It is proposed that a determination be made in the second quarter of 2014 that will allow ASIC to make rules requiring the central clearing of G4‑IRD by G4 Dealers.
5.4.1 Products subject to the determination
Commercial and regulatory developments in G4‑IRD have resulted in liquidity moving to centrally cleared trades. Stakeholders have said that, in these instances, not only should there be limited regulatory impact from mandatory central clearing, but opportunities for substituted compliance can provide significant benefits.
It is expected that the net effect will be a significant reduction in the regulatory burden as well as improved business opportunities for Australian banks. Australian banks have submitted that:
Given the scope of our international operations, we may be subject to reporting, clearing and ultimately trade execution requirements imposed by other jurisdictions, such as the EU, in order to implement their G20 commitments …
In that context, we believe that one of the key objectives of the Australian government and agencies in implementing Australia’s G20 commitments should be to ensure international co‑ordination, in order to minimise regulatory duplication and overlapping regulatory requirements.1
The transition to central clearing of G4‑IRD between dealers has accelerated. Australian banks’ notional principal outstanding of IRDs cleared at one of the international clearing houses, LCH.C Ltd, which includes these products, had increased to US$1.4 trillion by November 2013. 2
Dealers operating in the Australian market have reported that most new transactions in G4‑IRD are centrally cleared, especially interdealer transactions entered into with overseas‑headquartered banks, many of which are either already, or expect soon to be, subject to central clearing mandates in place overseas.
These obligations are reflected in Chart 1, which shows that nearly all G4‑Derivatives transactions by Australian banks are with foreign counterparties. These transactions are increasingly subject to foreign central clearing obligations.
In addition, increasing numbers of transactions amongst Australian banks will also need to be centrally cleared. This is because:
- foreign regulators require central clearing; and
- there are reduced commercial opportunities to trade without centrally clearing.
Definition of G4 Dealers
The Report recommends that the central clearing obligation should apply to dealers with significant cross border activity in G4 IRD (G4 Dealers). The regulators have considered options for identifying G4 Dealers. Further detail is at Appendix A.
It is proposed that entities subject to mandatory central clearing would be financial entities who have reached a certain threshold of activity. There are several possibilities for determining how the threshold should be calculated. For example, one possibility would be to align the threshold with that for phase 2 of the trade reporting obligation prescribed in ASIC’s trade reporting DTRs regime, being $50 billion or more notional OTC derivatives outstanding held by a financial entity as at an agreed date. Another possibility would be to calculate the threshold based on notional OTC IRDs outstanding. The threshold would be calculated on a legal entity basis, so only the outstanding OTC derivatives entered into by the legal entity would be counted (and would not include outstandings of related entities).
In addition, for the avoidance of doubt, it is the intention that public entities such as central banks, debt offices, supra‐national multilateral development banks and entities such as the International Monetary Fund (IMF) would be out of scope of any future central clearing rules.
5.4.3 Exemptions of intragroup trades
The EU and US have both introduced an exemption from the central clearing obligation for intra group transactions. This is to avoid introducing any requirement to centrally clear derivatives transactions that are not transferring any risk into or out of a single corporate group.
It is proposed that intragroup trades would be exempted from central clearing requirements, subject to appropriate conditions (such as notification requirements).
5.4.4 Comparison with other jurisdictions
Japan began requiring mandatory central clearing in November 2012, beginning with Japanese index based credit default swap (CDS) indices referencing Japanese underliers (that is the iTraxx Japan Index Series) and plain vanilla JPY denominated interest rate swaps referencing LIBOR.
Mandatory central clearing requirements initially apply to transactions between large domestic financial institutions registered under the Financial Instruments Exchange Act (FIEA) that are members of the CCP, Japan Securities Clearing Corporation (JSCC).
In Hong Kong, the Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have proposed broadly that Hong Kong entities that are counterparty to a central clearing eligible transaction be required to clear this transaction through a designated CCP if both they and their counterparty have exceeded a specified threshold (clearing threshold) and their counterparty is not exempted from the central clearing obligation.
The Hong Kong regulators have stated they are prepared to consider extending these exemptions in respect of transactions with certain public sector entities, as well as to non financial entities using OTC derivatives for commercial hedging purposes, intra group transactions and transactions involving jurisdictions that have a material level of foreign exchange control, and/or other local regulatory restrictions that make it impractical to require central clearing to take place in any jurisdiction other than its own jurisdiction.
In the EU, EMIR requires transactions be centrally cleared where they involve financial counterparties or non financial counterparties that exceed a specified central clearing threshold (which has been set at EUR 1 billion in gross notional value for OTC credit and equity derivatives, and EUR 3 billion in gross notional value for OTC interest rate, foreign exchange and commodity derivatives).
Transactions involving central banks and other public bodies charged with or intervening in the management of public debt can be exempted by way of a delegated act. The current exemption only relates to the US and Japan, but the EC has been asked to consider including Australia. Certain intragroup transactions are also exempted from a central clearing obligation, as well as transactions by non financial counterparties that are objectively measurable as reducing risks directly related to the commercial activity or treasury financing activity of the counterparty.
The United States
In the US, the CFTC adopted its first mandatory central clearing determination in December 2012 and requires four classes of interest rate swaps and two classes of CDS be cleared. Compliance will be phased in by type of market participant entering into a swap subject to the central clearing requirement, and the first phase commenced on 11 March 2013. Under Dodd Frank and CFTC rules, an exemption from the central clearing obligation is available for non financial entities and small financial institutions (those with total assets of $US 10 billion or less) where the relevant swaps are being used to hedge or mitigate commercial risk.
An exemption from the central clearing obligation is also available for transactions between certain affiliated entities. In June 2012, the SEC adopted rules regarding processes for determining whether specific derivatives contracts will be subject to mandatory central clearing requirements. The SEC has similar powers under Dodd Frank to provide exemptions from central clearing obligations to certain entities, but has not yet finalised the rules that would determine which exemptions would be available.
3. Do you agree with the proposal to restrict ASIC rulemaking to entities that are considered to be G4 Dealers, and to exempt intra group trades? Could you comment on the incremental costs and benefits of including or exempting other types of entities or transactions? For example including all AFSL holders and ADIs or alternately setting a high threshold of activity.
4. Do you have comments on the calculation methodology used for determining the proposed threshold of activity and the appropriate level of the threshold? Do you have views on whether notional OTC derivatives or notional OTC IRDs is the more appropriate basis for calculating the threshold? Or would you prefer a different methodology and if so, why?
- ANZ, CBA, Macquarie Bank Limited, NAB, Westpac, Comments on Australian Treasury’s December 2012 Consultation Paper on Implementation of Australia’s G20 over the counter derivatives commitments (‘Consultation Paper’) available at http://financialmarkets.tspace.gov.au/implementationg20/submissions/ ↩
- Information supplied by LCH.C Ltd ↩