inquiry Report on Data Availability and Use is available at:

http://www.pc.gov.au/inquiries/completed/data-access/report.

Regulatory Expectations for Conduct in Operating Cash Equity Clearing and Settlement Services in Australia

A Policy Statement by the Council of Financial Regulators

As revised September 2017

© Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury 2016. All rights reserved.

The contents of this publication shall not be reproduced, sold or distributed without the prior consent of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury.

ISBN 978-0-9924944-5-2 (Online)

Background

On 30 March 2016, the Government endorsed the conclusions of a review of competition in clearing Australian cash equities carried out by the Council of Financial Regulators (CFR) and the Australian Competition and Consumer Commission (ACCC) - together, the Agencies - in the first half of 2015. These conclusions are set out in the Agencies' report, Review of Competition in Clearing Australian Cash Equities: Conclusions (the Conclusions), published at the time of the Government's announcement.1

Among the conclusions arising from the review, the Agencies undertook to publicly set out regulatory expectations for ASX's conduct in operating its cash equity clearing and settlement (CS) services until such time as a committed competitor emerged. The Conclusions presented the core elements that the Agencies expected to be included in the set of regulatory expectations. The core elements aim to address key governance, pricing and access matters that are dealt with under ASX's pre-existing Code of Practice for the Clearing and Settlement of Cash Equities in Australia (the Code), as well as some of the additional commitments proposed by ASX in its submission to the review and some gaps in the Code identified by stakeholders. Consistent with the Agencies' commitment and drawing primarily on the core elements proposed in the Conclusions, the Agencies released the Regulatory Expectations for the Conduct of Cash Equity Clearing and Settlement Services in Australia (Regulatory Expectations) in October 2016.

In the first half of 2017, the Agencies consulted on the prospect of competition in settlement of cash equities in Australia. The stakeholders' responses are set out in the Agencies' report, Safe and Effective Competition in Cash Equity Settlement in Australia: Response to Consultation.2 The Agencies subsequently identified some aspects of the Regulatory Expectations that required consequential amendments, and have therefore issued these revised Regulatory Expectations in September 2017.

The Regulatory Expectations apply to ASX's engagement with, and provision of services to, users of its monopoly cash equity CS services for both ASX-listed and non-ASX-listed securities. Users are broadly defined to include participants of the ASX CS facilities; end users; unaffiliated market operators, central counterparties and settlement facilities; technology service providers; and other relevant stakeholders.

ASX is expected to act in accordance with these revised Regulatory Expectations. The Agencies acknowledge that the Regulatory Expectations are not legally enforceable under the existing legislative framework. Accordingly, the Conclusions recommended that legislative changes be implemented to grant the relevant regulators rule-making powers that would enable them to impose enforceable requirements on ASX consistent with the Regulatory Expectations if these expectations were either not being met or were not delivering the intended outcomes. These powers would be held in reserve and would be expected to be used only in the event of a material deviation from the Regulatory Expectations or where ASX's conduct was generating undesirable outcomes for the market. In addition, the Conclusions recommended that the ACCC be granted an arbitration power that would provide for binding resolution of material disputes, arising where a user was seeking access to any aspect of ASX's monopoly cash equity CS services, consistent with the Regulatory Expectations. The ACCC may therefore have regard to the Regulatory Expectations when making a binding determination under the proposed arbitration power. The Government has committed to pursue legislative changes in accordance with these recommendations.

Should a committed competitor emerge for any aspect of ASX's cash equity CS services, the Agencies will review and make any necessary changes to the scope of the Regulatory Expectations. The Agencies also expect to review the Regulatory Expectations periodically, including in the event of material changes to the operating environment for these services. Such reviews may assess the ongoing appropriateness of the Regulatory Expectations and their effectiveness in delivering the intended outcomes, with consideration given to stakeholder feedback.

The Agencies will also establish structured arrangements for engaging with stakeholders in relation to ASX's adherence to the Regulatory Expectations.

1 The Conclusions and the Government's response are available at http://www.treasury.gov.au/ ConsultationsandReviews/Consultations/2015/Review-of-competition-in-clearing-Australian-cash-equities.

2 The Response to Consultation is available at https://www.cfr.gov.au/publications/cfr-publications/2017/safe- effective-competition-response/pdf/response-to-consultation.pdf.

Regulatory Expectations

The Regulatory Expectations for the conduct of ASX's monopoly cash equity CS services are intended to support the long-term interests of the Australian market by delivering outcomes that are consistent with those that might be expected in a competitive environment. In particular, the Regulatory Expectations seek to ensure that ASX remains responsive to users' evolving needs and provides access to its monopoly cash equity CS services on a transparent and non-discriminatory basis with terms and conditions, including pricing, that are fair and reasonable.

ASX should maintain its Code, or should adopt another equivalent mechanism, to give effect to the Regulatory Expectations. ASX has also, in its Code, committed to submitting an annual external audit of its governance, pricing and access arrangements to the Agencies and members of relevant user governance arrangements, benchmarked against the Regulatory Expectations. This audit generally would not be required to form a judgement on the more subjective matters contained in the Regulatory Expectations, such as the promptness and efficiency of investments or the efficiency of prices. Rather, such an audit should develop an evidence base of relevant actions taken by ASX, and in particular provide assurance that it has policies and procedures in place aligned with the Regulatory Expectations and that it has conducted its operations in accordance with these policies and procedures. The outcomes of such audits are expected to be discussed with the ASX Boards, the Agencies and members of relevant user governance arrangements. The findings of such audits may be one input to any decision by the relevant regulators to employ the rule-making or arbitration powers once the supporting legislative framework is in place. The Agencies may additionally periodically request that ASX commission more detailed reviews of how particular aspects of its governance, pricing and access arrangements meet the Regulatory Expectations, or indeed carry out such reviews themselves.

