Last night, in two long-awaited and closely-timed releases by the Australian Government and ASIC, two critical steps in the long march of Australia’s derivative reforms have been taken: rules for mandatory clearing of derivatives and single-sided reporting relief. Due to their scope, most participants in Australia’s derivatives market should be keenly interested – whether they are funds, banks, end-users or clearing houses. As we discuss in this Alert, the core messages are as expected, but the small print still holds plenty of surprises.
The rules and regulations released are:
- drafts of the Corporations Amendment (Central Clearing and Single-Sided Reporting) Regulation 2015 and the Corporations (Derivatives) Amendment Determination 2015 (No. 1) with an explanatory guide. These were released by the Australian Treasury and can be found here; and
- a draft of the ASIC Derivative Transaction Rules (Clearing) 2015 with a consultation paper from ASIC. These were released by ASIC, and can be found here.
More than 120 pages were released, all at once, and reading all of these documents “cold” is not an easy task. There are a number of reasons for this. They operate in a complex framework created in Australian law some time ago to implement the G20 derivatives reforms (see our Alert here for background) and they interact with each other, ASIC Class Exemptions and previous Australian and international derivatives regulation. Also, they cover two separate issues – variations to Australia’s derivative reporting regime and the introduction of Australia’s clearing regime. Further, the ASIC documents deal only with clearing, but the Treasury documents deal with both. With all of this complexity, wading into the new documents is not for the uninitiated or faint-hearted. For those who want some help, we answer a few key questions here on both the two areas of change, with a brief background.
Single-sided trade reporting relief
In compliance with its G20 derivatives reform commitments, Australia introduced obligations to report derivative transactions some time ago. The core of these has been the ASIC reporting rules. Under these rules, obligations have been phased in over time, and only the last phase (called “Phase 3B”) still left. Entities in this phase were the holders of the smallest derivatives portfolios and their reporting obligations are to commence in October 2015. However, in December 2014, it was announced (see our Alert here) that these entities could be excused from reporting if their counterparty reported the transaction (this is called “single-sided reporting” because both sides of the trade don’t have to report the transaction). This announcement followed Australian funds and other buy-side entities expressing concern that the need for them to report, or find someone to do it for them, was too costly for the regulatory benefit which it would achieve. The draft regulation is intended to offer some relief to these entities. We set out below answers to a few key questions on the new requirements:
Are the new single-sided reporting regulations part of the ASIC reporting rules?
No. They will be a separate regulation of the Australian Government. Reporting entities which have the benefit of the regulation for transactions do not have to report those transactions under the ASIC rules. The regulations prevail over the ASIC rules.
Do they apply to “Phase 3B” reporting entities?
Yes, but not always. The draft regulations don’t use the term “Phase 3B”. The term “Phase 3B” was a term used by ASIC for phasing in reporting requirements and effectively meant reporting entities which had a derivatives portfolio of less than A$5 billion as at 30 June 2014. Those entities would commence reporting under the ASIC Rules in October 2015. The draft regulations get to the same point but they apply the “under A$5 billion” test at the end of each calendar quarter. If an entity satisfies the test for two successive quarters then it qualifies for the relief until it fails the test for two successive quarters. Once it fails for two successive quarters then the full reporting obligations apply. The drafting for this is a little tricky to work out, because the draft regulations use the different ASIC term “Phase 3” but you can get there if you take a little time. The result is important, as it means an entity can move in, and out, of the relief depending on changes in the size of its derivatives portfolio.
What transactions are exempted by the relief?
If a reporting entity does qualify for the relief, then they do not need to report transactions which are entered into with a counterparty which:
- is required to report the transaction under the Australian reporting rules (which means a “Phase 1” entity, a “Phase 2” entity and, if it does not have the benefit of this new relief, a “Phase 3” entity); or
- otherwise reports the transaction under the Australian reporting rules; or
- is a foreign entity reporting under the Australian alternative reporting regime (meaning that it reports the transaction under an equivalent foreign reporting regime and “tags” the transaction as being ASIC reportable).
If the transaction is not with one of these entities then the relief does not apply. This would exclude from the relief transactions with another entity which qualifies for this new relief, or an entity which does not report, or “tag” under the Australian rules. This is particularly important for funds with small portfolios who transact with foreign counterparties, as the draft relief may not “get you home” in the way which might have been hoped. For these entities, a reliance may need to be placed on the delegation “safe-harbour” arrangements set out in the current ASIC reporting rules (which have their own complexities as well).
