A new era for post-gfc financial markets

The pace of regulatory reform has been particularly hectic in the area of financial markets and derivatives law. During the last 18 months, we have seen an unprecedented number of reform proposals, position papers, industry consultations and proposed regulations at the national and international level.

Much of the international attention has centred on the extent to which derivatives products can be blamed for the Lehman collapse. That has led to questions about how best to reform market practices, prudential protection, and disclosure of over-the-counter (OTC) derivatives such as the credit default swaps (CDSs) and collateralised debt obligations (CDOs) which were the basis of the Lehman failure and of the near collapse of many other major institutions.

The G20, of which Australia is a member, has created several working groups to consider the issues. Their enquiries have been supplemented in Australia by the Joint Regulators’ OTC Working Group, a joint effort by the Australian Prudential Regulation Authority (APRA), the Reserve Bank of Australia (RBA) and the Australian Securities and Investments Commission (ASIC) to monitor international industry developments and assess the state of the local OTC derivatives market. The Joint Regulators’ survey released in late May 2009 concluded that market risk was low in relation to OTC derivative markets in Australia. 

The pace of the reform process is in part due to the ambitious timetable for international reform agreed to by the G20 leaders in their Pittsburgh Agreement in September 2009. In particular, it was agreed that:

“…all standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at latest. OTC derivatives contracts should be reported to a trade repository. Non-centrally cleared contracts should be subject to higher capital requirements.”

Two main goals have been at the forefront of these international reform moves:

  1. Encouraging OTC products to be traded on an organised and regulated exchange or trading platform, rather than being non-transparent, private transactions, and
  2. Having OTC contracts reported to a trade repository and made subject to central counterparty clearing. This means clearance and settlement by a clearing house, as occurs on organised futures exchanges. If that can be achieved with all relevant OTC products, and in particular credit default swaps, there would be a dramatic reduction of a counterparty risk arising from such transactions. That is because the clearing house will act as a substituted counterparty to each transaction.

In Australia, there have been several important initiatives:

  • reforming laws related to short selling
  • reform proposals, subsequently not pursued, to control and in some circumstances prohibit rumourtrage
  • tightening the penalties relating to insider trading, and
  • cracking down by ASIC on retail derivatives businesses.

The issue of perhaps the greatest significance locally is the transfer of market supervision powers from the Australian Securities Exchange (ASX) to ASIC, which is discussed in the article by Lucinda McCann and Karina Dullea appearing in this issue.