Consistent with its existing arrangements to comply with its broader obligations under the Corporations Act 2001, ASX should continue to capture any complaints submitted by users, as well as its corresponding responses, within its complaints-handling system.

The Regulatory Expectations comprise the elements set out below.

User input to governance

To ensure responsiveness to users' evolving needs, transparent formal mechanisms should be maintained within ASX's governance framework to give users a strong voice in strategy setting, operational arrangements and system design, and to make ASX's monopoly cash equity CS services directly accountable to users. As part of this:

(a)

ASX should make an explicit public commitment to investing promptly and efficiently in the design, operation and development of the core CS infrastructure for the Australian cash equity market, including the Clearing House Electronic Sub-register System (CHESS) and any future replacement system. This commitment should be supported by governance processes that enable users to provide input on the setting of the investment strategy. Investments should ensure that, to the extent reasonably practicable, the performance, resilience, security and functionality of the core CS infrastructure meet the needs of users, recognising the diversity and differing needs of users. At a minimum, the core CS infrastructure should accommodate internationally accepted communication procedures and standards.

(b)

ASX should ensure that the membership of its user governance arrangements is representative of the user base of its CS services, and that members are able to have a strong input into the agenda and format of meetings or other user governance mechanisms and the setting of priorities.

(c)

ASX should demonstrate that it has had regard to the views of members in setting the terms of reference for the external audits of its governance, pricing and access arrangements carried out in accordance with the Regulatory Expectations. This may take the form of members' non- objection of the proposed terms of reference. These terms of reference may change following any review of the Regulatory Expectations.

(d)

ASX should maintain accountability arrangements that provide for regular public attestations as to the effectiveness of its interactions with users. For example, the following arrangements would be appropriate:

(i)

ASX's user governance mechanisms operate on a 'comply or explain' basis; that is, the relevant Board would take actions in accordance with recommendations from the user governance mechanisms, or else explain why such actions had not been taken.

(ii)

ASX report, on at least an annual basis, the service developments and investment projects that it has progressed and how it has taken into consideration the views of users.

(e)

ASX should formally commit to retaining a Board structure for ASX Clear and ASX Settlement that comprises a minimum of 50 per cent of non-executive directors that are also independent of ASX Limited, and where a subset of these independent directors can form a quorum.

(f)

ASX should establish governance structures and reporting lines at the management and operational levels that promote access to its CS services on commercial, transparent and non-discriminatory terms. These arrangements should ensure that the interests of users are upheld in accordance with Regulatory Expectation 3. This may be demonstrated, for example, through the key performance indicators set for relevant management.

Transparent, non-discriminatory, and fair and reasonable pricing of CS services

ASX should publicly commit to an appropriate minimum level of transparency of pricing across its range of monopoly cash equity CS services (including the provision of data). The pricing of these services should not discriminate in favour of ASX-affiliated entities (except to the extent that the efficient cost of providing the same service to another party was higher). Other than where pricing is anti-competitive or gives rise to financial stability or market functioning issues, the fees charged by ASX are a commercial matter for ASX and its customers. Nevertheless, to ensure that the fees charged by ASX for its cash equity CS services are transparent, non-discriminatory, and fair and reasonable:

(g)

ASX should ensure that all prices of individually unbundled CS services, including rebates, revenue-sharing arrangements and discounts applicable to the use of these services:

(i)

are transparent to all users of the services

(ii)

do not discriminate in favour of ASX-affiliated entities, except to the extent that the efficient cost of providing the same service to another party was higher

(iii)

are made available to stakeholders in a form such that the impact of pricing changes can be readily understood.

(h)

ASX should maintain an appropriate method for determining the prices of its CS services so as to generate expected revenue that reflects the efficient costs of providing those services, including a return on investment commensurate with the commercial risks involved.

(i)

ASX should make an explicit public commitment that any changes in the prices of its CS services will not be implemented in a way that would materially shift revenue streams between aspects of its trading, clearing and settlement services.

(j)

ASX should publish any increases in its CS fee schedules along with an attestation justifying their reasonableness. For the most material such increases, this attestation would be expected to refer to relevant metrics and other evidence, such as the calculated return on equity, benchmarked price lists, or an independent review of how ASX's cash equity CS fees compare with those of CS facilities in other markets.

(k)

ASX should maintain an appropriate model for the internal allocation of costs, including the cost of allocated capital, as well as policies to govern the transfer of prices between the relevant ASX Group entities. Compliance with the model and policies would be expected to be subject to internal audit review. The model and policies should be based on reasonable cost allocation principles. For example:

(i)

where possible, costs should be directly allocated to the service(s) which give rise to those costs

(ii)

shared costs should be allocated based on appropriate and transparent metrics.

(l)

ASX should negotiate commercially and in good faith with unaffiliated market operators and CS facilities regarding fees and other financial contributions charged for any extensions to its monopoly CS services, and in particular those provided under the existing Trade Acceptance Service and the Settlement Facilitation Service.

