BILLS DIGEST NO. 49, 2012–13

22 November 2012

Corporations Legislation Amendment (Derivative Transactions) Bill 2012

Kali Sanyal, Economics Section

Jonathan Chowns, Law and Bills Digest Section

Glossary

Abbreviation

Definition

ACCC

Australian Competition and Consumer Commission

AML

Australian market licence (or licensee, depending upon the context used)

APRA

Australian Prudential Regulation Authority

APRA Act

Australian Prudential Regulation Authority Act 1998

ASIC

Australian Securities and Investments Commission

ASIC Act

Australian Securities and Investments Commission Act 2001

CCPs

Central counterparties for derivative transactions

Council

Council of Financial Regulators

CSFL

Clearing and settlement facility licence (or licensee, depending upon the context used)

Corporations Act

Corporations Act 2001

DTR

Derivative transaction rules

DTRR

Derivative trade repository rules

G-20

Group of Twenty (G-20) forum of 19 countries and the European Union

GFC

Global Financial Crisis

LI Act

Legislative Instruments Act 2003

MABRA

Mutual Assistance in Business Regulation Act 1992

MABRR

Mutual Assistance in Business Regulation Regulations

OBPR

Office of Best Practice Regulation

OTC derivatives

Over-the-counter derivatives

OTF

Organised Trading Facility

RBA

Reserve Bank of Australia

RB Act

Reserve Bank Act 1959

RIS

Regulation Impact Statement

TR

Trade repository

Date introduced:  12 September 2012

House:  House of Representatives

Portfolio:  Treasury

Commencement:  Sections 1 to 3 commence on Royal Assent.  Schedule 1 which contains all the substantive provisions of the Act commence on the 28th day after the Act receives Royal Assent. While the amendments commence at this time, the rule making power of the Australian Securities and Investments Commission (ASIC) regarding derivative transactions will not be triggered unless and until the Minister prescribes a derivative class in respect of one or more of the trade reporting, clearing or execution mandates.

Trade repository licensing applications may be lodged from the date of commencement, subject to prescription or approval of the relevant form. However, ASIC would be unable to satisfy itself of the criteria for granting a licence until derivative trade repository rules (which set out the operational requirements of a licensee) are finalised.

There are prohibitions applicable from the date of commencement on a person holding themselves out to be a licensed or prescribed facility for the purpose of any of the three mandates, when they are not a licensed or prescribed facility. Prohibitions on operating an unlicensed trade repository will only come into effect after regulations are made providing that specified classes of trade repository must be licensed.[1]

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill's home page, or through http://www.aph.gov.au/Parliamentary_Business/Bills_Legislation. When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website at http://www.comlaw.gov.au/.

Purpose

The primary purpose of the Bill is to provide a legislative framework to implement Australia’s Group of Twenty (G-20) commitments in relation to ‘over the counter’ derivatives reform.

An important element of the Bill is that it establishes a framework that allows for rules and regulations to be made, in the future, in a manner that can adapt to changing market conditions and so that they can be co-ordinated with the regulatory response of other nations. The rules and regulations include derivatives transaction rules (DTRs) which will be issued by the Australian Security and Investments Commission (ASIC). DTRs will apply to those classes of derivatives prescribed by the Minister. The DTRs may establish mandatory obligations concerning reporting, clearing or execution, in relation to transactions in that class.

The Bill also sets out a new licensing regime for derivative trade repositories which will record trade data and make it available to the relevant regulators. The new licensing regime is based on existing licensing regimes for other kinds of market operators.

The Bill inserts definitions of Australian derivative trade repository licence, derivative trade repository rules, derivative transaction rules in section 9 and section 761A of the Corporations Act 2001 (the Corporations Act). The Bill will also amend the Act in order to:

•       enable the Minister to prescribe a certain class of derivatives (in relation to a mandatory obligation)

•       allow ASIC to then issue a derivatives transaction rule for participants transacting in the prescribed class of derivatives

•       require any such rule to be consented to by the Minister

•       introduce a licensing regime for trade repositories and

•       make consequential amendments to the Australian Prudential Regulation Authority Act 1998, the Australian Securities and Investments Commission Act 2001, the Mutual Assistance in Business Regulation Act 1992 and the Reserve Bank Act 1959.

Background

The global financial crisis (GFC) generated a sense of urgency in managing the massive build-up of systemic risk which occurred in some advanced countries through the rapid growth of highly complex, leveraged derivative products which were traded outside appropriately regulated and transparent markets.

What is a derivative product?

A derivative is a security instrument based on a contract conferring the parties the right to exercise the contract at a specified price over a limited time period. The price of the instrument is essentially dependent upon or derived from one or more underlying assets.

The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterised by high leverage.

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. 

Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.[2]

Developments in Australia

In September 2009 the Group of Twenty (G-20) (a platform of governments of the 20 largest economies) endorsed a global transition of derivative products— which are currently traded through bilateral arrangements between parties, or ‘over-the-counter' (OTC) — towards recognised exchanges or trading platforms where appropriate, in order to boost market transparency. The G-20 agreement also included that all standardised OTC derivatives should be cleared through a central counterparty (CCP) and all OTC derivatives should be reported to trade repositories, in order to enhance transparency and reduce systemic risk. The G-20 committed to make this transition by the end of 2012.[3]

Subsequently, regulatory agencies in Australia engaged actively through global forums in order to develop a comprehensive framework for improving transparency and risk management in relation to derivatives trading.

As a follow up to its G-20 commitments, the Government asked the Council of Financial Regulators (the Council)—which comprises the Reserve Bank (the RBA), the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC) and the Australian Treasury—to undertake a consultation and review of the existing financial infrastructure so as to enable it to deliver the required changes in regulations. The Council has engaged extensively with domestic market participants since 2009 to identify the most appropriate policy settings for Australia in meeting the G-20 commitments, including the release of a discussion paper in June 2011.

The discussion paper contained a number of suggestions, namely:

•       that in the absence of Australian regulatory action, domestic CCP solutions may not emerge

•       that where a market is of systemic importance to Australia, a move to offshore central clearing might introduce risks to the Australian financial system that do not currently exist

•       that the regulatory agencies considered the market for Australian dollar interest rate swaps to be systemically important within Australia and

•       that in light of this, the regulatory agencies were considering the case for a requirement that those instruments be centrally cleared, and as part of that were considering whether such clearing should take place domestically. [4]

Through the consultation phase, although central clearing was the main theme of the discussion, some relevant issues arose in considering how best to promote a move to other centralised arrangements such as trade repositories or trading venues. Accordingly, the consultations helped the Council with information relevant for considering other elements of the international reform agenda for OTC derivatives markets.[5]

The Council has recommended a legislative framework allowing regulators to take a dynamic approach as the Australian market evolves, and allowing for mandated outcomes should these be required for financial stability objectives and to meet Australia’s international obligations. However, the Council also asked the Government to exploit the opportunities of market driven solutions first, where possible, driven by appropriate regulatory incentives. The Council affirmed that restrictions on local participants accessing domestic or offshore financial infrastructure at the time should not be considered, subject to appropriate safeguards being in place.

The final report of the Council was released in March 2012. It outlined its proposed next steps towards the implementation of Australia's G-20 commitment to improve risk management and reduce systemic risk in the OTC markets for financial derivative products. The Government undertook consultations with stakeholders on possible amendments to build a legislative framework for complying with Australia's international obligations.

The Treasury, with other Council agencies, engaged with stakeholders for a two month period and sought views on the content of the regulations to be made under the legislative framework.

International developments

In June 2012, in a coordinating role, the Financial Stability Board (FSB) of the Bank for International Settlement (BIS) based in Basel, Switzerland, published its third report on jurisdictions’ progress towards meeting G-20 commitments regarding OTC derivatives.[6]

The report noted that all jurisdictions should put legislation and regulations in place promptly, and in a form flexible enough to respond to cross-border consistency and other issues that may arise.

… the United States Commodities and Futures Trading Commission has recently published proposed guidance on the extra territorial application of their implementations of the G20 commitments and their expectations of other jurisdictions, such as Australia.

The proposed guidance highlights the need for Australia to act quickly to ensure that Australian businesses and investors are able to demonstrate that they are subject to an equivalent regulatory regime and so be able to continue to participate in the major derivatives markets of the world while still being primarily regulated in Australia.

However, the guidance has also highlighted areas of inconsistency and further potential change so it is important for the Australian regime to remain flexible to ensure that future developments can be accommodated.[7]

In voicing a guarded optimism about the deadline of the end of 2012, The Economist pointed out that:

That deadline is unlikely to be met but some jurisdictions are further ahead than others. America’s Dodd-Frank Act requires most OTC derivatives to be traded on a so-called Swap Execution Facility (SEF), which is defined as “a trading system or platform in which multiple participants have the ability to execute or trade swaps”. Recent drafts of the European Union’s Mifid 2 legislation would see liquid OTC derivatives move onto a similar platform dubbed—abbreviation-haters, beware—an Organised Trading Facility (OTF).’[8]

In its progress report, the FSB concluded that:

Broadly speaking, the jurisdictions currently with the largest markets in OTC derivatives – the EU, Japan and the US – are the most advanced in structuring their legislative and regulatory frameworks. They expect to have regulatory frameworks in place by end-2012 and practical implementation within their markets is well underway. Other jurisdictions are generally less advanced although, as this report indicates, progress has been made by many of them, particularly with respect to central clearing and reporting to [trade repositories] (TRs).[9]

The Japanese Parliament passed the Financial Instruments and Exchange Act in May 2010, granting the Japanese Financial Services Agency (JFSA) the authority to regulate OTC derivatives. As in the US[10] and EU, only those classes of OTC derivatives identified by regulators will be subject to mandatory central clearing, chosen on the basis of volumes and the effect of central clearing on settlement risks in the domestic market. Japan also asked the US authorities for more clarification as to which mechanism would work between the US and Japan over the cross border trades.[11]

