Australia has been heavily engaged in international efforts to address conflicting and inconsistent implementation of G20 commitments across jurisdictions.
The sixth FSB Progress Report
The implementation of the G20 commitments is being monitored by the Financial Stability Board (FSB). The FSB membership includes the major financial centres around the world and in our region, including: China, Hong Kong, India, Indonesia, Japan, the Republic of Korea, Singapore and Australia.
The sixth FSB Progress Report (FSB Report), published in September 2013, provides an update on international, national and regional progress in finalising standards and implementing reforms to fulfil these commitments. The FSB Report draws on a number of sources to review market participants’ readiness to meet the requirements of reforms as they are implemented. In addition, it provides some preliminary consideration of the effectiveness of the reforms in meeting the G20’s underlying objectives of increasing transparency, mitigating systemic risk, and protecting against market abuse in the OTC derivatives market.
The FSB Report notes that actual use of centralised infrastructure by market participants is most advanced in trade reporting and central clearing of OTC interest rate and credit derivatives. To date, progress remains slow in the central clearing of products in other asset classes, while the use of organised trading platforms is not widespread in any of the asset classes.
The FSB Report observes that some jurisdictions already have central clearing requirements in place in the largest derivatives markets, with concrete rules already beginning to take effect.
The FSB Report also discusses areas where further work is needed to complete the reforms and achieve the G20 objectives, including:
- increased use of central clearing, and a renewed focus on the commitment to increase the use of exchanges and electronic trading platforms;
- establishment of resolution regimes for FMIs, including CCPs;
- continued work by regulators to cooperate in the application of regulations in cross border contexts, to enable them to defer to each other’s rules where these achieve similar outcomes;
- greater clarity from regulators regarding the detailed rules on the treatment of cross border transactions and the timetables for implementation; and
- ensuring that authorities can make full use of the data collected by trade repositories in fulfilling their financial stability responsibilities
The OTC Derivatives Regulators Group (ODRG) was established to find mutually agreed solutions to the problems created by cross border application of reforms of OTC derivative markets. It consists of regulators from Brazil, the European Union (EU), Hong Kong, Japan, Ontario, Quebec, Singapore, Switzerland, the US and Australia. 1
On 30 August 2013, the ODRG responded to an April 2013 request by the G20 Finance Ministers and Central Bank Governors, urging key OTC regulators to intensify their efforts to address and resolve remaining cross border conflicts, inconsistencies, gaps and duplicative requirements by the St Petersburg Summit, which took place in early September 2013.
The ODRG agreed the following:
- early and comprehensive consultation among relevant authorities when equivalence or substituted compliance assessments are being undertaken is essential;
- a flexible, outcomes based approach should form the basis of final assessments regarding equivalence or substituted compliance assessments;
- a ‘stricter rule’ approach would apply to address gaps in mandatory trading or central clearing obligations;
- authorities should have a framework for consultation on mandatory central clearing determinations;
- jurisdictions should remove barriers to reporting to trade repositories by market participants and to access to trade repository data by authorities; and
- there should be appropriate transitional measures and a reasonable but limited transition period for foreign entities to implement OTC derivatives reforms.2
In their previous April report, the ODRG agreed on principles with respect to conflicting and inconsistent implementation, which are outlined below.
Addressing conflicting implementation
The ODRG recognised that:
- national authorities have ultimate responsibility and authority to protect against all sources of risk to their markets; and
- statutory and regulatory requirements of each jurisdiction are core components of each respective market
Legal systems and market conditions differ among jurisdictions and due account should be taken of such differences in determining the cross border application of laws and regulations.
Treatment of regulatory gaps and substituted compliance
The ODRG agreed that substituted compliance, equivalence or recognition would not solve the problem of gaps between the rules of different jurisdictions. For example, a gap would be deemed to occur when:
- a category of counterparties or products are exempt ex ante from central clearing or trading obligations in one jurisdiction but not in another; and
- a product is subject to a central clearing or trading obligation in one jurisdiction but not in another.
In such cases, the group agreed to take a ‘stricter rule applies’ approach. Under this approach the rules in the jurisdiction that would apply the requirement would prevail. In other words, exemptions would not be imported.
EC and CFTC agreement on cross-border regulation
On 11 July 2013, the Commodity Futures Trading Commission (CFTC) and the European Commission (EC) announced a path forward regarding their joint understandings on a package of measures for how to approach cross border derivatives. 3
The two agencies acknowledged that, notwithstanding the high degree of similarity that already exists between the respective requirements, without coordination, subjecting the global market to the simultaneous application of each other’s requirements could lead to conflicts of law, inconsistencies, and legal uncertainty.
CFTC final guidance and extension of exemption
On 12 July 2013, the CFTC approved its final interpretive guidance and policy statement regarding the cross border application of certain swaps provisions, and granted a further exemption from complying with certain requirements for swap dealers or major swap participants established in six jurisdictions, including Australia, out to 21 December 2013 or 30 days following a substituted compliance determination, whichever comes first. 4
On 20 December 2013 the CFTC announced the outcome of its substituted compliance assessment of six jurisdictions, including Australia, with respect to their regulation of swap dealers and major swap participants. The CFTC determined that Australian swap dealers subject to APRA and ASIC’s regulatory regimes can rely on substituted compliance in respect of a number of ‘entity level’ requirements under the CFTC’s regime.