Commercial, transparent and non-discriminatory access to CS services - service levels, information handling and confidentiality

ASX should facilitate access to its cash equity CS services (including data) on commercial, transparent and non-discriminatory terms. Non-discriminatory terms in this context are terms that do not discriminate in favour of ASX-affiliated entities (except to the extent that the cost of providing the same service to another party is higher). As part of this:

(a)

ASX should have objectives for its CS services that include an explicit public overarching commitment to supporting access to its CS services on commercial, transparent and non- discriminatory terms. ASX should maintain standard user terms and conditions that are consistent with these objectives, taking into account the legitimate business interests of ASX and any parties seeking access to its CS services.

(b)

Service level agreements should commit ASX to providing access to its CS services for unaffiliated market operators and CS facilities on operational and commercial terms and service levels that are materially equivalent to those that apply to ASX as a market operator or CS facility.

(c)

ASX should publish and adhere to protocols for dealing fairly and in a timely manner with requests for access. These protocols should include reasonable timeframes for responding to enquiries and arrangements for dealing with disputes. Nothing in the protocols should affect either party's right to refer a dispute to arbitration by the ACCC once the arbitration regime is implemented.

(d)

ASX should make an explicit commitment to ensuring that any investments in the systems and technology that support its cash equity CS services do not raise barriers to access from unaffiliated market operators or CS facilities. Announcements of any material investments in the systems and technology that support ASX's cash equity CS services should be accompanied by a public attestation that those investments will be designed in a way that does not raise such barriers.

(e)

ASX should retain, and periodically review, its standards for the handling of sensitive or confidential information. Consistent with governance arrangements that promote access on commercial, transparent and non-discriminatory terms (see Regulatory Expectation 1(e)), these arrangements should ensure that conflict sensitive information pertaining to the strategic plans of unaffiliated market operators or CS facilities is handled sensitively and confidentially, and cannot be used to advance the interests of ASX as a market operator or CS facility.

Minimum Conditions for Safe and Effective Competition in Cash Equity Clearing in Australia

A Policy Statement by the Council of Financial Regulators

As revised September 2017

© Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury 2016. All rights reserved.

The contents of this publication shall not be reproduced, sold or distributed without the prior consent of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury.

ISBN 978-0-9805857-5-9 (Online)

Background

On 30 March 2016, the Government endorsed the recommendations of a review of competition in clearing Australian cash equities carried out by the Council of Financial Regulators (CFR) and the Australian Competition and Consumer Commission (ACCC) - together, the Agencies - in the first half of 2015. These recommendations are set out in the Agencies' report, Review of Competition in Clearing Australian Cash Equities: Conclusions (the Conclusions), published at the time of the Government's announcement.1

With the Government's endorsement of the Agencies' recommendations, a policy stance of openness to competition has been confirmed. This stance recognises prevailing legislative settings that are accommodative of competition, as well as the potential benefits of competitive discipline. At the same time, the Conclusions acknowledge that competition in clearing could have cost, risk and efficiency implications for the functioning of markets, financial stability and access for unaffiliated market operators and clearing and settlement (CS) facilities. Accordingly, the Conclusions recommend legislative changes to facilitate a set of minimum conditions for safe and effective competition in cash equity clearing (Minimum Conditions (Clearing)).

As a first step, the Agencies have undertaken to set out the Minimum Conditions (Clearing) in a publicly stated policy. This document fulfils this commitment. The Conclusions recommend that the Minimum Conditions (Clearing) cover the following: (i) adequate regulatory arrangements; (ii) appropriate safeguards in the settlement process; (iii) access to settlement infrastructure on non-discriminatory, transparent, fair and reasonable terms; and (iv) appropriate interoperability arrangements between competing cash equity central counterparties (CCPs).

The Minimum Conditions (Clearing) have been developed with reference to the prevailing market structure in settlement - in which there is a sole provider of settlement services. However, the Agencies conducted a consultation on safe and effective competition in settlement of cash equities in Australia in the first half of 2017, which found that the prospect of competition emerging may have increased since the 2015 review of competition in clearing. Accordingly, the Agencies released a set of Minimum Conditions for Safe and Effective Competition in Cash Equity Settlement in Australia (Minimum Conditions (Settlement)) in September 2017.2 The Agencies subsequently identified some aspects of the Minimum Conditions (Clearing) that required consequential amendments, and have therefore issued these revised Minimum Conditions (Clearing) in September 2017.

The Minimum Conditions (Clearing) aim to give potential entrants sufficient clarity as to the measures that the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (the Bank) would require be taken before they could advise in favour of a licence application. This should assist in establishing the business case for any competing provider. In addition to meeting existing licensing requirements under the Corporations Act, any licence applicant would be expected to demonstrate that it could viably provide services in this market in a manner consistent with the Minimum Conditions (Clearing).

Some aspects of the Minimum Conditions (Clearing) are not enforceable under the existing regulatory framework (such as requirements for materially equivalent settlement arrangements and the establishment of interoperability). The Agencies will therefore work with Government to implement legislative changes that would:

•

allow the relevant regulators to implement and enforce the Minimum Conditions (Clearing) through the use of a rule-making power if and when a competitor emerged; and

•

grant the ACCC power to arbitrate disputes regarding access to services licensed under Part 7.3 of the Corporations Act. In the context of the current settlement market structure, this would ensure that any competing CCP was able to access ASX's settlement infrastructure on a transparent and non-discriminatory basis with terms and conditions, including price, which are fair and reasonable.

1 The Conclusions and the Government's response are available at http://www.treasury.gov.au/ ConsultationsandReviews/Consultations/2015/Review-of-competition-in-clearing-Australian-cash-equities.

2 The Minimum Conditions (Settlement) are available at https://www.cfr.gov.au/publications/cfr- publications/2017/minimum-conditions-safe-effective-competition/pdf/policy-statement.pdf.