How do you know whether the relief can apply to your transaction?
Good question. Some of the regulations are drafted so that they apply when another reporting entity isrequired to report the transaction or does report the transaction. However, if the other reporting entity is a foreign reporting entity which has the benefit of alternative reporting, the relief works only if they actually do “tag” the relevant transaction or report it under the Australian requirements. Importantly, the draft regulations are not drafted so that it is enough that the other reporting entity merely promises to report the transaction. Accordingly, entities relying on the relief may need to check that their counterparty actually is required to report under the Australian rules or, if it isn’t, ensure that it actually does report the transaction. There is likely to be a need to develop an operational solution for this, to avoid reducing the benefit of the relief when dealing with non-Australian counterparties.
Is anything required in order to take the benefit of the relief?
No. There is no application, authorisation or lodgement required in order to take the benefit of the relief. Once it is in force, it will just apply in accordance with its terms. It comes into effect in October 2015, just before the Phase 3B entities would otherwise be required to report.
Does the relief cover all obligations under the Australian reporting rules?
Not entirely. There are obligations in the ASIC reporting rules beyond the need to report transactions. These include obligations to keep records, for example.
Is there anything else worthy of note?
Well, yes actually. There is an inclusion in the regulations which might be quite useful for a number of reporting entities who do not consider themselves “real” participants in the derivative markets. This a new exemption from reporting requirements for reporting entities who would be exempted “end-users” if they did not hold an Australian financial services licence. These entities will be exempted from the reporting requirements for classes of derivatives which are not covered by an authorisation under their licence. The explanation given for this is that entities which have a licence which only covers a single class, such as electricity derivatives, should not be required to report other classes. However, this would seem to extend further, to cover entities which have no derivatives authorisation at all. If this is the intention, it could be quite an unexpected and welcome relief to entities who hold licences for activities quite distinct from derivatives, and enter into derivatives only sparingly.
What are the next steps?
The consultation period on the draft regulations ends on Friday 26 June, 2015.
The G20 derivative reforms also require Australia to introduce the mandatory clearing of certain derivatives. These requirements have already been introduced in the United States, and are soon to be implemented in Europe too. Accordingly, the creation of the Australian obligation to clear interest rate derivatives denominated in Australian dollars, United States Dollars, Euro, British Pounds and Japanese Yen was announced last year (see further background here). The draft regulations set the framework for the operation of the rules, including limits on who the clearing requirements can apply to. The draft ASIC clearing rules set out more detail of those requirements. In this way they work together, and need to be read together. We set out below some answers to key questions on the new requirements:
Do all types of derivatives need to be cleared?
No. The draft regulations provide that the obligations only apply to interest rate derivatives denominated in AUD, USD, EUR, GBP and JPY. The draft ASIC rules specify that the requirements are applicable only to Basis Swaps, Fixed-to-Floating Swaps, Forward Rate Agreements or Overnight Index Swaps which meet certain specifications. There are also exclusions specified, such as where the transactions include optionality, payments in different currencies, have a conditional notional amount or if they are entered into on a regulated market.
Are all counterparties required to clear these derivatives?
No. Only the following entities are intended to be caught by the requirements:
- Australian Authorised Deposit-taking Institutions (ADIs) or Australian holders of a Financial Services Licence (AFSL), either of which holds A$100 billion or more of total gross notional outstanding of over-the-counter (OTC) derivatives for two consecutive quarters
- foreign ADIs or AFSL holders, or other overseas-regulated foreign entities who provide derivatives to wholesale clients and which are registered or required to be registered as carrying on business in Australia, which hold A$100 billion or more total gross notional outstanding OTC derivatives for two consecutive quarters (some care needs to be taken here, as “foreign clearing entity” is defined differently in the draft regulations and the draft ASIC rules).
The threshold is applied to all OTC derivatives, and not just those which would have to be cleared. For trustees and responsible entities, it is determined on a per trust or scheme basis. Also, for the foreign entities, the threshold is applied only to the transactions which are booked to profit or loss accounts in Australia, are entered into in Australia, or are a transaction to which the Australian derivative transaction reporting regime applies because of the application of the Nexus relief (see more on this here). Also, the application of the threshold is to be conducted each quarter. This means, for example, that the clearing obligation ceases to apply to an entity which does not meet the threshold on two consecutive quarterly dates. It also means that the clearing obligation can start to apply to an entity if they do meet the threshold on two consecutive quarters.