Japan does not include an execution mandate in its obligations for OTC derivatives; however, the JFSA anticipates establishing a draft regulatory framework to require certain OTC derivatives to be executed on electronic trading platforms.[12]

The Hong Kong Monetary Authority (HKMA) and Hong Kong Securities and Futures Commission (SFC) have finalised their approach to mandatory central clearing.[13] With the release of the conclusion of the consultation process embodying the draft regulations, on 11 July 2012, the HKMA announced that:

We also aim to introduce the relevant Bill into the Legislative Council by the end of 2012 and conduct a public consultation on the draft subsidiary legislation at about the same time. Subject to passage of the relevant legislation by the Legislative Council, the target is to implement the new regulatory regime around mid-2013.[14]

The Monetary Authority of Singapore (MAS) released an addendum in August 2012, over its original consultation document released in February 2012, outlining its proposed approach to central clearing of OTC derivatives.

As stated in the policy consultation on OTC derivatives dated 13 February 2012, MAS intends to subject financial institutions and non-financial entities above certain thresholds to the clearing obligation. MAS will prescribe specified entities, and exempt entities who deal in derivative contracts that fall below certain thresholds. MAS will consult on the subsidiary legislation setting out the proposed thresholds after further study.

MAS proposes to provide for both top-down and bottom-up approaches to identify derivatives contracts that would be subject to the clearing obligation. Detailed guidance on how eligible CCPs can submit applications under the bottom-up approach to include certain derivatives contracts for mandatory central clearing will be set out in guidelines to be issued at a later date. To facilitate the process of determining the products and entities to be subjected to the clearing obligation, MAS also proposes to provide for powers to request for information from relevant persons. [15]

In the meantime the MAS issued notice to all banks stationed in Singapore advising them how to manage capital adequacy ratios in view of the emerging regulatory regime.[16]

It appears that the MAS did not propose to mandate the use of a domestic CCP but would allow mandatory central clearing to take place through foreign CCPs subject to equivalent regulation in their home jurisdictions.

The consultation document does not set out a timeframe for implementation, but the MAS has previously stated an aim to introduce the new regime, including changes to the Securities and Futures Act, by the end of 2012.[17]

The Canadian Securities Administrators (CSA) has published a series of consultation papers on OTC derivatives regulation.[18] It proposed that a regulatory regime be created for trade repositories, and that there be a capacity to mandate reporting of OTC derivatives transactions.[19]

Basis of policy commitment

Since the GFC, the Government undertook measures to develop a regulatory regime that would operate seamlessly with global counterparts across jurisdictions.

The Government is committed to the following three key G-20 recommendations:

•       the reporting of all OTC derivatives to trade repositories

•       the clearing of all standardised OTC derivatives through CCPs and

•       the execution of all standardised OTC derivatives on exchanges or electronic trading platforms, where appropriate. [20]

The Bill follows on from the announcement in a joint media release of the Deputy Prime Minister and Treasurer, the Minister for Financial Services and Superannuation and the Parliamentary Secretary to the Treasurer on 18 April 2012.[21]

Committee consideration

The Senate Standing Committee for the Scrutiny of Bills commented on the structure of the Bill which leaves much of the detail of the new legislative scheme to several kinds of subordinate legislation—derivative transactions rules, determinations, regulations and derivative trade repository rules—which are not yet available.  The Committee noted that it ‘leaves the question as to whether the approach adopted in this bill is appropriate to the consideration of the Senate as a whole (emphasis in original)’.[22]

The Bill was referred to the Joint Committee on Corporations and Financial Services, and the Committee submitted its report on 11 October 2012.[23] The Committee recommended that the Bill be passed.

The Coalition members of the committee welcomed the Joint Committee majority report’s recognition that the electricity sector did have a range of legitimate concerns in relation to the regime under this Bill. The Coalition members of the Committee strongly supported the amendment for an OTC derivatives market. They were, however, critical of the process. According to the Opposition, the concerns raised by the electricity sector should have been dealt with much earlier through a properly responsive consultation process by the Government.[24]

At the time of writing, it appears that no other r political parties had expressed a view on the Bill.

Position of major interest groups

Finance and Treasury Association (FTA) – In a submission to the Treasury consultation process, FTA expressed its concern about ensuring its Australian corporate treasurer members continue to be able to use flexible OTC instruments such as forward foreign exchange contracts and cross currency swaps and asked the Government that those vital tools not be made prohibitively expensive and administratively unworkable.

