Derivatives clearing, exchange-trading and collateral in Australia

Types of transaction

What categories of equity derivatives transactions must be centrally cleared and what rules govern clearing?

At the time of writing, interest rate derivatives denominated in certain currencies only are subject to mandatory clearing in Australia, and equity derivatives are not subject to the Australian mandatory central clearing regime.

What categories of equity derivatives must be exchange-traded and what rules govern trading?

There are no categories of equity derivatives that are required to be exchange traded. However, in practice the main equity derivatives that are exchange traded are options, warrants, futures contracts and contracts for difference. The relevant rules are the ASX Operating Rules, the ASX 24 Operating Rules (and associated clearing and settlement rules) and the various ASIC Market Integrity Rules.

Describe common collateral arrangements for listed, cleared and uncleared equity derivatives transactions.

In the case of OTC equity derivatives in the Australian market, collateral arrangements are more relevant for uncleared transactions (noting that equity derivatives are currently not subject to mandatory clearing in Australia). For uncleared equity derivatives transactions entered into under an ISDA Master Agreement, parties commonly document their collateral arrangement using an ISDA Credit Support Annex under a title transfer approach. Parties may also structure the collateral arrangement using a security interest approach although that has not been as common as the title transfer approach.

In the case of exchange-traded equity derivatives where there is a potential exposure for the clearing house, the relevant clearing house will generally call for margin from the relevant clearing participant, who will in turn call for margin from the relevant client. This may be cash or acceptable securities (subject to a haircut).

Must counterparties exchange collateral for some categories of equity derivatives transactions?

Prudential Standard CPS 226 (CPS 226) sets out the margining requirements for non-centrally cleared derivatives, including OTC equity derivatives transactions. CPS 226 imposes both variation margin requirements and initial margin requirements. These margining requirements can apply directly to an ‘APRA covered entity’, which includes entities such as an ADI (including a foreign ADI), a general insurer, a life company and a registrable superannuation entity. These margining requirements can also apply indirectly to a ‘covered counterparty’ if the covered counterparty is trading with an APRA covered entity directly subject to CPS 226. An entity will be a ‘covered counterparty’ if it is a ‘financial institution’, subject to certain exclusions. CPS 226 in turn defines ‘financial institution’ fairly broadly, which may include entities such as hedge funds, trading firms and foreign deposit-taking institutions.

Please see question 24 for more on exchange-traded equity derivatives.