Current developments in the regulation of OTC derivatives in Australia

At the 2009 G20 Pittsburgh Summit, in the aftermath of the GFC, the Australian Government joined other jurisdictions in committing to substantial reforms to practices in over-the-counter (OTC) derivative markets.

The aim of reforms is to bring transparency to these markets, promoting financial stability, improving risk management practices and assisting with detection and prevention of market abuse.

These reforms provide a framework for the regulation of OTC derivatives reporting, central clearing and trade execution and affect almost all participants in the financial services sector who trade in OTC derivatives.

Australia’s response to the G20 commitments

The Australian legislative framework to implement these reforms commenced in January 2013, when Pt 7.5A of the Corporations Act 2001 became effective. Under Pt 7.5A, the Minister may prescribe certain classes of derivatives as being subject to an ASIC rule-making power for mandatory transaction reporting to a derivative trade repository, mandatory clearing by a central counterparty or mandatory execution on a trading platform.

A decision by the Minister prescribing a class of derivatives under the framework will be based on advice from the Council of Financial Regulators (CFR). The CFR is comprised of ASIC, the Reserve Bank of Australia and the Australian Prudential Regulation Authority (the Regulators).

The OTC reforms are being implemented in Australia in three stages, as outlined below.

Stage 1: Derivative transaction reporting

The first stage is derivative transaction reporting. Under the Derivative Transaction Rules (Reporting) 2013 (DTRs) issued by ASIC, counterparties to certain OTC derivatives must report trading data - such as transaction maturity, notional investment amounts and counterparty details - to licensed trade repositories (TRs).

Who has to report and what do they have to report? 

The DTRs apply to anyone who is a “Reporting Entity”:

  • an Australian Entity - a corporation incorporated or formed in Australia
  • a foreign subsidiary of an Australian Authorised Deposit Taking Institution (ADI) or an Australian AFS Licensee
  • a foreign ADI that has a branch located in this jurisdiction
  • a foreign company that is required to be registered under Division 2 of Part 5B.2 of the Corporations Act.

A “Reporting Entity” must report information about:

  • all derivative transactions (“reportable transactions”) entered into by the Reporting Entity. An Australian entity must report all OTC derivatives to which it is a party, regardless of where the OTC derivative is entered into. A foreign entity must report all OTC derivatives to which it is a party and which it has entered into in this jurisdiction or has booked to a branch in Australia
  • its outstanding positions (“reportable positions”) in derivatives as at the date the requirement to report reportable transactions in the relevant asset class commences.

A Reporting Entity can delegate its reporting obligations to a third party, e.g. a counterparty, central counterparty, trading platform, service provider, broker or any person. It’s expected that many Reporting Entities will be looking to appoint their bank counterparties as their reporting delegates. However, a Reporting Entity always remains responsible for complying with the DTRs, even when they have appointed a delegate.

What derivatives are captured?

OTC derivatives are defined broadly under the DTRs as derivatives that are not traded on an Australian or foreign prescribed financial market. A Reporting Entity must report information about the entry into, modification, termination or assignment of, OTC derivatives arrangements for the following asset classes:

  1. commodities other than electricity
  2. credit
  3. equity
  4. foreign exchange (FX)
  5. interest rates.

Who do you report to?

Reporting Entities must report to a licensed or prescribed TR. There are currently no Australian licensed TRs, although it’s expected that a TR will be licensed by the end of this year.

What exemptions apply?

A foreign Reporting Entity is exempt from reporting to an Australian licensed TR where there is a prescribed TR in the jurisdiction that the foreign Reporting Entity is incorporated or formed in and either the foreign Reporting Entity has reported the information under substantially equivalent requirements to a foreign TR, or the foreign Reporting Entity is not required to report such information to the prescribed TR.

The list of prescribed foreign TRs applies until the end of 30 June 2015.

“End-users” are currently exempt from the trade reporting requirements.