FTA considers that deals done by non-financials are a tiny part of the derivative markets here and abroad, and are not material in their impact on systemic risk and hence should be exempted from the proposed rules (emphasis in original).[25]

In summing up, the FTA asserted that:

To provide non-discriminatory access to central clearing and exchange platforms may be to put at risk the very purpose of creating them as a way of reducing aggregate system risk. While it is desirable that like instruments and counter-parties be grouped together, the OTC derivative industry is characterised by a high degree of heterogeneity of instruments and differing credit risks among banks and other types of counter-parties. Incompatible risks and agents should be capable of being excluded. The design of such systems and standards and protocols is best left to experts within industry bodies rather than regulators.[26]

On 27 July 2012, Clayton Utz, a law firm, in a published alert noted that:

The Bill is silent on the jurisdictional reach of the mandatory obligations. The April consultation paper contemplated that the jurisdictional reach of the framework would be clarified by the regulations, with potential for further refinement in the DTRs.

The consultation paper also indicated that the jurisdictional reach may be considered separately for reporting, clearing and execution obligations. Market participants can expect further consultation on this crucial aspect of the new regime.[27]

National Generators Forum (NGF) – is a national industry association representing private and government owned electricity generators. According to the association, energy companies and associated industry peak bodies asked for exemptions of energy derivatives from the mandatory reporting, trading and clearing obligations. They argued that:

Both the European Union, through the European Market Infrastructure Regulation, and the United States of America, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), provide for exclusions under certain circumstances. Specifically, the EU has identified certain quantitative thresholds, under which market participants are exempt from central clearing. Further, these thresholds exclude hedging operational risk from the relevant calculations. The Dodd-Frank Act provides for a “commercial end-user exception” from central clearing obligations for non-financial entities using OTC derivatives to hedge or mitigate commercial risk.…

Australia’s response, has taken an alternative approach [in the draft legislation] by providing the Minister and the Australian Securities and Investment Commission (ASIC) with broad powers to make determinations and rules applying to OTC electricity derivatives.

The proposed legislation creates another layer of regulatory uncertainty for the energy market, which is already operating in an environment where the future of climate change policy is unclear and impacting market liquidity.

…

Notwithstanding these comments, it remains our strong preference for explicit exclusions to be incorporated within the framework legislation for energy OTC derivatives, or indeed those businesses whose primary activities involve the generation or retailing of energy in the [National Electricity Market] NEM.[28]

King & Wood Mallesons, another law firm, put up an advisory pointing out the ambiguity of the intended targets of the Bill, by saying that:

It is only a framework, so detail on what, and who, is to be caught by the new requirements is not included. Also, there is no indication as to which parts of the framework are to be utilised first (although the Explanatory Document does note that a number of stakeholders favoured mandating central clearing, rather than relying on market forces). This all depends on the Minister’s determination and the ASIC DTRs. Key outstanding matters include the intended jurisdictional reach, the types of derivatives caught and the entities which are required to comply. Further consultation awaits on these critical matters.[29]

In an advisory issued to clients, PricewaterhouseCoopers catalogued a series of steps across the United States and the European Union, and advised the regulators to face the challenges. Their points are:

The challenge of global consistency has become apparent as world regulators wrestle with the rule-making process. Three important goals have emerged, as noted in the recent US congressional hearings on derivatives market reform:

·         Global regulations should avoid the emergence of opportunities for regulatory arbitrage

·         Market disruption must be avoided

·         Incentives for off shoring must be eliminated.

While these goals are commendable and even critical to the ongoing operation of orderly efficient markets, the practical challenges in achieving them are considerable.[30]

In making an observation about the Dodd-Frank regime in the US, the international consulting
firm Ernst & Young identified certain challenges that still remain valid.

The Act mandated significant changes to the OTC market but left many of the specific details to rulemaking by the two key OTC market regulators: the Commodity Futures Trading Commission (CFTC) for swaps and the Securities and Exchange Commission (SEC) for security-based swaps (swaps and security-based swaps collectively referred to as swaps or derivatives)…Preparation for the new regulations includes examining the entire business model and defining fundamental changes to business and transaction-booking strategies.[31]

KPMG, which is another consulting house, raised similar questions with reference to Dodd-Frank regime in the US.[32]

Main issues

Concerns exist about the applicability of central clearing despite the international regulatory push. Concerns about the manner in which central clearing is to be implemented are legitimate, despite broad support for such measure. Particularly, given the nature of fragmentation of global markets, and regulatory inconsistencies and complexities so prevalent in a world where different countries’ jurisdictions may have potentially conflicting central clearing mandates, these concerns have to be addressed prudently.[33]

Which products need to be included in a mandatory central clearing requirement? Given the complex nature of derivative trading, international agreement on requiring the broad features of OTC derivatives products to be centrally clearable, still falls short of a comprehensive approach to the issue. The risks of the product could be managed better by CCPs, if there were standardisation and a lack of complexity in the terms of the contract; liquidity and broad usage; and readily available pricing information.[34]

In Australia’s case, stakeholders in the consultation phase advised the Council that:

any mandatory central clearing requirement define its product scope carefully rather than use a broad definition of ‘derivative’ such as that used in the Corporations Act 2001. There was broad agreement that Australian dollar-denominated interest rate derivatives were one class of derivatives for which a mandatory clearing requirement could be viably imposed. It was also generally agreed that FX swaps and forwards could be exempted (in line with the proposed exemption from the requirements of the Dodd-Frank Act announced by the US Treasury). A number of stakeholders also called for intra-group transactions to be exempted.