Given the importance of the Minimum Conditions (Clearing) in ensuring that competition did not adversely affect financial stability or effective market functioning, ASIC and the Bank would be unable to advise in favour of a licence application until these measures had been implemented. Consistent with the position of openness to competition, however, ASIC and the Bank would be prepared to engage with any potential entrant in the interim and commence consideration of a licence application, should one be submitted.

The proposed legislative framework to implement the Minimum Conditions (Clearing) would set out the relevant high-level requirements, leaving the relevant regulators to impose any specific obligations at a later stage through the use of the rule-making powers. It is envisaged that the new legislation would set the scope of the rule-making powers and the circumstances in which these powers could be used. The accompanying Explanatory Memorandum could provide further guidance on the nature of specific requirements that might be imposed through the use of these powers. In the case of interoperability, for instance, the rules would be likely to include such details as the criteria against which a CCP would be obliged to consider an access request from a competitor (and the acceptable grounds for rejecting such a request), the required scope and operational functionality of a link, and the timeframe on which a request that met the criteria should be granted.

Certain of the Minimum Conditions (Clearing) would need to be further supported by operational changes and, once implemented, would rely on other aspects of the regulatory framework. In the case of interoperability, for example, the rule-making power would establish and enforce the access requirement; once in place, the relevant regulators would monitor the operation of the link and the management of risks arising from the link under existing powers. The Bank would need to elaborate additional guidance to the Financial Stability Standard for Central Counterparties (CCP Standards) that deals with the management of risks arising from interoperable links.3 At the same time, the Agencies would clarify arrangements for the regulatory oversight of matters such as default management and CCP recovery in a multi-CCP environment.

To the extent possible, the relevant regulators would offer a prospective competitor guidance on potential specific requirements through bilateral discussions prior to submission of a licence application, but detailed specific requirements would not be articulated or implemented until such time as a committed competitor emerged or was likely to emerge. The Agencies recognise that the rule-making process and the need to make operational arrangements to support a multi-CCP environment would defer the commencement of operations by a competitor. However, to implement the rules and require that operational changes be made in advance would lead to redundant industry investment and regulatory cost should a competitor fail to emerge. This is particularly important given that the rules will deal with matters such as interoperability and materially equivalent settlement arrangements between the emerging competitor and incumbent CCP, which could be costly to establish.

3 The Bank's CCP Standards are available at http://www.rba.gov.au/payments-and-infrastructure/financial-market- infrastructure/clearing-and-settlement-facilities/standards/central-counterparties/2012/.

Accordingly, ASX would not be required to make up-front operational changes to accommodate competition until such time as a competing CCP committed to entry. However, at the same time, the technological design of ASX's CS infrastructure should not raise barriers to the potential future implementation of interoperability or access to settlement arrangements by a competing CCP.

This statement should be read alongside the analysis on the costs and benefits of competition detailed in the Conclusions. This statement should also be read alongside the Regulatory Expectations for Conduct in Operating Cash Equity Clearing and Settlement Services in Australia (Regulatory Expectations), which will continue to apply in the case that ASX remains the sole provider of clearing or settlement services.4 If competition in settlement were to emerge then, where appropriate, this document should also be read alongside the Minimum Conditions (Settlement).

The Agencies also expect to review the Minimum Conditions (Clearing) periodically, including in the event of material changes to the operating environment or market structure for these services, such as the emergence of a competing settlement facility.

Minimum Conditions for Safe and Effective Competition in Clearing

The Minimum Conditions (Clearing) relate to the following.

1.

Adequate regulatory arrangements. These should include:

(a)

rigorous supervision against the CCP Standards and other requirements under the Corporations Act

(b)

application of the CFR's framework for regulatory influence over cross-border CS facilities

(c)

ex ante wind-down plans

(d)

appropriate arrangements for regulatory oversight in a multi-CCP environment.

2.

Appropriate safeguards in the settlement process. The cash equity settlement model applied in a multi-CCP environment should seek as far as possible to preserve the efficiencies of the prevailing settlement model at the time a competitor emerged, while:

(a)

affording materially equivalent priority to trades novated to a competing CCP

(b)

minimising financial interdependencies between competing CCPs in the settlement process

(c)

facilitating appropriate default management actions.

3.

Access to securities settlement infrastructure on non-discriminatory, transparent, fair and reasonable terms.

4.

Appropriate interoperability arrangements between competing cash equity CCPs.

Each of the Minimum Conditions (Clearing) identified above is considered in greater detail in the remainder of this policy statement.

4 The Regulatory Expectations are available at http://www.cfr.gov.au/publications/cfr-publications/ 2016/regulatory-expectations-policy-statement/.

Adequate regulatory arrangements

(a) Rigorous oversight against the Financial Stability Standards and other requirements under the Corporations Act

The Corporations Act gives ASIC and the Bank joint regulatory responsibility for supervising CS facility licensees. The Bank is responsible for ensuring that CS facilities comply with the CCP Standards and take any other steps necessary to reduce systemic risk. The CCP Standards are aligned with the financial stability-related requirements of the CPMI-IOSCO Principles for Financial Market Infrastructure (PFMI)5, which establish an international benchmark for the risk management and operational standards of CS facilities. ASIC is responsible for ensuring CS facilities comply with other obligations under the Corporations Act, as elaborated in ASIC's Regulatory Guide 211: Clearing and Settlement Facilities: Australian and Overseas Operators (RG211).6

Equivalent application of these oversight standards across competing CCPs should be sufficient to limit any scope for competition on the basis of less onerous risk controls, and thereby ensure that the market continues to function in a safe and effective manner. The Agencies nevertheless acknowledge the need for close vigilance at the margins of the standards, including cost-cutting measures and product development processes.

