The Australian Parliament has just passed the Corporations Legislation Amendment (Derivative Transactions) Bill 2012.

The Derivative Transactions Bill as passed however is not the same as the version introduced into Parliament in September.

The changes require the Minister and ASIC to have regard to the likely impact on the underlying physical markets when making a determination imposing a mandatory obligation or making a Derivative Transaction Rule (DTR) in relation to a commodity derivative.

Why have the changes been made?

The changes have been made in response to concerns expressed by stakeholders that limitations on the use of OTC derivatives may affect the operation of the underlying physical market.

Energy market participants have been particularly concerned to ensure that the operation of the National Electricity Market (NEM) is considered prior to the introduction of any determinations relating to electricity derivatives. These concerns stem from the fact that, unlike tangible commodities (such as oil, which can be stored in ships and tanks, or gold, which can be stored in bullion reserves), electric energy is very difficult to store or transfer between regions, which gives rise to volatile spot power prices. This can lead to very significant differences between the derivative price and the underlying spot commodity price, particularly for shorter term contracts.

Regulations that reduce the number of available participants in the electricity derivatives markets, or otherwise inhibit liquidity in those markets, could leave participants in the volatile underlying power price market considerably more exposed and ultimately increase rather than reduce systemic risk.

Several NEM participants made submissions to the Government highlighting these issues and indicating that, as a consequence, the derivatives reforms could potentially have led to less flexibility in the management of electricity market risks, and a consequent price increase for customers.

Next steps

The Bill is expected to be assented soon, with the substantive changes to come into effect on the 28th day after assent.

There are still important pieces of the puzzle that have not yet been finalised. It is not yet known if or when the responsible Minister will prescribe a class or classes of derivatives under the new laws. However, if this occurs, the Australian Securities and Investments Commission will consult publicly in relation to any rules that will apply to prescribed classes of derivatives.