Attention was drawn to some specific derivatives markets, where it was argued that mandatory central clearing could substantially improve risk management practices.[35]

Who will be participants in a mandatory central clearing requirement? Any mandatory clearing requirement needs to be applied only to participants who pose systemic risk, and exemptions should apply for smaller users of derivatives and institutions using derivatives for hedging purposes only. However, there is a concern about the implications of central clearing for corporate and other non‑financial users of derivatives. Hence there is an apprehension that the collateral requirements of central clearing are likely to significantly increase costs for these users and possibly discourage them from hedging.[36]

Can the cost burden make number of securities unavailable? Parties involved in derivative transactions trading made an observation that the move to central clearing would most likely increase the cost of dealing in OTC derivatives.

This increase in the cost may occur as a result of the yet to be evolved trading processes and subsequent need for traders to seek further legal support. In addition, the cost will also rise for the traders to allow investors to pick up or draw down couple of equities from their portfolios and an increase in collateral requirements.[37]

Clearing through an Australian CCP – Subject to allowing the Australian participants to operate in international financial markets unimpeded, the legitimacy of sovereign control on the domestic market has to be balanced. Hence the design of a domestic CCP (e.g. acceptable collateral, operational timelines, participation requirements) needs to be tailored to Australian institutions so as to allow Australian regulators to have direct regulatory oversight of the CCP.

There are concerns that the set-up costs of a domestic CCP would be significant, and possibly not warranted given the Australian market could be served by existing offshore CCPs. However, any domestic CCP will need to meet the requirements for recognition that are being set down by US and European Union (EU) regulators, such that foreign banks could meet their home-regulator clearing requirements by clearing in Australia. In proceeding with a domestic clearing requirement, Australian regulators need to ensure they have a full understanding of the requirements that offshore regulations would impose on foreign institutions that participate in the Australian market. One measurement may be to keep clearing of OTC products separate from a CCP’s other businesses.[38]

Risks of clearing through an offshore CCP – Most Australian market participants are not confident that the clearing of markets through CCPs located offshore will help reduce systemic risk in domestic market. So the importance of local regulators being able to manage systemic risk has to be maintained. However, there is persistent doubt in the market as to Australian regulators’ capability to ensure full control over the businesses of Australian institutions or systemically important markets, because many transactions currently occur (and will continue to occur) offshore.

Some Australian financial institutions noted concerns about counterparty credit risk to their clearing member should they participate in a CCP indirectly. There were also concerns about legal protections for posted collateral, particularly when that collateral is posted with an offshore-based entity. A number of stakeholders called for a (possibly international) regulatory plan for handling a serious default in a CCP.[39]

Legal issues – Unless overseas CCP is recognised through Australian legislation, market participants would not be confident in participating in exchanges overseas. The legal protections around a CCP’s ability to port client positions require clarification. In order to successfully and quickly port positions and collateral from a defaulting member to a back-up member, it is crucial that the clearinghouse is able to, in a very short timeframe, determine client obligations, market value and value of posted collateral.[40] There are other issues related to clearing through an offshore CCP, including tax consequences and the scope for conflict between Australian and foreign legal requirements.[41]

Extraterritoriality – Australia’s regulatory response has to be consistent with, and recognised by, overseas regimes.

Basel III capital framework –it is the opportune moment that two streams of reform are coinciding and the Basel III capital rules will create an incentive to move to central clearing because exposures to a CCP will generally attract a lower capital charge than other bilateral exposures. However, some Australian financial institutions might find that ‘OTC derivatives used to hedge specific risks might become too costly to deal in from a capital charge perspective. This may lead to some end users (most likely corporates) becoming either unwilling or unable to hedge risks appropriately’.[42]

Key provisions

All substantive amendments are made by Schedule 1. Schedule 1 comprises Part 1 which amends the Corporations Act and Part 2 which amends other Acts.

Part 1 of Schedule 1: Amendments to the Corporations Act 2001

Items 1 to 31 insert new definitions and make consequential amendments arising from the creation of a new regulatory regime for derivative transactions and derivative trade repositories.

Item 32 inserts new Part 7.5A into the Corporations Act, which deals with the regulation of derivative transactions and derivative trade repositories.

New Part 7.5A is made up of eight Divisions:

Division 1 (proposed section 900A) defines the scope of the new regulatory scheme.

Division 2 deals with derivative transaction rules (DTRs). DTRs are rules concerning derivative transactions. Rules may cover entry into a derivative arrangement, modification, assignment or termination of such an arrangement. The definition also allows for other types of transaction to be included through regulations.  Subdivision A deals with the making of DTRs. Subdivision B of Division 1 deals with compliance with DTRs. Subdivision C of Division 1 deals with the process of making DTRs.