(b) Application of the CFR's framework for regulatory influence over cross-border CS facilities

If a new entrant CCP was seeking to leverage existing capabilities in overseas cash equity markets ASIC and the Bank's supervisory approach would be guided by the CFR's Regulatory Influence Framework. This is a framework for ensuring that Australian regulators have sufficient influence over overseas providers of clearing and settlement services in the Australian market to support domestic policy objectives.7

One measure under the Regulatory Influence Framework, which would apply primarily where a CS facility was both systemically important in Australia and had a strong domestic connection, is the requirement to incorporate locally and seek a domestic CS facility licence. As articulated in the additional guidance on the Regulatory Influence Framework, the threshold for application of this requirement would be likely to be set at a relatively low level for any CCP seeking to clear ASX securities. The Agencies consider this to be an integral part of the Minimum Conditions (Clearing), at least until ASIC and the Bank are comfortable with the arrangements for cross-border coordination and management of FMI recovery and resolution.8 The precise threshold for the requirement would be discussed and agreed with a prospective competitor in order to provide the entrant with sufficient certainty to support business plans and investment decisions. The threshold would also be made transparent to market participants, market operators and ASX, to ensure that all stakeholders had the necessary information to formulate business plans with certainty.

5 The PFMI, published by the Committee on Payment and Settlement Systems (now known as the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions is available at http://www.bis.org/cpmi/info_pfmi.htm

6 ASIC's Regulatory Guide 211 is available at http://asic.gov.au/regulatory-resources/find-a-document/regulatory- guides/rg-211-clearing-and-settlement-facilities-australian-and-overseas-operators/

7 The CFR's framework for ensuring appropriate influence over cross-border clearing and settlement facilities (the Regulatory Influence Framework) is available at http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2012/cross-border-clearing>. Guidance on the application of this framework in the case of CCPs is available at http://www.cfr.gov.au/publications/cfr- publications/2014/pdf/app-reg-influence-framework-cross-border-central-counterparties.pdf

8 The international work on recovery and resolution of FMIs is currently ongoing. Domestically, in February 2015, the government released a consultation paper on legislative proposals to establish a special resolution regime for FMIs in Australia, available at http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Resolution- regime-for-financial-market-infrastructures>. The CFR's response to this consultation was published in November 2015. This is available at http://www.cfr.gov.au/publications/cfr-publications/2015/resolution-regime-financial- market/.

(c) Ex ante wind-down plans and associated commitments

Since a commercially driven exit of a CCP in a competitive environment could disrupt activity in the segment of market activity that it cleared, the Agencies see a case to include measures aimed at mitigating such market disruption within the Minimum Conditions (Clearing).

In particular, all competing CCPs - including the incumbent and any new entrants - would be required to commit ex ante to a notice period of at least one year prior to any planned exit from the market. This should be supported by ring-fenced capital sufficient to cover operating expenses for the duration of the notice period, calculated on a rolling basis, as well as clearly articulated wind-down plans which would be discussed with ASIC and the Bank.

The Agencies acknowledge that the conditions stated here are more stringent than the requirements for orderly wind-down envisaged in the CCP Standards; Standard 14 on general business risk requires that 'at a minimum, a CCP should hold, or have legally certain access to, liquid net assets funded by equity equal to at least six months of current operating expenses'. The Agencies consider this difference to be appropriate, as this condition is intended to provide for a planned exit for commercial reasons, while the Standard 14 seeks to protect against exit due to the crystallisation of business risk.

Furthermore, as discussed above, a commercially driven exit of a CCP could disrupt activity in the segment of market activity that it cleared. Such disruption could also arise if an existing provider scaled back its activities due to increased costs (e.g. if its exposures became concentrated in less liquid products). The Agencies would therefore work with the CCPs and relevant market operators to establish ex ante contingency arrangements to ensure the continued provision of clearing services for less liquid securities in the event that the incumbent CCP for those securities exited the market or reappraised its provision of those services.

(d) Appropriate arrangements for regulatory oversight in a multi-CCP environment

The Agencies do not see a strong case for a material change in ASIC and the Bank's supervisory responsibilities in a multi-CCP environment. This view is consistent with the idea that participant oversight is central to a CCP's risk management activities, given the proprietary risk exposure that a CCP assumes to its participants.

However, a more fragmented view of participants in a multi-CCP environment could disrupt arrangements for monitoring and managing clearing risk, including perhaps most notably in default management. As part of the Minimum Conditions (Clearing), the Agencies would clarify arrangements for regulatory oversight, particularly in relation to default management and CCP recovery, at such time as a committed competitor emerged.

Competition in clearing could also give rise to adverse selection in both products and participants. For instance, a competing CCP may be motivated to only offer clearing services in the most liquid securities or to structure their business so as to favour larger participants over smaller participants. This could lead to the fragmentation of the market along the lines of liquidity, with potential implications for the profile of exposures to be managed by each CCP. If a competing CCP were to emerge, the Agencies might consider steps to mitigate these effects, such as through closer oversight of product and participant scope; it is acknowledged, however, that there could be practical challenges in implementing such steps.

