3. Market Assessment and Recommendations from Australian Regulators

In July 2013, the regulators released the third Report on the Australian OTC Derivatives Market (the Report). 1

MARKET ASSESSMENT

The Report was compiled following a survey of market participants’ OTC derivatives market activities and practices.

The survey considered G4‑IRD and AUD‑IRD, as well as certain North American and European referenced credit derivatives. In addition, respondents were asked about their level of engagement with central counterparties (CCPs) that clear OTC derivatives, as well as their use of trade execution infrastructure and their risk management practices for non centrally cleared trades.2

To supplement the written survey, the regulators held meetings with a representative sample of dealers and other OTC derivatives market participants. In addition to data from the survey, the assessment has drawn on OTC derivatives markets data collected and published by the Bank for International Settlements (BIS), the Australian Financial Markets Association (AFMA), CME Group and LCH.Clearnet Ltd (LCH.C Ltd).

The Report concluded that there would be benefit to the Australian financial system from adopting an approach that is consistent with that of overseas regulators, who are proceeding with mandatory central clearing across a range of instrument classes, subject to the availability of suitable clearing arrangements.

CENTRAL CLEARING OF G4‑IRD

The Report found that international consistency is a key consideration in assessing the case for implementing a domestic central clearing mandate for G4‑IRD. Collectively, there is material activity in G4‑IRD in the Australian market. Many trades in these products by internationally active participants are already caught by the requirements of other jurisdictions and are therefore already, in effect, subject to mandatory central clearing.

Internationally active participants have established direct or indirect access to at least one CCP offering clearing of these products.

The Report recommends that the Government consider a central clearing mandate for G4‑IRD, primarily on international consistency grounds. The initial focus of such a mandate should be dealers with significant cross border activity in these products.

CENTRAL CLEARING OF AUD‑IRD

The Report reiterates the regulators’ earlier conclusion that there would be a substantial benefit from increased central clearing of AUD‑IRD.

There is evidence of an increase in central clearing in this market among Australian participants. However, until recently industry progress has been limited by the lack of availability of direct clearing for domestic market participants.

Two CCPs have received regulatory approval to offer clearing of AUD‑IRD directly to Australian participants. A number of Australian participants have now established operational arrangements to clear transactions as direct clearing members of these CCPs. Clearing arrangements for non dealer financial institutions and other smaller users of OTC derivatives remain relatively limited at this stage.

The regulators will continue to monitor progress in implementing appropriate central clearing arrangements for AUD‑IRD, before recommending mandatory central clearing for this product class.

CENTRAL CLEARING OF NORTH AMERICAN‑ AND EUROPEAN‑REFERENCED CREDIT DERIVATIVES

The Report does not recommend mandating central clearing of North American‑ and European‑referenced credit derivatives at this time.

While there is material activity in North American and European referenced credit derivatives in the Australian market, the regulators have observed a relatively low level of activity in these products among domestic participants, including Australian banks. Furthermore, domestic participants are currently unable to directly clear North American and European referenced credit derivatives, and are only clearing to a limited extent through client clearing services.

The regulators are seeking further information about Australian market participants’ counterparty exposures in these products and the breadth of central clearing of these products. The regulators will revisit these recommendations in future reports.

USE OF TRADING PLATFORMS

The Report notes that there are in principle benefits in greater utilisation of trading platforms in the Australian OTC derivatives market. However, further consideration needs to be given to what constitutes an acceptable trading venue for these purposes, as principles are still being developed in the major derivatives trading jurisdictions.

The regulators will continue to monitor developments in other jurisdictions and seek more detailed information on activity in the Australian market, with a view to more clearly defining the characteristics of suitable trading platforms. This work will be assisted by the improved market information that will be available as a result of the implementation of trade reporting.

  1. Report on the Australian OTC Derivatives Market, July 2013, available at: http://www.cfr.gov.au/publications/cfr‑ publications/2013/report‑on‑the‑australian‑otc‑derivatives‑market‑july/index.html
  2. The survey was circulated to 55 institutions, with 30 responses received.