What information do you have to report?

A Reporting Entity must report:

a)for each reportable transaction and reportable position: 

  • i. the economic terms of the transaction
  • ii. product, transaction and entity identifiers
  • iii. information on whether the transaction is centrally cleared
  • iv.  valuation (mark-to-market, mark-to-model or other valuation) and collateral information.

 

b) for each reportable transaction and reportable position relating to an FX derivative:

  • i. total amount of the first underlying currency or payout where a fixed payment is made at maturity based on certain conditions being met at expiry or during the life of the derivative to which the transaction relates
  • ii. total amount of the second underlying currency
  • iii. notional currency payable by the Reporting Counterparty
  • iv. notional currency payable by the Non-Reporting Counterparty
  • v. rate of exchange of the currencies
  • vi. forward exchange rate on the value date.
  • Generally, the information must be reported by no later than the end of the next business day after the requirement to report arises.

When do you have to comply?

The reporting obligations are being implemented in 3 phases. Entities may opt-in to comply with the requirements early.

Under phase 1, an Australian Reporting Entity registered as a swap dealer with the CFTC started reporting transactions in commodity, credit, equity, foreign exchange and interest rate derivatives from 1 October 2013 and will be required to report positions in these derivatives from 1 October 2014.

Under phase 2 a Reporting Entity that is:

  1. an Australian ADI , AFS Licensee, a CS Facility Licensee, an Exempt Foreign Licensee or a Foreign ADI; and
  2. has gross notional outstanding of AUD 50 billion or more in derivative positions (across all asset classes) as at 31 December 2013,

must start reporting transactions from 1 April 2014 and reporting positions from 1 October 2014 for credit and interest rate derivatives. For commodity, equity and foreign exchange derivatives, the entity will need to start reporting transactions from 1 October 2014 and reporting positions from 1 April 2015.

Under phase 3, which applies where a Reporting Entity does not have gross notional outstanding of AUD 50 billion or more in derivative positions (across all asset classes) as at 31 December 2013:

  • “Phase 3A” entities (entities holding $5bn or more total gross notional outstanding in reportable OTC positions as at 30 June 2014) - report credit and interest rate derivatives 7 months after the 1st TR is licensed and in any event not before 13 April 2015
  • Phase 3B entities - report credit and interest rate derivatives the earlier of 13 months after the 1st TR is licensed and 12 October 2015
  • Phase 3A and 3B entities report equity, FX and commodity derivatives the earlier of 13 months after the 1st TR is licensed and 12 October 2015
  • One-off position reporting will commence around 6 months after these initial reporting dates.

Stage 2: Central clearing

Under the regulatory framework for OTC derivatives markets the CFR is responsible for advising the Minister in relation to a clearing mandate, which would require clearing of specified classes of OTC derivatives subject to ASIC rules.

In July 2013, the CFR recommended that Government mandate central clearing of OTC transactions among internationally-active dealers in interest rate derivatives (IRDs) denominated in US dollars, euros, British pounds and Japanese yen. On 27 February 2014, in line with this recommendation, Treasury published a proposals paper recommending a central clearing mandate for OTC derivative transactions in these “G4” IRDs. The consultation period closed on 10 April 2014 and Government is considering its response.

In April 2014, the CFR released a report recommending Government also consider implementing a mandatory clearing obligation for OTC transactions in Australian dollar interest rate derivatives for internationally active dealers.

Stage 3: Trade execution on trading platforms

In their October 2012 report on the Australian OTC derivatives market, the Regulators indicated that they saw in-principle benefits of greater utilisation of trading platforms in the Australian OTC derivatives market. Since then, some overseas jurisdictions have made progress in reviewing their regulatory regimes for trade execution venues or for imposing mandatory trade execution requirements. In light of these developments the Regulators have advised that they consider it necessary to look at whether some classes of OTC derivative products are suitable for execution on trading platforms in the future.