The draft ASIC rules also allow for entities to opt-in to the clearing requirements if they are not otherwise caught. This option may be exercised if it is needed for substitutive compliance purposes under foreign regulation.
Are all of the transactions of these counterparties subject to the requirements?
No. Only interest rate derivatives in those five currencies which are entered into with either another entity which is subject to the Australian clearing obligation, or with a financial institution called a foreign internationally active dealer. These are entities which are already, or will be, subject to the clearing requirements under United States law because they are either “Swap Dealers” or “Security-Based Swap Dealers” under the Dodd-Frank Act. Such entities will be caught by clearing requirements in the United States. Transactions between two foreign entities will only be subject to clearing if, for at least one of the foreign entities, the transaction is booked to their profit or loss account in Australia, satisfies the nexus test in Australia’s nexus relief for reporting requirements (if that relief is applicable), or is entered into in Australia. These rules show a close linkage with ASIC’s extra-territorial approach to reporting.
When does clearing have to take place?
Clearing must take place as soon as practicable after the clearing transaction is entered into and, in any case, within one business day, Sydney time. This includes the entry into a transaction within the scope of the requirements, as well as its modification. However, there is no backloading requirement in relation to transactions which were entered into before the clearing obligations start (with the exception of extensions to maturity dates of more than 12 months).
Can the clearing take place outside of Australia?
Yes. Transactions required to be cleared may be cleared either on a clearing house which holds an Australian CS Facility licence (two of which are not Australian), or a clearing house which has been “prescribed” for the purpose of these clearing requirements. Currently, the regulations name 4 clearing houses as being prescribed and all of these are outside of Australia. Others may be added before the regulations are passed, and ASIC has an ability to add to the list later. Importantly for clearing houses which are prescribed, there is no variation to the requirements as to when a CS facility licence is needed. Instead, the ASIC consultation paper expressly refers to the application of ASIC’s existing guidance on this point. What this means is that the prescription as a clearing house for the purpose of these rules appears to offer no protection from the application of Australia’s licensing requirements for clearing houses. Prescribed clearing houses will need to manage their affairs carefully, if they do not want to trigger such a licensing requirement.
Are there any exceptions?
Yes. If there is no licensed or prescribed clearing facility through which the transaction can be cleared, if the counterparty is a related body corporate (and some other conditions are met, such as notice to ASIC) and if the transaction is part of a multilateral compression cycle (and some other conditions are also met). Significantly, there is an exception for “alternative clearing”, meaning where the transaction is cleared in accordance with foreign clearing requirements. This exception is broadly drafted and applies if the transaction is cleared in accordance with a foreign clearing requirement which allows clearing within 3 business days. Reliance on this exception is not limited to foreign entities, as Australian entities may also be subject to overseas requirements. The application of this exception is intended to avoid a need to clear a transaction under more than one regulatory system. This is important as a transaction can only be cleared once.
Is there anything which needs to be done by a clearing entity?
Yes. As a clearing entity has to know who the other clearing entities are for it to work out which transactions are subject to the clearing requirement there is a registration requirement. This means that entities which are caught by the requirement need to notify ASIC at least 30 days beforehand, and within 30 days of ceasing to be caught. There are important provisions relating to the sharing of this information contained in the ASIC consultation paper.
When do the obligations commence?
The ASIC consultation paper sets out that the first quarterly date for determining application of the requirements will be 30 September 2015 and the second will be 31 December 2015. Mandatory clearing should first start on 7 March 2016.
Is it expected that these obligations will be extended to other counterparties in the future?
There is no published proposal to extend the requirements further at this stage.
What are the next steps?
Comments on the draft regulations should be provided to the Australian Treasury on 26 June 2015. Comments on the draft ASIC clearing rules, and the consultation paper, should be provided to ASIC by 10 July 2015.
These draft regulations and rules represent the final Australian regulations on one of the key G20 derivative reforms (trade reporting) and the first regulations for another (clearing). Market participants should take some time to work out whether, and how, these latest releases could impact on them. This is particularly important whilst consultations on them remain open, as issues are still able to be raised, and changes suggested. After this, changes are likely to be more difficult to make. Instead, the regulatory focus will move to the next G20 commitment – margining.