Changes proposed by Australia’s top exchange to its new blockchain-based settlement system for stocks have drawn fire from prominent sections of users, who fear that the amendments will create new risks.

Under the proposal published in February, the Australian Securities Exchange will move to an exception-only reporting model, meaning that clearing brokers will no longer receive confirmation messages for trades that settle successfully. The overnight netting cycle will also be replaced by a continuous process, which ASX says will result in greater capacity.

The consultation closed on March 18. Based on conversations with seven industry sources, ASX will have received some unhappy feedback—pointing to hiccups in the rollout of distributed ledger technology (DLT) in finance as the technology’s popularity grows around the world.   

“The proposed changes in functionality shift substantial processing load and risk onto clearing brokers,” says Damian Jeffree, senior director of policy at the Australian Financial Markets Association (Afma). “[The changes] will require substantial rework of systems and processes at what is quite an advanced point in the project, and this increases risks.”

ASX’s new settlement system will replace its current aging system known as Chess. Under Chess, both securities and funds settle on a net basis across participants, and this will be retained.

But individual confirmation messages for successful transactions will no longer be sent out. Rather, participants will be notified of the total funds settled, as well as of the instructions that have failed. They will be able to request the details of the underlying instructions that formed part of settlement for a specified account, security, basis of movement, and settlement date.

Participants will be required to self-determine settlement finality by performing additional processing, reconciliation and verification activities 

Judith Fox, Stockbrokers and Financial Advisers Association

Judith Fox, chief executive of Australia’s Stockbrokers and Financial Advisers Association (Safaa), echoes Jeffree’s criticisms of the proposal, arguing that it will result in “a significant increase” in operational risk for participants.

“They will no longer be provided with an auditable settlement chain to definitively identify the settlement obligations being netted and fully settled,” she explained in her consultation response seen by WatersTechnology sibling publication Risk.net. “Participants will be required to self-determine settlement finality by performing additional processing, reconciliation and verification activities for a large volume of client transactions during business hours.”

Fox also agrees with Jeffree that market participants will have to redo much of the work they have already completed.

“This introduces additional costs. Furthermore, all additional change at this stage in the project incurs additional delivery risk,” she wrote in her response.

The proposal was put forward as late as five years after work on the Chess replacement began and only two years before its delayed go-live date.

ASX itself said in its consultation that software providers might need to “refactor”—in simple terms, restructure—some of the software they had been developing in preparation, depending on whether they had already developed to the code delivered to the “customer development environment”.

Afma and Safaa are calling for an independent review of the proposal to determine if it poses any additional risks to users.

Scale but at a cost

Some software vendors are also critical of the changes being considered by ASX.

An executive at a vendor that connects to Chess says reducing the number of confirmation messages could introduce systemic risk in the event of a counterparty failure or liquidation event.

“Today everything is kept in sync and all participants are fully informed as to how the cancellation and netting process works. There are never any concerns about missing anything,” the person says, referring to so-called novation netting, in which offsetting transactions are cancelled and replaced with a new, net transaction.

“But because they need to reduce their messaging volumes, the ASX is no longer going to tell the market how those trades have been cancelled. They’re just going to expect that participants in the market will work it out themselves.”

The executive also worries that the ASX proposal will introduce further reconciliation points in a system that was designed to require far fewer reconciliations than Chess.

We are not putting operational risk on our customers but are proposing to do things a different way than we have done historically over the past three decades

Tim Hogben, ASX

The exchange denies that the changes—which it says are supported by regulators—shift more work to users and expose them to additional risks.

“We are not putting operational risk on our customers but are proposing to do things a different way than we have done historically over the past three decades,” Tim Hogben, chief operating officer at ASX, tells Risk.net. “Customers are still going to get all the information they need. They are just going to get it through different means and different workflows.”

He argues the changes are necessary to ensure the new system can scale “so we never have to talk about capacity again”. They will allow the Chess replacement to handle 15-20 million trades a day and ultimately up to 40-50 million, he says. Chess has the capacity to cater for 7 million trades per day over multiple consecutive days. It is unclear what the new system would be able to handle without the changes.

ASX decided to revisit the design of the DLT system after experiencing a major spike in trading volumes in March 2020, when activity exceeded previous peaks by more than seven times, the exchange said in its consultation.

The Australian Securities and Investments Commission has also expressed “significant concern” about an outage at the exchange on November 16. ASX has said the incident was caused by a software glitch during the rollout of its updated platform for equities. Asic is investigating the incident, which includes assessing whether ASX has sufficient technological resources to operate its markets.

Dividing opinion

A spokesperson for the exchange provides further defense of its suggested changes. He says ASX received around 30 responses out of a total of approximately 70 “relevant stakeholders”, which includes vendors, clearing and settlement participants, alternative market operators and industry associations.

“The less than 50% submission rate could reflect a general satisfaction with the proposals being consulted on and/or confidence that an overall view will be accurately captured in the submissions made by the vendors and industry associations,” the spokesperson says in an email.

He adds that the feedback included confidential comments in support of ASX’s efforts to “reduce the number of messages” it sends and “scale to much higher volumes”.

But for some market participants the envisaged changes to the netting process are a bigger concern. ASX determined that, as volumes increase, netting will take increasingly longer and will at some point exceed the time available for overnight processing. It decided the best option would be to calculate netting on a continuous basis as trades are registered and novated to its clearing house, ASX Clear.

Will the proposed new workflow create a global precedent for netting pre-settlement obligations on a distributed ledger? Or might it be a consequence of a technology that may not readily scale up to ‘net’ peak trade volumes?

Paul Conn, Computershare

Paul Conn, president of global capital markets at vendor Computershare, argues that continuous netting could undermine “settlement discipline” by enabling a short position to remain open and unchecked for an extended period without either a penalty or the risk of being closed out “through a buy-in arrangement, for failing to deliver [securities]”.

“These are two mechanisms that can be used by a settlement system operator to encourage on-time settlement and enforce settlement discipline,” says Conn, who helped develop Chess when he held senior roles at ASX earlier in his career.

In a blog published on March 15, he also wrote that the planned changes raised a number of questions, including: “Will the proposed new workflow create a global precedent for netting pre-settlement obligations on a distributed ledger? Or might it be a consequence of a technology that may not readily scale up to ‘net’ peak trade volumes?”  

Several other exchanges and market infrastructures, including the US Depository Trust and Clearing Corporation, are developing DLT platforms to handle post-trade processing.

ASX plans to release completed code for the Chess replacement at the end of June, it said in its consultation in February. More recent comments by Hogben chime with this timeline: he says the exchange is on track to complete “customer-facing functionality” in June, with testing starting after that.

Asic did not respond to a request to comment about the proposed changes. ASX’s other regulator, the Reserve Bank of Australia, declined to comment.