ASX CHESS: Technology not regulation is solution to ASX's CHESS troubles – The Australian Financial Review

Opinion
Clearing and settlement modernisation will not succeed without finding a sensible way to introduce new technologies and allow competition with incumbent exchanges.
The Australian Securities Exchange’s inability to deliver a replacement for CHESS, its electronic settlement facility, has plunged Australia’s financial sector into uncertainty. As the ASX looks for a way forward in the coming months, it is worth seeking guidance from history as well as garnering the views of all stakeholders.
Next year is the 40th anniversary of Paul Keating becoming treasurer. During his tenure, Australia’s financial system began harvesting the benefits of competition and deregulation. As a result, our system is resilient while supporting efficient capital formation. This should be a source of pride.
ASX chairman Damian Roche and chief executive Helen Lofthouse at the parliamentary inquiry into CHESS replacement debacle.  Oscar Colman
The reform processes kick-started by Keating should serve as inspiration for our current Treasurer to build the foundations for Australia’s next stage of economic expansion. One such foundation is critical financial infrastructure. Another is the regulatory structure that supports our financial markets.
ASX’s CHESS replacement failure has resulted in an overdue debate about whether principle-based policy design, competition and deregulation, applied wisely, would strengthen our financial infrastructure while preserving the outcomes desired by regulators.
When CHESS was implemented, it led the world in direct digital name-on-register capability. It is an early version of tokenisation which is only now emerging as the new global standard on reducing friction in financial markets.
When the ASX tried to modernise CHESS, it erred by trying to completely displace existing and functioning infrastructure rather than trying to remove bottlenecks and insert better capabilities into current infrastructure. The many damning aspects of Accenture’s review can be traced back to this strategic error.
Globally, regulators have promoted new technologies through the use of pilot or ‘sandbox’ arrangements, where new products are allowed to operate within constraints.
This expensive mistake may be further compounded. Public commentary is focused on imposing greater scrutiny and oversight on the ASX and its facilities by the RBA, ASIC, and Treasury. The ASX, RBA, ASIC and Treasury are working out our next steps but there is a risk that we learn the wrong lessons.
Clearing and settlement modernisation will not succeed if we think of it as only a matter of execution; that it can be wholly solved if we had better project managers, better contractors, and stronger regulators.
It is very unlikely that tighter regulation on clearing and settlement will result in superior outcomes. That rests on building modern critical infrastructure that uses new transaction technology, while renewing regulations that focus on the outcomes policymakers want rather than clinging to outdated (and monopolistic) structures.
To achieve this, we should follow a dual-track approach. There is both a great need for long-term structural reform as well as immediate action on allowing new and better clearing and settlement facilities to enter Australia, by allowing them to access the current licensing framework. Both are needed to preserve the health and competitiveness of our financial markets.
The technologies to supplement and eventually replace CHESS already exist. The challenge is finding sensible ways to introduce them. Globally, regulators have promoted new technologies through the use of pilot or ‘sandbox’ arrangements, where new products are allowed to operate within constraints. New products that prove effective will ultimately compete with incumbent exchanges and Central Securities Depositories (CSD), just like CHESS.
Such a stepwise approach nurtures innovation without affecting stability. It is in harmony with the deregulatory agenda kicked off by Keating. This is preferable to ASX’s original ‘big bang’ approach of switching the entire system over from CHESS which was always fraught with risk and aimed at preserving a monopolistic position over clearing and settlement.
Indeed, we should question the current arrangement where our dominant exchange, the ASX, also operates our only CSD, ASX Clear. Is this in the best interest of market participants and the public, especially considering Australia has one of the largest pools of savings through our superannuation industry?
Some commentators have claimed that the barriers to competing with ASX Clear have been lowered. This is misleading, as new entrants are obliged to challenge the monopoly under regulations that make any additional CSDs uneconomic and impractical. It is also unimaginative, as our peers around the world are looking at rewarding innovations rather than stifling it.
It is therefore critical that changes to the clearing and settlement licensing regime be accompanied by reforming the broader policy settings around the themes of fair competition, dynamic ecosystems, innovative technology, capability and governance. Without such structural renewal, Australia’s financial system will no longer be a world leading example in another few decades.
And so this moment is an opportunity for the current treasurer. He can do as Keating did four decades ago. Over the past few decades, we’ve had a raft of parliamentary, regulatory, and policy processes (we know the list: Campbell, Wallis, Murray). But we have not publicly discussed what type of financial market structure we want for the next 40 years.
A new inquiry could look at the potential of new technologies, what our peers abroad are doing, and modern regulatory structures. Importantly, this could be a vehicle to bring in the voices of market participants at the policymaking level rather than during implementation where their influence is limited.
The new Treasurer can lay out new target outcomes for a changing landscape and ensure that Australia does not fall behind in a capability where we once led the world.
David Ferrall is CEO FinClear. FinClear is Australia’s leading independent technology and infrastructure provider for financial market access, whose technology is involved in settling around half of the ASX’s retail investor transactions.
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