Participants in the Australian over-the-counter (OTC) derivatives markets should consider reviewing their OTC derivatives documentation, following the release earlier today of the FIA-ISDA Addendum for Cleared Derivatives Transactions by the International Swaps and Derivatives Association, Inc. (ISDA) and the US Futures Industry Association (FIA).
The Addendum is designed to document the relationship between a clearing member and its customer for the purposes of clearing OTC derivatives transactions, where the clearing member is a registered futures commission merchant under US law.
The publication is in anticipation of a substantial increase in clearing volumes for OTC derivatives transactions, as rules made under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) come into force requiring OTC derivatives to be cleared through central counterparties (CCPs).
How does the Addendum work?
Where a market participant engages with a registered futures commission merchant under a futures customer agreement, the Addendum is designed to supersede that agreement only in the case of cleared OTC derivatives. This documentation structure is characteristic of the "futures clearing" model that is typical in the US.
Among other provisions, the Addendum contains representations reflecting the US regulatory regime applicable to cleared OTC derivatives, procedures for clearing members to close-out and liquidate transactions following a "Close-out Event" or "Tax Liquidation Event" and tax provisions relating to cleared OTC derivatives. The Addendum contemplates that the parties may wish to customise certain of the provisions.
The FIA and ISDA have recognised that certain provisions of the Addendum may need to be altered in light of future regulatory developments.
The move to central clearing under the Dodd-Frank Act is part of the US's agenda for implementing its G-20 commitment that "all standardized over-the-counter derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and centrally cleared, by the end of 2012".
Australia is proposing to implement its own G-20 commitment by establishing a new regulatory framework for OTC derivatives via amendments to the Corporations Act before the end of 2012. Under the changes, the Australian Government will have, amongst other measures, the power to impose mandatory clearing in relation to designated OTC derivatives products.
New central clearing measures will also be brought into law in other jurisdictions, including the EU, as other G-20 nations seek to implement their G-20 commitment.
Lower capital charges on cleared derivatives under Basel III will create even more momentum for Australian OTC derivatives market participants to move to central clearing.
Implications for Australia
In light of these developments, many participants in the Australian OTC derivatives markets may be reviewing their OTC derivatives documentation in anticipation of moving to central clearing via CCPs. In particular, Australian participants who deal with US futures commission merchants may choose to use the Addendum as a basis for negotiating elements of the suite of new documentation they may be required to settle as part of their move to central clearing.