A clearing mandate … but not including AUD!

Today, the Council of Financial Regulators released its 2013 Report on the Australian OTC derivatives market (a link to this can be found here). This report follows on from the previous report in October 2012. In the report the Australian regulators make a number of recommendations to the Australian Government on key derivatives reform issues.

Most important of these is the recommendation that the Government consider a central clearing mandate for interest rate derivatives denominated in US dollars, Euros, Pounds Sterling or Yen. The reasons given for this are that there is material activity in these derivatives in the Australian market, internationally active participants are already clearing these products because of the requirements of other jurisdictions and the largest Australian banks are clearing these products through client clearing arrangements with participants in global central clearing houses. The regulators noted that the initial focus should be dealers with significant cross-border activity in these derivatives and that the timing would be determined in accordance with the authorities in the jurisdiction of the relevant currency. International consistency was a key consideration for the Australian regulators in assessing the case for recommending a clearing mandate for these products.

Analysis conducted by the regulators demonstrated strong “in-principle benefits” from the central clearing of Australian dollar denominated interest rate derivatives, certain foreign exchange derivatives, cross-currency swaps and potentially Australian reference-entity credit derivatives too. However, access to clearing for Australians who would be caught by a mandate in these products could be an issue at this time and, in some cases, there is no overseas mandate requiring their clearing either. Accordingly, there is not a current recommendation to require clearing of these derivatives.

Given some of the previous analysis, the exclusion of AUD denominated interest rate derivatives from the recommendation could seem quite surprising. Instead, the regulators will:

“monitor for a further period Australian banks’ progress in implementing appropriate clearing arrangements before recommending mandatory central clearing of Australian dollar – denominated interest rate derivatives.”

The regulators note that two CCPs are now offering direct clearing services in Australia for AUD denominated interest rate derivatives and that they expect that operational arrangements will be in place by the end of this year. Accordingly, the regulators will review this recommendation early next year. If there is a mandate for AUD denominated interest rate swaps, the regulators suggest that its initial scope is to be aimed at the interdealer market.

The Council’s report on the market does not make any recommendation for requiring the use of trade execution platforms. Nor does it make any recommendation for mandatory requirements in relation to risk management techniques for non-cleared trades (such as margining or others like trade compression or portfolio reconciliation). However, the use of these techniques is encouraged.

If the recommendations in the report are accepted by the government the next step would be for the Commonwealth Treasury to consult on a proposed clearing determination and for ASIC to prepare draft derivatives transaction rules.

Reporting, now final.

ASIC has met another key G20 milestone, with the finalisation of the Derivative Transaction Rules (Reporting) and the Derivative Trade Repository Rules.

The implementation of this regime follows ASIC’s consultation with market participants and industry service providers. Our alerts on those consultations can be found here and here. The final rules clarify some uncertainties and concerns which were raised during the consultation process, such as:

  • ASIC has tightened the scope of the reporting entities by capturing foreign subsidiaries of ADIs and AFSL holders only (not foreign subsidiaries of Australian entities more generally);
  • derivatives traded on particular overseas markets (being those ASIC recognises as subject to sufficiently equivalent regulation to a Part 7.2A of the Corporations Act) are carved out from the reporting regime; and
  • an ongoing exception from the Australian reporting regime is provided for overseas entities in certain circumstances (i.e. the alternative reporting regime).

However, rules on other important issues have remained unchanged from the consultation process. For instance:

  • reporting is required to be made by T+1;
  • following the transitional period (ending 1 October 2014), two-sided reporting will apply in Australia;
  • outside of the end-user consultation process, inter-group and intra-group transactions will be subject to the reporting regime; and
  • no changes have been made to address concerns regarding foreign privacy constraints. Entities may need to approach ASIC for individual relief if this issue is relevant and ASIC is to provide guidance on when it may grant such relief.

The rules seek to balance implementing a regime in time for substituted compliance under foreign reporting regimes with maintaining a realistic timeframe within which market participants can build appropriate systems and processes for reporting in Australia. To this end, a phase-in period has been introduced specifically for Australian entities registered (or provisionally registered) as Swap Dealers under the United States Dodd-Frank Act from 1 October 2013. Australian Swap Dealers will be required to report all classes of derivatives (not just interest rate and credit derivatives) from that date. This is the new “Phase 1” under the reporting regime.

The compliance dates for all other entities have been pushed back. A summary of the first relevant dates for market participants is in the table below:

Click here to view table.

For Phases 2 and 3, these entities will need to start reporting all other types of derivatives that are Reportable Transactions from 1 October 2014 and 1 April 2015 respectively. An ‘opt-in’ regime is available for entities that wish to comply with the requirements earlier than they would otherwise be required to do so. Also, some transitional relief is available (subject to conditions).

Whilst the Rules have been published, this is by no means the final product of the reporting regime. Further guidance and consultation are in the pipeline for release and market participants may need to interact with ASIC. For instance, ASIC will publish a Regulatory Guide indicating the types of derivatives that ASIC expects to be reported. In the meantime, ASIC has indicated that the derivatives ASIC expects to be reported are based on the ISDA taxonomy. This issue is subject to continuing industry consultation. Furthermore, ASIC will also consult on whether end-users should be subject to the reporting regime. This consultation is scheduled to start in late 2013-early 2014.

Yet another wave of regulation

It was inevitable that the waves of Australian regulation would join those of the United States and Europe which are already crashing against many Australian financial services businesses. With more than 300 pages of cross-border guidance having been recently released by the CFTC there seems to be more than enough to keep participants busy. Hopefully, as recent developments have indicated each of these waves will be pulling and pushing our market participants in the same direction. Otherwise it will be a very stormy regulatory sea.