Assessment of ASX Clearing and Settlement Facilities – October 2023 4. Special Topic – The Current CHESS

4.1 Summary

This chapter presents results of a detailed review of the current CHESS – ASX's CS system for cash equities. The resilience and lifespan of the current CHESS has become more critical following the pausing of the CHESS Replacement Program. ASX has developed a plan for the support and maintenance of the current CHESS over the next couple of years and has also made a public undertaking that they have the resources and capabilities to support the ongoing operation, maintenance and investment in the current CHESS.^[11] However, the Bank is still concerned about risks in a few key areas for which further evidence is needed to provide assurance that these risks are being mitigated. These key risk areas are:

• management of ageing assets supporting the current CHESS
• capacity requirements and bottlenecks
• the management and sufficiency of resources
• the overall management of risks.

The expectations outstanding from the Bank's Letter of Expectations have also been included as recommendations throughout this chapter. The findings in this chapter have been reflected in the ratings for the relevant FSS. An update on the CHESS replacement is also provided.

4.2 Background

In November 2022, ASX announced it was pausing the CHESS Replacement Program to reassess all its aspects. The Bank and ASIC have publicly noted the significant ramifications of this decision concerning the replacement of critical financial market infrastructure. Following this decision, ASX will need to focus more intensely on the longevity of the current CHESS. The Bank and ASIC have taken regulatory actions since ASX's announcement to ensure the highest priority is given to ensuring the stability and resilience of the current CHESS and progressing the design and implementation of its replacement.

It is critical that ASX ensures the current CHESS system continues to reliably service the market until after its replacement goes live. The Bank, alongside ASIC, will take any further regulatory response required to ensure ASX places high priority on maintaining and supporting the current CHESS to meet ongoing resilience, reliability, integrity and security needs. This detailed review into the current CHESS is part of the Bank's regulatory response.

4.3 Scope of this special topic review of the current CHESS

To determine the scope of this review, the Bank mapped the key risks of the current CHESS to the FSS:

• Operational Risk – Performance, resilience and capacity: The main risk for the current CHESS stems from it being a 29-year-old system that was expected to be replaced by April 2023.^[12] The FSS on Operational Risk requires ASX to ensure that the current CHESS has a high degree of security and operational reliability as well as adequate, scalable capacity. ASX is also required to organise the current CHESS's operations to ensure service continuity in a crisis.
• Operational Risk – Availability of resources and vendor management: ASX has significant key person risk in relation to the current CHESS given the required skillset to service the ageing system, including resources with experience in the programming language. Furthermore, the current CHESS's supporting technology and infrastructure rely on continued vendor support that cannot be assured long term. The FSS on Operational Risk requires ASX to ensure that it can reliably access well-trained and competent personnel and other resources to support the ongoing operation and maintenance of the current CHESS. The Operational Risk FSS also requires ASX senior management to identify, monitor and control outsourcing risks and third-party dependencies.
• Operational Risk – Risk management framework: The FSS require that ASX should have a robust operational risk management framework to identify, monitor and manage operational risks.
• Governance – Financial stability objectives and stakeholder interests: The abrupt pause to the CHESS Replacement Program has raised questions about ASX's compliance with its obligation to have governance arrangements that are clear and transparent, promote the safety of the central counterparty, and support the stability of the broader financial system. The FSS also impose obligations in relation to stakeholder consultation and engagement.
• Governance – Conflicts of interest: In its previous assessments of ASX, the Bank expressed concerns about potential conflicts between the commercial interests of ASX Limited and the financial stability obligations of the CS boards. The Bank's guidance accompanying the Governance FSS specifies that a CS facility that is part of a for-profit entity may need to place particular emphasis on managing any conflicts between income generation and safety. It is critical there are measures in place to appropriately manage any such conflicts, including to ensure the maintenance and support of the current CHESS is given high priority.

4.4 Findings and recommendations

4.4.1 Operational Risk – Performance, resilience and capacity

The Operational Risk FSS requires ASX to have exacting targets for systems such as the current CHESS. While the current CHESS has been performing reliably to-date, the Bank's focus is on gaining assurance of future performance and resilience, which depends on ongoing vendor support for its hardware and software, including upgrades, security patches and bug fixes.

In December 2022, ASIC directed ASX to provide to ASIC and the Bank a Special Report on the current CHESS. The Special Report was published in June 2023 and included a CHESS Roadmap, and an action plan to enhance the current CHESS and ensure it remains operationally reliable until a new solution is implemented.^[13] The roadmap initiatives, however, only cover up to 2026. ASX confirmed that many vendors for the current CHESS's supporting technology and infrastructure have not yet announced upgrade plans beyond 2025. This is a key risk that requires ongoing management. It will be important for ASX to frequently update its CHESS Roadmap with new actions as vendor plans become clearer. A robust annual process for updating the CHESS Roadmap is needed to ensure all actions related to the support and maintenance of the current CHESS are clearly communicated as part of the management of risks related to the current CHESS.

