Registration, reporting and liability for derivatives transactions in Australia

Liability and enforcement

What is the territorial scope of the laws and regulations governing listed, cleared and uncleared equity derivatives transactions?

In respect of derivatives transaction reporting, the ASIC Derivative Transaction Rules (Reporting) 2013 apply to reporting entities, which may in practice be domestic or foreign. However, in practice the obligations would apply only to a foreign entity to the extent it had brought itself within the scope of the Australian regulation by obtaining an Australian licence, authorisation or exemption (or that it had registered or provisionally registered as a swap dealer with the US Commodity Futures Trading Commission in accordance with the Commodity Exchange Act 1936 (US)).

What registration or authorisation requirements apply to market participants that deal or invest in equity derivatives, and what are the implications of registration?

An entity that deals in equity derivatives on behalf of Australian clients will generally be required to either obtain an Australian financial services licence or rely on a relevant exemption.

In respect of exchange-traded derivatives, becoming a participant of the ASX or ASX 24 markets will result in an entity becoming subject to extensive regulation by the relevant market operators and ASIC.

See question 24 in respect of OTC derivatives and the scope of reporting requirements.

What reporting requirements apply to market participants that deal or invest in equity derivatives?

As noted in question 3, Australia has a derivatives transaction reporting regime that gives effect to G20 commitments made in 2009. The regime imposes reporting obligations on entities referred to in question 26.

ASX and ASX 24 participants are also subject to various reporting obligations.

What legal issues arise in the design and issuance of structured products linked to an unaffiliated third party’s shares or to a basket or index of third-party shares? What additional disclosure and other legal issues arise if the structured product is linked to a proprietary index?

The characterisation of the structured product and whether or not it is being offered to retail investors will determine whether, and if so, what type of disclosure document is required (eg, a prospectus or product disclosure statement). If a disclosure document is required, the content requirements are prescribed by the Corporations Act, but if, for instance, the product is also a warrant there will be additional disclosure requirements under the warrant rules. If the product is offered only to wholesale, there are no disclosure requirements prescribed by the Corporations Act and disclosure tends to be more limited. In this context the disclosure must not be misleading or deceptive.

Structured products that are linked to other indices (proprietary or otherwise) may give rise to certain intellectual property considerations in relation to the use of those indices.

Describe the liability regime related to the issuance of structured products.

The issuance of structured products in Australia must be made under a disclosure document in compliance with the Corporations Act. The Corporations Act also contains a liability regime for the issue of structured products under a disclosure document where the issue of the disclosure document or the disclosure document itself is misleading or deceptive or the disclosure document is defective.

A investor who invests in a structured product under a disclosure document and suffers loss because of a defective disclosure document, or misleading or deceptive conduct, may recover the amount of the loss or damage from any person involved in the contravention. In certain circumstances, such conduct may constitute an offence under the Corporations Act punishable by imprisonment or a large fine.

What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is convertible for shares of the same issuer?

Unless the issue is being made to sophisticated or professional investors, the issue of securities that are convertible into shares of the issuer will ordinarily require a prospectus or other disclosure document to be prepared under Chapter 6D of the Corporations Act, lodged with ASIC and the ASX and provided to the persons to whom the offers to issue the securities are made.

Such a disclosure document may also be required for secondary sales of such securities, if a prospectus was not prepared at the time of their initial issue, the securities were not quoted and the secondary sale takes place within 12 months of their issue.

There is no requirement for the convertible security to be registered; however, if the security is intended to be tradeable on the ASX, it will need to comply with the ASX listing rules and the terms of the security will be reviewed by the ASX.

The main tax issue with a convertible instrument is typically whether the instrument is characterised as a debt interest or an equity interest for Australian tax purposes (see question 12). This will depend on the terms of the instrument, although notes that are mandatorily convertible or are convertible at the option of the issuer would normally be equity interests while notes that are convertible at the option of the holder would normally be debt interests. However, specific advice should be obtained to confirm the correct characterisation from an Australian tax perspective.

From the holder’s perspective, the conversion of a convertible interest into shares of the issuer may give rise to an immediately taxable gain or may be disregarded (that is, any gain or loss on the conversion is not immediately recognised but is deferred until realisation of the shares into which the instrument is converted). Whether the gain is immediately taxable or is disregarded depends on the terms of the instrument and whether the instrument is characterised as a ‘traditional security’ for tax purposes (broadly, a debt security issued without a significant discount). Where the gain is taxable, it is generally taxable as income (and not capital gain).

From an Australian GST perspective, the sale and conversion of the security will usually be an input taxed (exempt) financial supply. This means that no GST will be payable on the supply but the issuer and the holder may not be entitled to claim full input tax credits for any GST incurred on costs associated with the supply (eg, legal fees, accounting fees, etc). Certain acquisitions may qualify for a reduced input tax credit of 75 per cent or 55 per cent of the GST amount.

The issue of convertible notes or conversion of a convertible interest into shares of the issuer can potentially give rise to Australian landholder stamp duty. This will depend on a number of factors, including whether the issuer is a listed entity or an unlisted entity, whether the issuer holds, directly or indirectly, any interests in land in any state or territory of Australia with a market value exceeding certain thresholds, and the proportionate interest in the issuer (together with that of any associates, or as part of an associated transaction) that the holder (together with associates) acquires upon conversion. For example, if the issuer is an entity listed on the ASX or other recognised exchange, a liability to landholder duty generally does not arise unless the holder’s convertible interest in the issuer amounts to an entitlement on a notional winding up of the issuer to property of the issuer representing an interest of 90 per cent or more.

What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is exchangeable for shares of a third party? Does it matter whether the third party is an affiliate of the issuer?

See question 31. Broadly similar legal considerations apply to exchangeable securities and to convertible securities.

The main tax, GST and stamp duty issues with an exchangeable instrument are broadly the same as those that arise for a convertible instrument, as summarised in question 31.