Proposed subsection 901A(2) gives ASIC the power to make DTRs which may impose requirements in relation to execution, reporting or clearing. Proposed subsection 901A(3) provides that DTRs may deal with matters that are incidental or related to reporting, clearing or execution and sets out examples of the kinds of incidental or related matters that might be dealt with. Proposed subsections 901A(5), 901A(6) and 901A(7) explain the meaning of ‘execution requirements’, ‘reporting requirements’ and ‘clearing requirements’.

Proposed section 901B provides that the DTRs can apply only to derivative transactions relating to derivatives specified in a disallowable legislative instrument made by the Minister. In making a determination, the Minister must have regard to certain matters listed in proposed subsection 901B(3). Proposed subsection 901B(3) was amended in the House of Representatives on the initiative of the Government. The amendment adds the requirement that the Minister have regard to the effect on the underlying physical market prior to making a determination mandating a commodity derivative. Proposed subsections 901B(4) requires the Minister to consult with ASIC, APRA and the Reserve Bank before making a determination but proposed subsection 901B(5) provides that a determination is not invalid if the Minister fails to properly consult. ASIC, APRA or the Reserve Bank may, of their own initiative give advice to the Minister about a proposed determination by the Minister (proposed subsection 901B(6)).

Proposed sections 901C and 901D provide that the regulations can put limits on the scope of the DTRs.

Proposed section 901E in subdivision B makes it an obligation to comply with DTRs and imposes a civil penalty for breach. However proposed section 901F allows for the regulations to provide for alternatives to civil proceedings.

Proposed sections 901H to 901K, in subdivision C, deal with the matters to which ASIC must have regard in making DTRs, the manner in which it must consult before making DTRs and provide that ASIC must not make DTRS without the prior written consent of the Minister. Proposed section 901H was amended in the House of Representatives on the initiative of the Government. The amendment adds the requirement that ASIC have regard to the effect on the underlying physical market prior to making a DTR.  Proposed section 901L allows for the making of DTRs without consultation or Ministerial consent if ASIC is of the opinion that it is necessary or in the public interest to do so in order to protect the Australian economy or the efficiency, integrity and stability of the Australian financial system.

Division 3 of new Part 7.5A (proposed section 902A) makes ASIC responsible for supervising licensed derivative trade repositories.

Division 4 of new Part 7.5A (proposed sections 903A to 903K) gives ASIC the power to make derivative trade repository rules (proposed section 903A), sets out the matters with which the derivative trade repository rules may deal (proposed section 903B), makes it an obligation to comply with derivative trade repository rules and imposes a civil penalty for breach (proposed section 903D). A Trade Repository is a body that centrally collects and maintains the records of
over-the-counter (OTC) derivatives. The Trade Repository Rules are to be made by ASIC and will govern the operation of a trade repository.  The rules could deal with, for example, non‑discriminatory access to the repository as well as imposing restrictions on the use and disclosure of data. However proposed section 903E allows for the regulations to provide for alternatives to civil proceedings. Proposed section 903F sets out the matters to which ASIC must have regard when making the derivative trade repository rules and proposed sections 903G and 903H require public consultation and prior written Ministerial consent before derivative trade repository rules are made. Proposed section 903J allows for the making of derivative trade repository rules without consultation or Ministerial consent if ASIC is of the opinion that it is necessary or in the public interest to do so in order to protect the Australian economy, the efficiency, integrity and stability of the Australian financial system or the security or confidentiality of derivative trade data.

Division 5 of new Part 7.5A deals further with the regulation of licensed derivative trade repositories. Proposed section 904A requires a licensee to comply with a licence, proposed section 904B imposes limitations on use and disclosure of data by a licensee, proposed section 904C imposes obligations on a licensee to notify ASIC if it considers that it may have breached or be about to breach its obligations under a licence. Proposed section 904D creates a positive obligation on a licensee to give such assistance to ASIC, APRA or the Reserve Bank as is reasonably required to enable those regulators to perform their functions.

Proposed sections 904F to 904K give the Minister and ASIC the power to give binding directions to a licensee in breach of its obligations.

Division 6 of new Part 7.5A deals with the licensing of derivative trade repositories. Proposed subsection 905A(1) allows the regulations to identify classes of derivative trade repositories that must be licensed. Proposed subsection 905A(2) provides that it is an offence to operate a repository identified in the regulations as being in a class requiring a licence if the operator does not have a licence.

Proposed sections 905B to 905E provide the mechanisms for the granting of licences.

Proposed sections 905F provides that ASIC may impose, vary or revoke conditions on a licence and deals with the manner and circumstances in which it may do so.

Proposed section 905H to 905N provides that ASIC may cancel or suspend a licence and deals with the manner and circumstances in which it may do so.

Proposed section 905P sets out the matters to which ASIC must have regard when it grants a licence under proposed section 905C, imposes, varies or revokes conditions under proposed section 905F or suspends or cancels a licence under proposed section 905J. The matters ASIC must have regard to are as follows:

•       the structure, or proposed structure, of the derivative trade repository

•       the nature of the activities conducted, or proposed to be conducted, by the derivative trade repository

•       the size, or proposed size, of the derivative trade repository

•       the persons who are, or may be, required to report derivative trade data to the derivative trade repository

•       the technology used, or proposed to be used, in the operation of the derivative trade repository and

•       whether it would be in the public interest to take the action.