Appropriate safeguards in the settlement process

The entry of a competing cash equity CCP would have implications for the design, operation and organisation of the settlement model. Any changes to the existing settlement arrangements could potentially give rise to additional costs, as well as financial and operational risks. In light of this, the Agencies see a case to set minimum conditions around the design of the settlement model for a multi- CCP environment. As far as possible, the new model would need to preserve the efficiencies of the prevailing settlement model in a single-CCP environment, while affording materially equivalent priority to a competing CCP. It should also minimise financial interdependencies between CCPs in the settlement process and facilitate appropriate default management actions.

Access to settlement services on transparent, non- discriminatory, and fair and reasonable terms

In the absence of an alternative provider of cash equity settlement services emerging, any new cash equity CCP would require access to the vertically integrated incumbent settlement services of ASX Settlement. To the extent that it remains the sole provider of cash equity settlement services, ASX Settlement would be required to facilitate the provision of access to its cash equity settlement infrastructure on a transparent and non-discriminatory basis with terms and conditions, including price, that are fair and reasonable. The Regulatory Expectations, outlined by the Agencies in a separate policy statement, deal with access to ASX's monopoly CS services. The relevant provisions in the Regulatory Expectations explicitly address access on transparent, non-discriminatory, and fair and reasonable terms; these provisions would also apply to ASX's provision of CS services to a competing CCP for cash equities under the Minimum Conditions (Clearing). Additionally, following the proposed legislative changes as previously noted, the ACCC will have the power to arbitrate disputes in relation to price and/or non-price terms and conditions of access where negotiations guided by the Regulatory Expectations fail.

Appropriate interoperability arrangements between competing CCPs

Interoperability has been identified as a potentially effective mechanism for ensuring that the benefits of competition are realised while mitigating some of the adverse implications, including market fragmentation and increased operational costs for participants. Based on analysis summarised in the Conclusions, the Agencies consider that a requirement to establish appropriate interoperability arrangements between cash equity CCPs, prior to a competing CCP commencing operations, would be a necessary condition to support competition.

Given commercial and operational considerations, the incumbent CCP may have little incentive to voluntarily develop interoperability arrangements with a new entrant. 'Open access' obligations or other regulatory measures may therefore need to be imposed to facilitate the establishment of fair and effective interoperability between the incumbent CCP and any new CCP seeking to enter the Australian cash equity market.

The Agencies also acknowledge that interoperability may give rise to additional complexities and risks. Should a competing CCP emerge, an effective risk management framework for interoperability arrangements would need to be put in place in order to mitigate these incremental risks. Specifically, the Bank would need to issue additional guidance to clarify how the requirements under CCP Standard 19 (FMI Links) should be met for the purpose of establishing safe and effective interoperable links.

Minimum Conditions for Safe and Effective Competition in Cash Equity Settlement in Australia

A Policy Statement by the Council of Financial Regulators

September 2017

© Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury 2017. All rights reserved.

The contents of this publication shall not be reproduced, sold or distributed without the prior consent of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and the Department of the Treasury.

ISBN 978-0-6480470-3-2 (Online)

Background

In March 2016, the Government endorsed the recommendations of a review of competition in clearing cash equities in Australia carried out by the Council of Financial Regulators (CFR) and the Australian Competition and Consumer Commission (ACCC) - together, the Agencies. Importantly, the Government's endorsement included a policy stance of openness to competition. The conclusions from that review are set out in the Agencies' report, Review of Competition in Clearing Australian Cash Equities: Conclusions (the Conclusions).1

As per the recommendations from the Conclusions, the CFR released two policy statements in October 2016: Regulatory Expectations for Conduct in Operating Cash Equity Clearing and Settlement Services in Australia (Regulatory Expectations) and Minimum Conditions for Safe and Effective Competition in Cash Equity Clearing in Australia (the Minimum Conditions (Clearing)).2

These policy statements were developed with reference to the prevailing market structure in settlement - in which there is a sole provider of settlement services. However, the Agencies considered it appropriate to explore the prospect of competition emerging in settlement and the need for additional policy guidance to support safe and effective competition, should it emerge.

For this purpose, the Agencies released a consultation paper on Safe and Effective Competition in Cash Equity Settlement in Australia in March 2017.3 The Agencies also met with a number of interested parties to discuss their views on the prospect of competition and the need for policy guidance.

Feedback received from stakeholders during consultation acknowledged that the prospect of competition in settlement had increased, but also highlighted some of the barriers to entry, as well as some potential risks, cost and efficiency implications of competition in settlement.4

Accordingly, to address the identified barriers and risks, the Agencies have undertaken to set out Minimum Conditions for Safe and Effective Competition in Cash Equity Settlement in Australia (Minimum Conditions (Settlement)). The Minimum Conditions (Settlement) apply when the same equity security can be settled in more than one Security Settlement Facility (SSF).

The Minimum Conditions (Settlement) aim to give prospective providers of settlement services sufficient clarity as to the measures that the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (the Bank) would require be taken before they could advise in favour of a licence application. This should assist in establishing the business case for any competing provider. In addition to meeting existing licensing requirements under the Corporations Act 2001 (the Corporations Act), any licence applicant would be expected to demonstrate that it could viably provide services in this market in a manner consistent with the Minimum Conditions (Settlement).

1 The Conclusions and the Government's response are available at

http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Review-of-competition-in-clearing- Australian-cash-equities>.

2 The Minimum Conditions (Clearing) is available at < https://www.cfr.gov.au/publications/cfr- publications/2016/minimum-conditions-safe-effective-cash-equity/pdf/policy-statement.pdf>; The Regulatory Expectations are available at

https://www.cfr.gov.au/publications/cfr-publications/2016/regulatory-expectations-policy-statement/pdf/policy- statement.pdf>.

