When Settlement Systems Fail

Hi there, and welcome to Global Custody Pro, I’m Brennan McDonald, and I’m the Managing Editor. I’m writing about the global custody industry after 12+ years in financial services, most recently working for a leading global custodian. You can reply to this email with any feedback you have, I’d love to hear from you - you can also follow us on Linkedin.

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When Settlement Systems Fail: The Hidden Risks of Market Infrastructure

Risk management forms the foundation of the financial services industry. The entire sector operates by carefully calculating and managing various risks for profit. Over decades of experience, including market crashes and systemic failures, a comprehensive set of global and national regulations has developed to govern how financial market infrastructures must handle risk.

Clearing and settlement systems represent the essential machinery beneath visible market activity. These systems must function flawlessly because they process the actual exchange of assets and payments after trades are executed. Their reliability is so crucial that many governments classify them as critical national infrastructure.

When market participants execute trades, they do so with the fundamental assumption that the underlying settlement systems will deliver without fail. This confidence enables the entire financial ecosystem to function smoothly, from individual investors to global institutions. Without this trust in settlement reliability, markets would face significant friction and potential paralysis during periods of stress.

Yesterday, the Australian regulators ASIC and the Reserve Bank of Australia took action against ASX Clear and ASX Settlements in response to the CHESS batch settlement failure in December 2024.

I’m not going to write about ASX and the CHESS replacement - instead, I’m going to use this regulatory action in Australia as an opportunity to jump back up a few levels to the global expectations for operational risk management at settlement venues (formally called Securities Settlement Facilities or SSFs) and clearinghouses (Central Counterparties or CCPs).

The Principles for Financial Markets Infrastructures

The Principles for Financial Markets Infrastructure are the international standards for financial markets infrastructures (FMIs). They are issued by the CPMI and IOSCO, they set out 24 high level principles.

The idea for these principles is that each country then sets up its regulatory framework to align to these expectations, and entities covered by these rules both perform their own self-assessments to benchmark against the PFMI and regulators perform assessments and supervision over the same.

Although I’ve written previously about the PFMI framework, each principle is substantial in what it means for the organisations that must meet its expectations. For example, Principle 1 is “legal basis”.

This high-level principle sits atop an enormous amount of documentation! There has to be a certain legal basis for the whole operations of a financial market infrastructure. There must be enforceability of actions of the FMI in relation to participants and stakeholders, there must be mechanisms for mitigating the risks of any conflict of laws between countries, and all of the rules, procedures and contracts relating to the FMI must be enforceable in each relevant country.

From this short examination of just one principle, we can see that if you were setting up a financial market infrastructure such as a clearinghouse from scratch, an entire program of work would just be the empowering legislation, the legal framework and all of the attached definitions and contractual terms and risk mitigation actions. This includes working out what happens in default scenarios or if an FMI fails and needs to be “resolved” by regulators and the industry.

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Principle 17: Operational Risk

Principle 17 addresses a critical concern: operational failures in market infrastructure can cascade into system-wide financial crises. Unlike ordinary businesses, FMIs form the backbone of global capitalism. When they fail, entire markets can freeze.

While most organizations maintain some form of operational risk management, these firms must operate at a higher standard. Their frameworks must be exceptionally robust for three key reasons:

First, they handle the actual movement of securities and cash between institutions. Any disruption directly impacts the completion of trades and transfers worth billions of dollars daily.

Second, these systems are deeply interconnected. A failure at one clearinghouse or settlement venue could trigger immediate problems across multiple markets and jurisdictions.

Third, technology resilience requirements go far beyond typical enterprise standards. Regulated operators in this space must invest heavily in redundant systems, comprehensive disaster recovery capabilities, and regular testing regimes that can demonstrate rapid recovery from virtually any scenario.

This explains why regulators expect two-hour recovery times and same-day settlement completion capabilities even during extreme disruptions. These standards require high technical investments but reflect the critical nature of these market utilities. There are additional complications when legacy technology platforms must meet increasingly stringent operational and regulatory requirements.

FMIs prepare self-assessments of how they meet all of these expectations so that across countries, you can monitor the strengths and weaknesses of different CSDs, CCPs, SSFs, TRs and payment systems.

For example, we can look at how a major FMI in Hong Kong discloses how it manages operational risk. HKEX subsidiary HKFE Clearing Corporation Ltd explains how it meets Principle 17 in its February 2025 disclosure:

Furthermore, every quarter there is a package of files called PFMI disclosures that are released following a standard format. This includes information about availability, total number and duration of failures, recovery time objective and actual availability. The FMI discloses the history of all failures in the quarterly period since the start of reporting.

The PFMI framework transforms operational risk management from a mere local compliance exercise into a global responsibility. While these principles set the international standard, they work through a two-tier approach:

1. FMIs must self-monitor and publish quarterly disclosures covering all 24 PFMI principles. These reports include both hard numbers (like system uptime) and detailed explanations of risk controls. There are also callouts for why certain numbers or explanations are not necessary such as an FMI not offering a type of product.

2. Local regulators provide ongoing supervision to ensure these critical systems remain resilient. The stakes are extremely high: a multi-day outage could trigger chain reactions throughout global markets, potentially freezing trading and settlement activities worldwide.

Though the PFMI provides consistent global standards, each country adapts these principles into their own regulatory frameworks. This creates a comprehensive safety net where local rules and global expectations work together. The result is an enormous daily effort across every department of these FMIs and their participants to prevent the kind of operational risk management failure we glimpsed with the ASX CHESS batch settlement incident.

Key Takeaways

• Financial market infrastructures must follow strict global standards to manage operational risks that could threaten the entire financial system.

• Settlement failures (like the ASX CHESS incident) trigger regulatory action because reliable settlement is critical to market confidence.

• The Principles for Financial Markets Infrastructures (PFMI) create consistent global expectations for risk management across different countries.

• Financial market infrastructures must aim to recover within two hours of any disruption to maintain market stability.

• Operational risk management requires both regular self-assessment by organizations and ongoing regulatory supervision to be effective.

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