The ASX wins a more regulated monopoly

The ASX has signed on to being more inclusive and transparent in return for the extension of its clearing monopoly. But with competition culled, a new door may open for foreign interests.

Competition is generally a good thing, as long as the benefits it delivers outweighs the costs and risks associated with it. It is evident from the Council of Financial Regulators’ examination of the pros and cons of introducing competition to the ASX’s monopoly in the clearing and settlement of Australian cash equities that it isn’t convinced it would lead to net gains.

It is also obvious from the council’s report to Wayne Swan that even if it did, the scale of the potential benefits would be very modest given the relatively small scale of the Australian equities market and its own conclusion that ASX’s clearing and settlement fees are already broadly comparable to other markets of a similar scale.

Drawing from the European experience (the only region where competition in clearing has been introduced) the council said that a reduction in clearing fees of 30 per cent (drawn from the European experience) would yield aggregate direct savings of about $15 million – but could generate large up-front costs to market participants as well as higher regulatory costs.

That perspective is consistent with the argument that the ASX’s Elmer Funke Kupper has made in relation to the introduction of competition in trading – that the reduction in ASX fees that has occurred as a result of the competition from Chi-X has been more than offset by higher regulatory and infrastructure costs.

The council also made it clear that much of the feedback it received from market participants was that the current market conditions, the magnitude of regulatory reforms already introduced, the existing increase in spending on technology and the pressure on profits would be exacerbated by any increased operational and regulatory costs flowing from introducing competition to clearing and settlement.

The council has previously looked, quite extensively but somewhat inconclusively, at cross-border clearing and settlement issues and the regulation, or not, of over-the-counter derivatives in particular. There are obvious financial stability issues associated with allowing clearing and settlement of domestic market activity to occur offshore, beyond the jurisdiction of local financial regulators.

In its report to Swan the council made it clear that, should competition to ASX from an overseas-based central counterparty emerge, it would set a relatively low threshold in terms of market share for a requirement that the offshore entity establish an Australian legal and operation presence.

That would undermine the perceived benefits to a competitor of leveraging off their existing infrastructure to generate incremental revenue from taking share off ASX. (While the council’s report is confined to cash equities, the reference to relatively low thresholds before a domestic presence has to be established might also point to broader thinking about how to deal with the international dimensions of cross-border clearing and settlement of securities, including derivatives).

The role of central counterparties within financial systems is significant and sensitive – the integrity and stability of the markets relies on the integrity and stability of the central counterparty – and it is understandable that Australian regulators are loathe to relinquish authority over entities operating within their markets and allow transactions to be cleared in distant jurisdictions and the capital and collateral and regulation that supports them to be held and overseen offshore.

It is also the case that scale efficiencies, liquidity and system stability are the reason that in most jurisdictions central counterparties are monopolies.

The council hasn’t closed the door permanently on the prospect of competition in clearing and settlement but it has deferred any notion that it might open soon. It has recommended, and Swan has accepted, that a decision on any licence application from a central counterpart seeking to operate in Australia should be deferred for two years.

In the meantime it has recommended, and ASX has accepted, that ASX work with industry stakeholders to develop a code of practice for clearing and settlement of cash equities that would provide for user input to strategy and system design, make pricing more transparent and create protocols for dealing with access to its facilities in a fair and timely fashion.

At the end of the two year period the council’s agencies (the Reserve Bank, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and Treasury) would review the code’s effectiveness and revisit the prospect of opening clearing and settlement to competition.

If the ASX is half-sensible the conclusion in two years’ time would be the same as it is today – that the prospective gains aren’t sufficient to countenance the likely costs and risks.

While it is conceivable that the market environment might be a more positive one than it is today it is improbable that the level of cost reductions competition might produce will be materially different to what they might be today or that the costs and risks would somehow have reduced in the meantime.

The ASX’s monopoly in clearing and settlement was cited by Swan as a key reason for the federal government’s opposition to the aborted merger of the Singapore Stock Exchange and ASX in 2011 and therefore the preservation of the monopoly, for now, might appear to rule out any prospect of the ASX engaging in strategic deals with offshore exchanges.

However, given the depth of regulatory reviews of the regulation of central counterparties since that merger was abandoned, the far stronger knowledge and principle bases the council now has and the bottom line that any material level of clearing and settlement activity in cash equities will have to be regulated within this jurisdiction the monopoly may be less of an impediment to a deal today than it was then, particularly once the code and the transparency it will force is in place.

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