3 The consultation is available at https://www.cfr.gov.au/publications/consultations/safe-and-effective-competition-in- cash-equity-settlement-in-australia/index.html>.

4 A more detailed summary of the feedback received is available in the Agencies' report: Safe and Effective Competition in Cash Equity Settlement in Australia: Response to Consultation, available at

https://www.cfr.gov.au/publications/cfr-publications/2017/safe-effective-competition-response/pdf/response-to- consultation.pdf>.

Some aspects of the Minimum Conditions (Settlement) are not enforceable under the existing regulatory framework (such as access by a competing clearing and settlement (CS) facility on transparent, non-discriminatory, and fair and reasonable terms). Nevertheless, the Agencies expect that service providers of settlement services will operate in a manner that is consistent with the Minimum Conditions (Settlement).

The Agencies will work with the Government to fully implement the Minimum Conditions (Settlement) through legislative changes. It is proposed that the legislative changes will include provisions that:

•

allow the relevant regulators to implement and enforce the Minimum Conditions (Settlement) through the use of a rule-making power; and

•

grant the ACCC power to arbitrate disputes regarding access to services (including data).

The proposed legislative framework to implement in full the Minimum Conditions (Settlement) would set out the relevant high-level requirements, leaving the relevant regulators to impose any specific obligations at a later stage through the use of the rule-making powers.

Given the importance of the Minimum Conditions (Settlement) in ensuring that competition does not adversely affect financial stability or effective market functioning, ASIC and the Bank would be unable to advise in favour of a licence application from a potential competitor until these legislative measures had been implemented. Consistent with the position of openness to competition, however, ASIC and the Bank would be prepared to engage with any potential entrant in the interim and commence consideration of a licence application, should one be submitted. In the event that a committed competitor submits an application for a CS facility licence, consistent with past practice, a public consultation on the potential effects of the applicant's services on the market may be conducted by the relevant agency, in order to ensure that any potential risks have been adequately dealt with by stakeholders and the regulators.

To the extent possible, ASIC, in consultation with the Bank, would offer guidance to a prospective competitor on potential specific requirements before the submission of a licence application. However, detailed specific requirements would not be articulated or implemented until such time as a committed competitor emerged, or was likely to emerge.

Accordingly, ASX may not be required to make operational changes to accommodate competition until such time as a competing SSF committed to entry. However, at the same time, the technological design of ASX's CS infrastructure should not raise barriers to entry or otherwise seek to frustrate access to data or services that are necessary for the provision of settlement services by a competing service provider. ASIC and the ACCC have a particularly strong interest in this outcome being delivered.

The Agencies expect to review the Minimum Conditions (Settlement) periodically, including in the event of material changes to the operating environment or market structure for these services.

Minimum Conditions for Safe and Effective Competition in Settlement

The Minimum Conditions (Settlement) relate to the following.

1.

Adequate regulatory arrangements:

(a)

Rigorous oversight against the Financial Stability Standards and other requirements under the Corporations Act

(b)

Application of the CFR's framework for regulatory influence over cross-border CS facilities

(c)

Ex ante wind-down plans and associated commitments

(d)

Appropriate arrangements for certainty of securities transfer and administration.

2.

Access on transparent, non-discriminatory, and fair and reasonable terms.

3.

Appropriate links between competing SSFs.

4.

Appropriate regulatory arrangements for oversight of Primary and Secondary Markets.

Each of the minimum conditions identified above is considered in greater detail in the remainder of this policy statement.

Adequate Regulatory Arrangements

(a) Rigorous oversight against the Financial Stability Standards and other requirements under the Corporations Act

The Corporations Act gives ASIC and the Bank responsibility for the regulation of CS facility licensees. The Bank is responsible for determining financial stability standards for licensed CS facilities and assessing compliance by those facilities with those standards and their obligation to do all other things necessary to reduce systemic risk, to the extent that it is reasonably practicable to do so. The Bank's Financial Stability Standards for Securities Settlement Facilities (SSF Standards) are aligned with the financial stability-related requirements of the CPMI-IOSCO Principles for Financial Market Infrastructure (PFMI), which establish an international benchmark for the risk management and operational standards of CS facilities.5 ASIC is responsible for ensuring CS facilities comply with other obligations under the Corporations Act, as elaborated in ASIC's Regulatory Guide 211: Clearing and Settlement Facilities: Australian and Overseas Operators (RG211).6

The Bank and ASIC consider that equivalent application of the regulatory framework across competing SSFs should limit any scope for competition on the basis of less onerous risk controls, such that the market continues to function in a safe and effective manner.

Application of the existing regulatory framework for CS facilities in a multi-SSF environment is also expected to be sufficient to address any additional risks to central counterparties, for example from mismatches in timing of settlement across SSFs and 'un-netting' of trades during the settlement process.

(b) Application of the CFR's framework for regulatory influence over cross-border CS facilities

If a SSF was seeking to leverage existing capabilities in overseas markets, ASIC and the Bank's supervisory approach would be guided by the CFR's Regulatory Influence Framework.7 This is a framework for ensuring that Australian regulators have sufficient influence over overseas providers of CS services in the Australian market to support domestic policy objectives.