However, ASIC may also have regard to any other matter that ASIC considers relevant.

Division 7 of new Part 7.5A sets out the scope of the regulations that may be made in respect of derivative trade repositories. Broadly, the regulations may impose obligations on operators of repositories and confer powers on ASIC. Such obligations and powers can be similar to those that apply under the derivative trade repository rules.

Part 2 of Schedule 1: Amendments to the other Acts

Part 2 makes consequential amendments to the following Acts:

•       Australian Prudential Regulation Authority Act 1998

•       Australian Securities and Investment Commission Act 2001

•       Mutual Assistance in Business Regulation Act 1992 and

•       Reserve Bank Act 1959.

Concluding comments

In a submission to the consultation process held by the Council of Financial Regulators, the Australian Securities Exchange (ASX) stated that 'decisions on the precise coverage of derivative products and reporting parties will raise complex issues and potentially impose significant implementations costs in establishing reporting systems. Any detailed consideration of data coverage needs to be conducted on a case by case basis so the cost of collection can be assessed against the benefits of the data being collected.[43] Hence, although the Australian measures will be consistent with the international approach, regulators may consider imposing mandatory trade reporting requirements first, and then use these data to make a broader reform for synchronizing clearing through the central counterparties among global players. A comprehensive scenario modelling exercise involving the industry may also be needed to find out the flaws in the regulation, if any.

In the meantime, failure to pass this legislation would eventually make Australia a renegade on its pledge with the G-20 initiative to the reform of derivative transactions and would put an extra hurdle for Australian financial operators in enjoying a seamless operation across multiple CCP jurisdictions.

Members, Senators and Parliamentary staff can obtain further information from the Parliamentary Library on (02) 6277 2500.

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ISSN 1328-8091

[1].               Explanatory Memorandum, Corporations Legislation Amendment (Derivative Transactions) Bill 2012, p. vii, viewed 21 November 2012, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2Fems%2Fr4879_ems_a301c9b5-e8de-4cd4-aac4-fa4b75debf1b%22

[2].               Investopedia, ‘Definition of “derivative”’, Investopedia website, 2012, viewed 19 September 2012, http://www.investopedia.com/terms/d/derivative.asp#axzz26tCc39v4)

[3].               Financial Stability Board (FSB), ‘OTC derivatives market reforms’, third progress report on implementation, Basel, Switzerland, 15 June 2012, p. 2, viewed 20 September 2012, http://www.financialstabilityboard.org/publications/r_111011b.pdf

[4].               Council of Financial Regulators, ‘OTC derivatives market reform considerations’, report by the Council of Financial Regulators, March 2012, p. 7, viewed 19 September 2012, http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/Publications/2012/CFR%20report%20on%20over%20the%20counter%20derivatives/Downloads/PDF/CFR%20Report.ashx

[5].               Ibid.

[6].               Financial Stability Board (FSB) , ‘OTC derivatives market reforms’, third progress report on implementation, Basel, Switzerland, 15 June 2012, p. 2, viewed 20 September 2012, http://www.financialstabilityboard.org/publications/r_120615.pdf

[7].               Explanatory Memorandum, Corporations Legislation Amendment (Derivative Transactions) Bill 2012, op. cit., p. 3.

[8].               Editorial, ‘Derivative exchanges: open deck: shifting more derivatives trades into the open creates opportunities’, The Economist, 18 August 2012, viewed 21 November 2012,  http://www.economist.com/node/21560563

[9].               Financial Stability Board, ‘OTC derivatives market reforms’, op. cit.

[10].               US Securities and Exchange Commission (SEC), Joint report on international swap regulation, required by section 719(c) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 31 January 2012, viewed 24 September 2012, http://www.sec.gov/news/studies/2012/sec-cftc-intlswapreg.pdf

[11].               Japanese Financial Services Agency (JFSA), Proposed CFTC cross-border releases on swap regulations, letter to
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[12].               Council of Financial Regulators, ‘OTC derivatives market reform considerations’, op. cit., p. 12.

[13].               SEC, Joint report on international swap regulation, op. cit., p. 81, viewed 24 September 2012, http://www.sec.gov/news/studies/2012/sec-cftc-intlswapreg.pdf

[14].               Hong Kong Monetary Authority (HKMA), Consultation conclusions and supplemental consultation on the proposed

regulatory regime for the OTC derivatives market in Hong Kong, background information, 11 July 2012, viewed 24 September 2012, http://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2012/20120711e3a33.pdf

[15].               Monetary Authority of Singapore (MAS), Consultation paper II on proposed amendments to the Securities and Futures Act on regulation of OTC derivatives, consultation paper, August 2012, p. 1, viewed 24 September 2012, http://www.mas.gov.sg/~/media/resource/publications/consult_papers/2012/3%20August%202012%20Proposed%20Amendments%20to%20the%20Securities%20and%20Futures%20Act%20on%20Regulation%20of%20OTC%20Derivatives.ashx

[16].               Monetary Authority of Singapore (MAS), Notice on risk based capital adequacy requirements for banks incorporated in Singapore, MAS 637, notice to banks, Banking Act, Cap 19, 14 September 2012, viewed 24 September 2012, http://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Commercial%20Banks/Regulations%20Guidance%20and%20Licensing/Notices/MAS%20Notice%20637_14%20Sept%202012.ashx

[17].               Council of Financial Regulators, ‘OTC derivatives market reform considerations’, op. cit., p. 13.

