6.1 Mandatory central clearing of other products

Central clearing of AUD‑IRD

There is an emerging case for mandating central clearing of AUD‑IRD.

Industry take-up of central clearing had, until recently, been limited by the lack of availability of direct central clearing for domestic market participants. However two CCPs have received regulatory approval in July 2013 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.

APRA, ASIC and the Reserve Bank will conduct a further market assessment in 2014. This will review the case for mandating central clearing of AUD‑IRD. To gauge the regulatory impact of such a mandate, the regulators will examine the extent to which domestic participants have established direct clearing arrangements with the two CCPs that have been granted regulatory approval to provide these services.

Central clearing of other derivatives

The regulators will also seek further information about Australian market participants’ counterparty exposures in North American and European referenced CDS and the breadth of central clearing of these products. In light of this information, the regulators will review the case for a domestic mandate.

Indirect effects of regulation

Some stakeholders have raised concern that, despite not being subject to direct obligations, the indirect effects of global regulation have significantly increased the costs and complexity of managing their business’s risks. These costs are expected to rise as take-up of central clearing by major participants increases.

The regulators are undertaking further work to understand derivatives use by businesses other than the G4-Dealers. This will help to inform the regulators and the Government of the indirect effects of derivatives regulation on these businesses. This analysis will also consider incremental costs and benefits of extending a central clearing mandate to some businesses other than the G4-Dealers at some stage in the future.

Understanding the indirect effects of a clearing mandate on end-users will be a very important precondition prior to any decision to mandate the central clearing of AUD‑IRD in particular.

Preliminary views sought

Some stakeholders have raised that there would be benefit to the market from the Government providing a timetable for implementation of AUD‑IRD and other derivatives. This would assist market participants and service providers to prepare for the transition to mandatory central clearing.

In order to assist the Government to provide direction as early as possible following any future recommendations from the regulator, this paper seeks preliminary views on the benefits and costs of the mandatory clearing of other derivatives as well as an indicative timetable for implementing these.

This feedback will be used in order to best tailor any future consultation.

2 thoughts on “6.1 Mandatory central clearing of other products

  1. GreySpark Partners

    The ideal timeframes for a clearing mandate would be in a phased approach, such that each phase is separated by a 6 month interval. A proposed feasible timeline for an IRD mandate is as follows:
    • G4-IRD clearing mandate for G4 dealers: Q1 2015
    • AUD-IRD clearing mandate for AUD & G4 dealers: Q1 2015
    • G4-IRD and AUD-IRD clearing mandate for non-dealer financial counterparties trading over a specified gross notional threshold (per asset class): Q3 2015
    • G4-IRD and AUD-IRD clearing mandate for non-dealer non-financial counterparties trading over a specified gross notional threshold (per asset class): Q1 2016

  2. GreySpark Partners

    Response to question 7: From our deep involvement in the Australian OTC derivatives market, it would have been ideal to have a tentative timeframe specified for AUD-IRD mandatory clearing in the Treasury proposals paper to provide the market with some direction as to when this would eventuate. Due to the lengthy timeframes required to prepare for clearing readiness and high costs associated with clearing readiness, a tentative deadline would have been very useful in guiding the market in the right direction.
    A key benefit of clearing would be the Credit Valuation Adjustment (CVA) charges applied under the Basel III/CRD IV accords. The Basel Committee promotes central clearing through CCPs as per the below:
    • Applying a nominal 2% risk weighting for OTC Derivatives cleared through a CCP
    • Banks will find it much more expensive to trade bilateral OTC Derivatives due to increased regulatory capital requirements for exposures to non-CCPs

    Therefore the cost of trading bilaterally has increased substantially under Basel III, as Counterparty Credit Risk (under Basel III) = Default Risk of Counterparty (under Basel II) + CVA Risk (newly added under Basel III). This is particularly true for long-dated bilateral swaps, where the CVA charge would be applicable for the life of that trade.

    As a specific example, based on an IRS with €100m notional, 3 year maturity, with a BBB rated financial counterparty (funding charge assumed to be 3%), the breakdown of capital charges under Basel II and Basel III would result in the funding differential between bilateral trading and clearing = €999,000.

    In terms of NA and European referenced CDS, due to the low volumes of trading locally, we agree that this is not a priority at present due to the lack of significant levels of activity in the Australian market, but in the interests of international consistency, should be reevaluated over the next 12-18 months.

Comments are closed.