One measure under the Regulatory Influence Framework, which would apply primarily where a CS facility was both systemically important in Australia and had a strong domestic connection, is the requirement to incorporate locally and seek a domestic CS facility licence. As articulated in the Regulatory Influence Framework, a competing SSF that settles Australian securities would almost certainly have a strong domestic connection as it would operate in a primarily domestic market, perhaps with a high level of domestic retail participation. The Agencies consider this to be an integral part of the Minimum Conditions (Settlement), at least until ASIC and the Bank are comfortable with the arrangements for cross-border coordination and management of financial market infrastructure recovery and resolution.

5 The PFMI, published by the Committee on Payment and Settlement Systems (now known as the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions is available at http://www.bis.org/cpmi/info_pfmi.htm>.

The SSF Standards is available at http://www.rba.gov.au/payments-and-infrastructure/financial-market- infrastructure/clearing-and-settlement-facilities/standards/securities-settlement-facilities/2012/>.

6 ASIC's Regulatory Guide 211 is available at http://asic.gov.au/regulatory-resources/find-a-document/regulatory- guides/rg-211-clearing-and-settlement-facilities-australian-and-overseas-operators/>.

7 The CFR's framework for ensuring appropriate influence over cross-border clearing and settlement facilities (the Regulatory Influence Framework) is available at http://www.treasury.gov.au/ConsultationsandReviews/ Consultations/2012/cross-border-clearing>.

(c) Ex ante wind-down plans and associated commitments

Since a commercially driven exit of an SSF in a competitive environment could disrupt activity in the segment of market activity that it settled, the Agencies see a case to include measures aimed at mitigating such market disruption within the Minimum Conditions (Settlement).

In particular, all competing SSFs - including the incumbent and any new entrants - could be required to commit ex ante to a notice period of at least one year before any planned exit from the market. This should be supported by ring-fenced capital sufficient to cover any operating expenses for the duration of the notice period, as well as clearly articulated wind-down plans.

Similar to the Minimum Conditions (Clearing), this condition would be more stringent than the requirements for orderly wind-down envisaged in the SSF Standards; Standard 12 on general business risk requires that 'at a minimum, a securities settlement facility should hold, or have legally certain access to, liquid net assets funded by equity equal to at least six months of current operating expenses'. The Bank considers this difference to be appropriate, as this condition is intended to provide for a planned exit for commercial reasons, while SSF Standard 12 seeks to protect against exit due to the crystallisation of business risk.

(d) Appropriate arrangements for certainty of securities transfer and administration

Each SSF, in compliance with the Corporations Act, will have its own operating rules reflecting the settlement facility service it operates and other services it provides. The operating rules of a SSF, along with the operating rules of the listing market for the issuer, may govern the registration of legal title to, and in some cases administration of, securities in respect of which the SSF provides settlement services. Where there are competing SSFs, a registry acting on behalf of an issuer may be subject to requirements imposed by more than one SSF. For example, there may be circumstances under which registries, acting on behalf of issuers, receive instructions from competing SSFs relating to the same listed security. The registry will need to determine how to prioritise those instructions and ensure the resulting change of title to the securities is legally certain, which may be challenging in situations where the registry is not able to comply with, or reconcile the requirements imposed on it by, competing SSFs.

Accordingly, the Agencies consider that, in the event of a competing SSF emerging, there is a case for the relevant agency to have the ability, if required, to put in place regulatory arrangements to support certain aspects of the legal relationship between competing SSFs, registries and issuers. Such regulatory arrangements might involve prescribing protocols, rules or regulations setting out common principles for the transfer, registration and administration of securities.

Access on Transparent, Non-discriminatory, and Fair and Reasonable Terms

To address concerns regarding access to services (including data) necessary for the provision of settlement services by a competing SSF, the Agencies consider it appropriate that CS service providers be required to facilitate access to services (including data) on a transparent and non- discriminatory basis with terms and conditions, including price, that are fair and reasonable. For example, ASX is expected to comply with this requirement with respect to providing services (including data) necessary for the provision of settlement services by a competing service provider, and vice versa.

This is consistent with the Regulatory Expectations, which deal with access to the incumbent service provider's monopoly CS services. The relevant provisions in the Regulatory Expectations explicitly address access on transparent, non-discriminatory, and fair and reasonable terms should a competing provider of settlement services emerge. Additionally, following the proposed legislative changes as previously noted, the ACCC will have the power to arbitrate disputes in relation to price and/or non-price terms and conditions of access to data and services where negotiations guided by the Regulatory Expectations fail.

Appropriate Links between Competing SSFs

Further to the requirement for transparent, non-discriminatory, and fair and reasonable access, in order to facilitate market functioning in a structure with competing SSFs, the Agencies are of the view that it would be necessary to ensure that securities can be accessed by, and moved between, all of the SSFs. The nature of this link will depend on the particular model. It would also be necessary to have a process in place to prevent the risk of the same security holding being used multiple times during settlement.

Appropriate Regulatory Arrangements for Oversight of Primary and Secondary Markets

Any SSF proposing to provide settlement services that will offer a choice in settlement timeframe, should be aware that this may have implications for the functioning of any licensed financial market for which it is permitted to settle trades and for the participants and investors that use the market. There may also be implications for the listed entities and the transactions they conduct.

It is important to note that ASIC would have a regulatory role in any proposal in which the choice of settlement timeframe and/or facility occurred as part of contract formation on a licensed financial market. Such a proposal may raise significant policy considerations in respect of price formation, liquidity and fragmentation in the markets for securities settled by the respective competing SSF. Such proposals would require significant analysis to be undertaken by ASIC on the potential market impacts. A prospective provider of settlement services that seeks to offer such services should undertake bilateral dialogues with ASIC early in the development of its proposal.