[18].               Canadian Securities Administrators (CSA), Derivatives: OTC central counterparty clearing, Canadian Securities Administrators Derivatives Committee, CSA consultation paper 91-406, 20 June 2012, viewed 24 September 2012, http://www.osc.gov.on.ca/documents/en/Securities-Category9/csa_20120620_91-406_counterparty-clearing.pdf

[19].               Council of Financial Regulars, ‘OTC derivatives market reform considerations’, op. cit., p. 13.

[20].               Explanatory Memorandum, Corporations Legislation Amendment (Derivative Transactions) Bill 2012, op. cit., p. 1.

[21].               W Swan (Deputy Prime Minister and Treasurer), B Shorten (Minister for Financial Services and Superannuation) and B Ripoll (Parliamentary Secretary to the Treasurer), Implementing G20 commitment on OTC derivative reforms, joint media release, 18 April 2012, viewed 19 September 2012, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22media%2Fpressrel%2F1576035%22

[22].              Senate Standing Committee for the Scrutiny of Bills, Alert Digest No. 11 of 2012, 19 September 2012, http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=scrutiny/alerts/2012/index.htm 

[23].               Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into the Corporations Legislation Amendment (Derivative Transactions) Bill 2012, 11 October 2012, viewed 20 November 2012, http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=corporations_ctte/derivatives/report/index.htm

[24].               Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into the Corporations Legislation Amendment (Derivative Transactions) Bill 2012, 11 October 2012, additional comments from Coalition members of the Committee, p. 27, viewed 20 November 2012, http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=corporations_ctte/derivatives/report/index.htm

[25].               Finance and Treasury Association (FTA), Corporations Legislation Amendment (Derivatives Transactions) Bill 2012, response to Treasury consultation paper by the Finance and Treasury Association, 20 August 2012,
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[26].               Ibid.

[27].               Clayton Utz, ‘Derivatives reform Bill - no surprises for Australia's derivatives industry’, website, 27 July 2012, viewed 20 September 2012, http://www.claytonutz.com/publications/news/201207/27/derivatives_reform_bill-no_surprises_for_australias_derivatives_industry.page

[28].               National Generators Forum (NGF), Corporations Legislation Amendment (Derivatives Transactions) Bill 2012, submission, NGF website, viewed 21 September 2012, http://www.ngf.com.au/submissions/index.html

[29].               King & Wood Mallesons, Exposure draft of Australia's new derivative "Dodd-Frank" law released, 25 July 2012, viewed 21 September 2012, http://www.mallesons.com/publications/marketalerts/2012/pages/exposure-draft-of-australias-new-derivative-dodd-frank-law-released.aspx

[30].               PricewaterhouseCoopers (PWC), ‘Responding to the challenge of OTC market reforms’, PWC website, viewed 21 September 2012, http://www.pwc.com.au/industry/financial-services-regulation/otc.htm

[31].               Ernst & Young, Approaching new terrain: OTC derivatives readiness assessment, 2011, viewed 21 November 2012, http://www.ey.com/Publication/vwLUAssets/Approaching_new_terrain/$FILE/OTC_readiness_assessment_survey_report.pdf

[32].               KPMG, Dodd-Frank Act: regulation of over-the-counter derivatives (title VII), 2010, viewed 21 September 2012, http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/regulatory-practice-letters/Documents/rpl-1013-otc-derivatives.pdf

[33].               Council of Financial Regulators, ‘OTC derivatives market reform considerations’, op. cit., p. 7.

[34].               Ibid., p. 8.

[35] .               Ibid., p. 8.

[36].               Ibid., p. 8.

[37].               Ibid., p. 8.

[38].               Ibid., p. 9.

[39].               Ibid., p. 10.

[40].               NASDAQ OMX, ‘Segregation and portability’, webpage, 2012, viewed 21 November 2012,  http://www.nasdaqomx.com/trading/europeanclearing/newsmandatorychanges/segregationportability/

[41].               Ibid., p. 10.

[42].               Ibid., p. 10.

[43].               Australian Securities Exchange, Submission to Council of Financial Regulators - Implementation of a framework for Australia's G20 over-the counter derivatives commitments, 15 June 2012, p. 2, viewed 22 November 2012, http://www.treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/2012/Over%20the%20counter%20derivatives%20commitments%20consultation%20paper/Submissions/PDF/ASX_Group.ashx