At the G-20 summit in Pittsburgh in 2009, following the global financial crisis, the Australian Government joined other jurisdictions in committing to substantial reforms to practices in OTC derivatives markets.
Three of the key G-20 commitments1 in this area related to:
- the reporting of OTC derivatives to trade repositories;
- the clearing of standardised OTC derivatives through central counterparties; and
- the execution of standardised OTC derivatives on exchanges or electronic trading platforms, where appropriate.
These commitments aim to bring transparency to OTC derivative markets and improve risk management practices.
The implementation of the G-20 commitments is being coordinated and 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 FSB recently called on all jurisdictions to put legislation and regulations in place promptly, and in a form flexible enough to ensure that reforms are implemented consistently.2 The FSB also noted that most progress on implementation has been made in the major jurisdictions of the United States of America (US), European Union (EU) and Japan, it acknowledged that no single jurisdiction has fully met the G-20 commitments.
The international regulatory community is working toward improving clarity and reducing conflict but these remain significant concerns. Global regulators recently met to identify various potential conflicts, inconsistencies, and duplicative requirements within respective contemplated rules related to OTC derivatives. Following the meeting a statement of understandings as well as areas for further consideration was published in December 2012.3/sup>
In light of the uncertainty around the international framework for regulation of OTC derivatives, the Australian legislation does not pre-empt international developments; it instead allows for mandates to be determined based on regular consideration of domestic market developments and in coordination with other economies.
With regard to international developments, the Australian Government proposes to implement the G-20 commitments in a way that:
- ensures that Australian businesses can continue to participate in international markets while remaining primarily regulated in Australia; and
- ensures that Australia does its part to maintain a consistent global framework and remove opportunities for regulatory arbitrage.
The Australian legislative framework passed the Parliament in November 2012 and will have effect by year end.
Under the legislation, the Minister has the power to prescribe certain classes of derivatives as subject to mandatory reporting to a derivative trade repository, mandatory clearing by a central counterparty, or mandatory execution on a trading platform based on regular market assessments. Regulators may also make urgent recommendations in response to unexpected international or domestic developments that occur in between regular assessments, for example to deal with foreign rulemaking with extraterritorial application to Australia.
To give effect to any mandate, ASIC will be tasked with developing ‘derivative transaction rules’. These rules will clarify matters such as the institutional and product scope of the obligation, as well as details of how any relevant mandatory obligations can be complied with.
The legislation also establishes a licensing regime for derivative trade repositories, largely modelled on the existing licensing regimes for market operators and clearing and settlement facilities under the Act. ASIC will have primary responsibility for administering this regime and overseeing any trade repositories licensed under the regime, as well as making ‘derivative trade repository rules’ under section 903A to govern the conduct of those repositories.
A decision by the Minister prescribing a class of derivatives under the framework will be based on advice from APRA, ASIC and the Reserve Bank. ASIC is also required to consult with both APRA and the Reserve Bank before issuing any derivative transaction rules.
Recommendations from Australian Regulators
Consistent with this advisory role, APRA, ASIC and the Reserve Bank released the Report on the Australian OTC Derivatives Market in October 2012 (the Report).3 The Report examined the risk management practices of market participants, with a particular focus on how market participants are using centralised infrastructure, and the prospects for increased usage.
In preparing the Report, a wide-ranging survey of key participants in the Australian OTC derivatives market was undertaken during July 2012. The survey covered large domestic and international banking groups, smaller authorised deposit-taking institutions, fund managers, government borrowing authorities, corporate treasuries and electricity companies.
The Report reiterated the Council of Financial Regulators (Council) recommendation to the Deputy Prime Minister and Treasurer in March 2012. That is, that there are strong in-principle benefits from participants in the domestic OTC derivatives market making greater use of centralised infrastructure, such as trade repositories, central counterparties and trading platforms.
In promoting this outcome, the Report recognised the importance of retaining the benefits of OTC derivatives markets wherever possible. Accordingly, the Report favoured an industry-led transition to use of centralised clearing infrastructure, where possible. The Report also recognised that not all products and participants are amenable to a transition to centralised infrastructure; in such cases, it is important to ensure other risk management measures are rigorously applied.
The main recommendations of the Report are that:
- the Government consider a broad-ranging mandatory trade reporting obligation for OTC derivatives; and
- a mandatory clearing obligation is not necessary for any derivative at this time, but may become necessary in the future.
Regular market assessments
Regulators will continue to keep the OTC derivatives market under review, and future market assessments will examine whether the policy case is satisfied for mandatory central clearing and execution on trading platforms.
It is also anticipated that future market assessments will consider Australia’s position in relation to any decision to mandate derivatives in other jurisdictions. This analysis would consider whether there would be benefits to the Australian economy and/or the efficiency, integrity and stability of the Australian financial system from eliminating potential regulatory gaps by also mandating those derivatives in Australia.
- The G-20 also committed to subjecting non-centrally cleared derivatives to higher capital requirements. There is separately work underway by international standard-setters on proposals to strengthen risk management practices for non-centrally cleared OTC derivatives by introducing global minimum standards for margin requirements.
- OTC Derivatives Market Reforms – Fourth Progress Report on Implementation, Financial Stability Board, 31 October 2012, http://www.financialstabilityboard.org/publications/r_121031a.pdf.
- Joint Press Statement of Leaders on Operating Principles and Areas of Exploration in the Regulation of the Cross-border OTC Derivatives Market, December 4, 2012 available at http://www.cftc.gov/PressRoom/PressReleases/pr6439-12.