RBA’s $5b fund is for ‘double-black swan’ events

Both the RBA and the Australian Securities and Investments Commission will get stronger supervisory and licensing powers, the budget papers say.

The papers give no estimates for the cost of the new powers, saying their nature means there is no reliable way to forecast the expense.

ASX chief risk officer Hamish Treleaven welcomed the “sensible” measures and said such a resolution fund would only be used in the rarest, high-profile instances of financial institution collapses.

“It would have to be a double-black swan event,” Mr Treleaven said.

The ASX’s clearing house function acts as a promoter of financial stability. The ASX mitigates credit risk by standing in the middle of every transaction to intermediate the risk between trading counter-parties and acts as a shock absorber in times of financial stress.

Should a very large global banking institutional default, and if they are a member of the ASX clearing house, financial markets may respond in a volatile manner. The clearing house takes on the positions of the defaulting participant and then closes out those positions.

That would come at a cost to the ASX, the resources of which come from the initial margin that the defaulted party provided to the ASX, and separate pre-funded capital, which the ASX itself provides.

If, in the most extreme circumstances, that capital is not enough to close out the positions, the RBA will now have a $5 billion emergency fund to help it step in.

“It’s about having another tool if they needed to step in and promote financial stability in that time of extreme stress in very, very rare circumstances,” Mr Treleaven said.

Although the ASX has been left somewhat embarrassed after a series of technological glitches recently, the reforms are not linked to any trading blackouts.

Rather, the announcement can be traced back to a 2011 Council of Financial Regulator’s consultation on the review of financial market infrastructure regulation, which discussed the power to “step in” and take control of market platforms via the appointment of a statutory manager.

Following that consultation, the CFR – whose members include ASIC, the Australian Prudential Regulation Authority, Treasury and the RBA – recommended that step in powers be introduced.

The high-level design of a regime for step-in powers consulted on in 2015, and further details were hashed out in a second consultation in 2019.

In 2019, the International Monetary Fund’s financial sector assessment program also examined the issue.

Australia’s clearing and derivatives infrastructure handles market turnover equal to the country’s GDP every three days.

However, a significant chunk of the $60 trillion notional valued over-the-counter derivate contracts are centrally cleared, which has “led to a concentration of risks in the clearing and settlement facilities themselves”, the CFR’s 2019 consultation said.

Failures of clearing and settlement facilities could have “a significant adverse effect on market participants” and “disruption would likely spread rapidly across the financial sector, with flow-on effects to the real economy”.

As there are no current resolution regimes for clearing and settlement facilities in Australia, if market infrastructure failed it would be up to the government to attempt to resolve the issue without any dedicated powers to complete the task – or left to general corporate insolvency provisions.

“Such an outcome would risk disruption to critical clearing and settlement services and pose a major threat to financial stability. In 2014, the Financial System Inquiry recommended that a dedicated resolution regime be developed for FMIs, and the IMF supported this recommendation in its 2019 FSAP report.”

Resolution regimes have already been, or are in the process of being, introduced in Europe, Hong Kong, New Zealand, Singapore, the United Kingdom and the US.