No substituted compliance determination was made by the CFTC in respect of ‘transaction level’ requirements, which include mandatory clearing, portfolio reconciliation and compression, and swap relationship documentation. As the Australian Government implements further G20 commitments (such as mandatory clearing requirements), there may be future opportunities to seek additional substituted compliance determinations for some of these requirements.
The CFTC has not concluded substituted compliance assessments of foreign regulatory frameworks with respect to trade reporting and has provided transitional relief from certain trade reporting requirements until 1 December 2014 while it continues to conduct these assessments.
An earlier CFTC regulation governing exemption from the central clearing obligation for certain inter affiliate swaps extended relief to affiliates in the EU, Japan and Singapore, but not Australia. 5 These jurisdictions were exempted because the CFTC considered that they had ‘adopted swap clearing regimes and are currently in the process of implementation’. 6
ESMA rules on non-EU counterparties dealing in OTC derivatives
On 15 November 2013, the European Securities and Markets Authority (ESMA) finalised its regulatory technical standards (RTS) on the application of European Market Infrastructure Regulation (EMIR) to OTC derivative transactions between non EU counterparties in certain cases. 7
These RTS clarify the conditions where EMIR’s provisions regarding central clearing or risk mitigation techniques would apply to OTC derivatives by two non EU counterparties which have a direct, substantial and foreseeable effect in the EU. EMIR would only apply to transactions between two non EU counterparties if their jurisdictions’ rules are not considered equivalent to EMIR, and where one of the following conditions is met:
- one of the two non EU counterparties to the OTC derivative contract is guaranteed by an EU financial for a total gross notional amount of at least €8 billion, and for an amount of at least 5 per cent of the OTC derivatives exposures of the EU financial guarantor; or
- the two non EU counterparties execute their transactions via their EU branches and would qualify as financial counterparties if established in the EU.
The Final Report has been submitted to the EC, which has three months to decide whether to endorse the draft RTS.
ESMA advice on sufficient equivalence of the Australian regulatory regime
ESMA recently published its advice to the EC on its comparison of the Australian regulatory regime with EMIR8. The EC is considering whether to adopt implementing Acts in line with ESMA’s advice. With respect to central clearing, ESMA recommended that the Australian rules for mandatory central clearing be found equivalent to those under EMIR, if the product is subject to a mandatory central clearing obligation in Australia and the counterparty is not exempt from the obligation. Provided ESMA’s advice is implemented, this will mean that any Australian counterparties that are subject to the mandatory central clearing obligation in Australia can comply with EMIR (if they need to do so) by complying with the Australian rules.
Mandatory central clearing has not come into force yet in the EU. ESMA is currently processing authorisation applications by CCPs. It will also have to formulate RTS setting out the detailed implementation process, including timelines, for specific classes of derivatives, which will be subject to endorsement by the EC. The mandatory central clearing obligation is currently expected to come into force sometime in the second half of 2014. 9
ESMA’s advice further recommended that the Australian regime for CCPs be assessed as equivalent to that under EMIR. A positive determination of equivalence by the EC is one of the necessary conditions in order for Australian CCPs to provide (or to continue to provide in the case of ASX Clear (Futures)) clearing services to clearing participants established in the EU.
ESMA also advised that the Australian regimes for trade reporting and Trade Repositories (TRs) were equivalent to that under EMIR. This would mean that market participants subject to reporting requirements in the EU and Australia would be able to satisfy all of these requirements by complying with their Australian obligation. It would also mean that any TRs established in Australia in the future would be able to gain recognition in the EU.
ESMA advised that the Australian regime with respect to the risk management obligations applying to non centrally cleared OTC derivatives was not fully equivalent to that of the EU. Discussions in relation to this assessment are ongoing.
- OTC Derivatives Regulators Group — Report to the G20 meeting of Finance Ministers and Central Bank Governors, 16 April, 2013, available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/odrgreport.pdf ↩
- OTC Derivatives Regulators Group Report on agreed understandings to resolving cross border conflicts, inconsistencies, gaps and duplicative requirements, 30 August, 2013, available at http://www.cftc.gov/PressRoom/PressReleases/pr6678 13 ↩
- The European Commission and the CFTC reach a Common Path Forward on Derivatives, 11 July, 2013, available at http://www.cftc.gov/PressRoom/PressReleases/pr6640-13 ↩
- Exemptive Order Regarding Compliance with Certain Swap Regulations, 16 July, 2013, available at, http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister071213.pdf ↩
- CFTC Approves Final Regulations Governing Exemption from Required Clearing for Inter Affiliate Swaps, 1 April, 2013, available at, http://www.cftc.gov/PressRoom/PressReleases/pr6553-13 ↩
- Federal Register, Vol. 78 Thursday, No. 70 April 11, 2013, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2013-07970a.pdf ↩
- Final Report — Draft technical standards under EMIR on contracts having a direct, substantial and foreseeable effect within the Union and non evasion of provisions of EMIR, 15 November 2013, available at: http://www.esma.europa.eu/system/files/2013 -1657_final_report_on_emir_application_to_third_country_entities_and_non evasion.pdf ↩
- For details see: http://www.esma.europa.eu/news/ESMA-delivers-second-set-advice-EMIR-equivalence?t=326&o=home ↩
- For details see: http://www.esma.europa.eu/page/European-Market-Infrastructure-Regulation-EMIR ↩