The Treasury and ASIC recently released the draft rules and regulations in relation to single-sided reporting relief and central clearing requirements. The drafts that have been released are:
- Corporations Amendment (Central Clearing and Single-Sided Reporting) Regulation 2015;
- Corporations (Derivatives) Amendment Determination 2015 (No 1); and
- ASIC Derivative Transaction Rules (Clearing) 2015.
These new draft rules and regulations represent an important development in Australia's implementation of G20 derivatives reforms. Clients (and in particular Phase 3B reporting entities) should ensure they are familiar with the amendments introduced by these draft rules, and the effect they will have on their OTC derivative reporting and clearing obligations.
Single Sided Reporting
Background to the OTC derivatives trade reporting rules
In July 2013, ASIC published the ASIC Derivative Transaction Rules (Reporting) 2013 (the Rules) as part of Australia's implementation of G20 derivatives reforms. The Rules require both sides of an OTC derivative transaction to report (known as double-sided reporting) information about the transaction to a prescribed trade repository.
In December 2014, the Assistant Treasurer announced that Phase 3B entities would not be required to comply with these reporting obligations, provided that the relevant counterparty to the transaction was either required to the report the trade themselves, or had agreed to do so. The draft Corporations Amendment (Central Clearing and Single-Sided Reporting) Regulation 2015 proposes to implement this relief.
What is single-sided reporting?
Under single-sided reporting, only one side of an OTC derivative transaction is required to report. This helps reduce the regulatory burden on parties with lower levels of OTC derivatives transactions, while still ensuring regulators have access to the relevant information concerning the transaction.
Who will qualify for single-sided reporting?
Generally speaking, Phase 3B entities will be able to take the benefit of the single-sided reporting provisions. Notably however, the draft regulations do not actually use the term "Phase 3B entity" but instead refer to "Phase 3" entities. If a Phase 3 entity has less than $5 billion gross notional OTC derivatives positions outstanding at the end of a calendar quarter for two successive calendar quarters, then it will qualify for the relief (in this way, the draft regulations adopt the same definition of a Phase 3B entity as used in the relevant ASIC class order, but create a mechanism for re-valuing and potentially re-classifying an entity on an ongoing basis, rather than taking the value of their positions as at 30 June 2014 in accordance with the class order definition).
Importantly, this means that if a Phase 3B entity's positions exceed $5 billion for two successive calendar quarters, it will be re-classified as a Phase 3A entity, and the double-sided reporting regime will apply. The reverse is also true, meaning that a Phase 3A entity can become a Phase 3B entity if it falls beneath the $5 billion threshold for two successive calendar quarters.
Which transactions are exempted?
If the relief does apply, a Phase 3 entity will not have to report transactions where the counterparty is either required to report themselves or otherwise agrees to do so, or is a foreign entity reporting under an equivalent reporting regime and tags the transaction as being reportable to ASIC.
This means that, when the transaction is between two entities who both qualify for the single-sided relief, counterparties will need to determine who among them will comply with the reporting obligations.
Expansion of end-user exemption
In addition, the draft regulations include a new provision which exempts entities who would ordinarily be classified as end-users (and therefore exempt from the reporting requirements altogether), but for the fact that they hold an Australian financial services license, in certain circumstances. The effect of this draft regulation is that such entities can only be required to comply with the Rules with respect to derivatives for which they are explicitly authorised to provide financial services, under the terms of their AFSL. While the intention of this change is to ensure that licensees whose AFSL only covers one or more specific types of derivatives are not required to comply with reporting requirements with respect to other types of derivatives, it appears to have the effect of exempting all AFSL holders who would otherwise be classified as end-users from reporting obligations, where their AFSL has no derivatives authorisation at all. This represents quite a significant broadening of the end-user exemption.
Other important considerations
The draft regulations set out provisions that will apply in the event the single-sided exemption stops applying to a Phase 3 entity. In these circumstances, the entity is required to report relevant derivative position information as at the exemption end time, within six months after the exemption end time. If it fails to meet this requirement, the exemption is taken never to have applied to the entity. As such, it is critical for OTC derivative counterparties to constantly monitor their total exposures and stay abreast of their potential reporting requirements, particularly if their gross notional outstanding is hovering around the $5 billion mark.
Finally, the draft regulations also include some clarity as to how the proposed amendments will apply to responsible entities of registered schemes, and trustees of a trust, when they enter into or hold OTC derivatives transactions and positions on behalf of the registered schemes or trusts, rather than for their own account - essentially these entities will need to report on a per trust/fund basis.
The second key feature of the new draft rules and regulations is the introduction of mandatory clearing for certain classes of derivatives. This reform also represents the implementation of an important G20 commitment, and is due to commence on 7 March 2016 (with the first two relevant calculation dates being 30 September 2015 and 31 December 2015).
Which types of derivatives need to be cleared?
The draft regulations apply only to interest rate derivatives denominated in AUD, EUR, GBP, JPY and USD, and the requirements will only be applicable to basis swaps, fixed-to-floating swaps, overnight index swaps or forward rate agreements, which meet certain specifications and do not include optionality, payments in other currencies or conditional notional amounts, and are not entered into on a regulated market. It is proposed that the ASIC central clearing transactions rules will specify further types of derivatives in the future.
Who will be required to clear these derivatives?
Only the following entities will be caught by the central clearing requirements:
- Australian clearing entities: Australian ADIs or AFSL holders, either of which holds $100 billion or more of total gross notional outstanding OTC derivatives for two or more consecutive quarters; and
- Foreign clearing entities: foreign ADIs or AFSL holders, or other overseas-regulated foreign entities which provide derivatives to wholesale clients, are carrying on a business in Australia and which hold in excess of $100 billion total gross notional outstanding OTC derivatives for two or more consecutive quarters.
It is intended that these definitions will capture only the major domestic and foreign banks active in the Australian OTC derivatives market. Smaller financial entities and end users will be unaffected. In addition, market participants can choose to opt-in and comply with the requirements.
Will these entities need to clear all of their transactions?
The amendments propose that only those transactions entered into between two entities subject to the Australian clearing obligations, or between one such entity and a foreign internationally active dealer (an entity which is or will be registered as a swap dealer with the US CFTC or a securities-based swap dealer with the US SEC) will be subject to clearing requirements. This means that transactions with smaller financial institutions or end users who are not subject to the clearing requirements will not have to be cleared. Transactions between two foreign entities will only be caught if there is some jurisdictional nexus to Australia (for example the transaction is entered into within Australia or booked in Australia).
When does a transaction need to be cleared?
The draft rules provide that clearing must take place as soon as practicable after the transaction is entered into, and in any event within one business day (Sydney time).
Where does the clearing need to take place?
Central clearing can occur through all central counterparties licensed in Australia, or through a clearing house that has been prescribed by the regulations. The intention behind this provision is to provide some flexibility with respect to overseas central counterparties that are not required to be licensed in Australia, but through which Australian dealers may wish to clear.
The rules and regulations that have been released by Treasury and ASIC are only draft versions - comment is being sought from the public and it is possible that further changes will be made before the rules and regulations are finalised. It is important that market participants understand and evaluate the likely effect of these proposed rules on their businesses.