The Operational Risk FSS also requires ASX to ensure that the current CHESS has scalable capacity adequate to handle increasing stress volumes and achieve its service level objectives, including required processing speed. ASX should monitor, review and test (including stress test) the actual capacity and performance of the system on an ongoing basis.

Throughout the assessment period, the current CHESS operated with more than 100 per cent headroom to the maximum tested capacity of 10 million trades per day. The tested capacity is much higher than the average trading volume during the first five months of the 2023 calendar year of around 1.9 million trades, and a maximum of 2.9 million trades. ASX's existing forecast model predicts that daily trades are likely to reach the maximum tested capacity of 10 million by 2030.^[14]

The CHESS Roadmap envisages additional stress tests of the current CHESS by the end of 2023. These will be breakpoint stress tests with the objective of identifying the number of daily trades that result in the system failing to meet its performance targets.

4.4.2 Operational risk – Availability of resources and vendor management

As part of managing operational risk in accordance with the FSS, ASX should ensure that it can reliably access well-trained and competent personnel, and other resources to support the ongoing operation and maintenance of the current CHESS. Given the limited pool of people with the requisite programming skills and other competing priorities within ASX, the Bank is concerned about ASX's ability to secure required resources to support the current CHESS. The risk is currently being addressed through additional recruitment and training of existing and newly hired staff.

The current CHESS largely remains an internally developed and managed system. However, recognising challenges with maintaining sufficient internal resources, ASX has recently signed a new managed service agreement for the current CHESS operational system and the database with an existing partner. This new arrangement will allow ASX to refocus some internal resources to other tasks but will not eliminate the key person risks entirely. The Operational Risk FSS requires ASX management to identify, monitor and control outsourcing risks. The Bank and ASIC will continue to engage with ASX on its outsourcing plans in relation to the current CHESS.

4.4.3 Governance – Financial stability and stakeholder interests

The Bank has requested ASX publish its governance arrangements, including responsibilities and accountabilities, in relation to the current CHESS and the CHESS replacement. This is expected in the December quarter of 2023. The accountabilities should also be clearly documented in the accountability documentation for the relevant executives.

Some stakeholders of the current CHESS continue to express concerns about ASX's engagement with the industry. Issues of this nature have also been raised at other times during the history of the paused CHESS Replacement Program.

4.4.4 Governance – Conflict of interests

The Governance FSS specifies that a CS facility that is part of a for-profit entity may need to place particular emphasis on managing any conflicts between income generation and safety. ASX has engaged an external consultant to provide expert advice to identify potential conflicts between the commercial interests of ASX Group and the regulatory obligations of the CS facilities. The external review found that ASX has effective controls to managing intra-group conflicts of interest relating to the current CHESS and CHESS replacement. The review recommended several enhancements, including additional staff guidance on intra-group conflicts management and further strengthening the role of non-ASX directors on the CS boards in the decision-making process. The Bank will monitor ASX's implementation of these recommendations from the external review.

4.4.5 Operational risk – Risk management

ASX should have a robust operational risk management framework to identify, monitor and manage operational risks. The Audit of the Special Report on the support and maintenance of CHESS by EY finalised on 31 May includes recommendations to enhance risk monitoring and reporting practices for the current CHESS.^[16]

4.5 CHESS replacement update

During the next assessment period, the Bank, in coordination with ASIC, will continue working with ASX to ensure the previous failures of the CHESS Replacement Program are not repeated. The Bank's expectations publicly stated in its Letter of Expectations have been reviewed and, as applicable, are restated below as recommendations.

Footnotes

The undertaking was an expectation from the Bank's Letter of Expectations for the Current CHESS and CHESS replacement. [11]

This was revised from the original go-live date of April 2021. [12]

ASX (2023) ‘ASX CHESS Special Report of ASX Clear Pty Limited and ASX Settlement Pty Limited’, June. [13]

It is important to note that the forecast model is being refined for outlier events, such as the COVID-19 pandemic when in mid-March 2020 the trading volumes reached 7 million trades a day. [14]

As noted above, the Bank will be monitoring all expectations in the Bank's Letter of Expectations for the Current CHESS and CHESS replacement in the same manner as recommendations of this Assessment. [15]

EY (2023) ‘Audit of Special Report on the support and maintenance of current CHESS’ (May). [16]