Jurisdiction - Australia
Reports and Analysis
Australia – OTC Derivatives And Clearing And Settlement Facilities.

25 November 2012


Legal News & Analysis – Asia Pacific – Australia – Regulatory & Compliance


There have been a number of significant recent developments in Australia in relation to the regulation of clearing and settlement facilities, including in the context of the clearing of OTC derivatives.


OTC derivatives clearing
The Australian Commonwealth Government has released the Corporations Legislation Amendment (Derivative Transactions) Bill 2012 which provides a legislative framework to implement Australia’s G-20 commitments in relation to the central clearing of over-the-counter (OTC) derivatives. These reforms follow around 12 months of consultation with industry by the relevant Australian regulatory authorities. The Bill itself provides little more than the overall framework, conferring relevant general powers on the Minister to determine that certain “Derivatives Transaction Rules” apply to particular classes of derivatives, with such rules being promulgated by the Australian Securities and Investments Commission (ASIC). Such rules could, for example, mandate trade reporting, the central clearing of certain classes of derivatives (such as Australian dollar denominated interest rate derivatives) or the use of trading platforms. The Bill also provides a regime for the licensing of trading repositories, which would supplement the current legislation that provides a comprehensive regime for the licensing of trading platforms (i.e. markets) and clearing and settlement facilities (i.e. CCPs).
The Government’s response, supported by the policy of the relevant regulators, being ASIC, the Australian Prudential and Regulation Authority (APRA) and the Reserve Bank of Australia (RBA), is to provide a general framework for regulation, but at the same time to provide room for industry to lead reforms and solutions. It recognises that substantial work is being undertaken by regulators overseas which will impact Australian industry participants, and also that the issues are highly complex. Industry is therefore being encouraged to develop a solution which is appropriate for Australia, while at the same time the regulators have made it clear that they are prepared to impose mandatory obligations where necessary.
In October 2012, ASIC, APRA and the RBA issued a detailed joint report containing their key recommendations for the implementation of the Bill, should it be passed. These included recommendations to the following effect:
  • introduce a broad-based mandatory trade reporting obligation for OTC derivatives;
  • mandatory clearing of Australian dollar denominated interest rate swaps is not necessary at present, but if substantial industry progress towards central clearing of such swaps is not evident in the near future, this recommendation would be revisited;
  • various enhancements to risk management practices across the industry; and 
  • no specific recommendations at this time in relation to mandatory trading platform execution obligations.
 Regulation of clearing and settlement facilities
Closely tied to the issue of clearing OTC derivatives is the prospect that an offshore clearing house may seek to provide CCP services in Australia. This has caused the Australian regulators to revisit the regulation of clearing and settlement facilities (CS facilities) in Australia, with extensive consultation, with a view to aligning the regulation of CS facilities with IOSCO’s Principles for Financial Market Infrastructures released in April 2011. In particular:
  • In July 2012, ASIC, APRA, the RBA and the Commonwealth Treasury issued a paper entitled “Ensuring Appropriate Influence for Australian Regulators over Cross-border Clearing and Settlement Facilities”. In this paper, the regulatory agencies proposed a series of “graduated measures” which should apply to CS facilities in Australia, depending on their importance to the Australian market. All CS facilities would be required to comply with the RBA’s financial stability standards and other general requirements under the Corporations Act, as well as other prescribed governance and operational requirements. If a CS facility is regarded as being “systemically important” it would require an exchange settlement account with the RBA and be subject to additional controls. Further, if a CS facility is regarded as having a strong domestic connection with Australia, it would need to submit to the primary regulation of the Australian regulators and a domestic presence, with additional controls around outsourcing, staffing and data.
  • In August 2012 the RBA issued new financial stability standards, to bring them into line with IOSCO’s Principles for Financial Market Infrastructures. It is also proposed that offshore regulated CCPs which seek to be licensed in Australia would be subject to the RBA’s standards, although the RBA will recognise compliance by an offshore regulated CCP with materially equivalent standards under the relevant offshore regime. The RBA has indicated that it expects to finalise the standards before the end of 2012.
  • In 11 September 2012, ASIC released Consultation Paper 186 Clearing and settlement facilities: International principles and cross-border policy (update to RG 211), proposing amendments to its regulatory guidance for clearing and settlement facilities (CS facilities) to take into account updated international standards and other recent policy developments described above. ASIC has indicated that it expects the revised guidance will take effect by the end of 2012.
Government Registers Corporations Legislation Amendment (Derivative Transactions) Bill 2012
MF Global Australia Ltd
MF Global Australia Limited (MFGA) was one of the largest futures brokers and providers of contracts for difference (CFDs) in Australia. In re MF Global Australia Ltd (in liq) [2012] NSWSC 994, Black J considered a series of questions to enable the liquidators to determine the distribution of client monies and amounts recovered from clearing houses and counterparties following the insolvency of MFGA.
The key findings were: 
  • MFGA was entitled to use monies standing to the credit of the CMAs to meet its own margin and settlement obligations to hedge counterparties; 
  • amounts recovered from MFGA’s hedge counterparties, clearing houses, executing brokers and clearing brokers were “client money” such that they should be deposited in a client money account (CMA);
  • the balances of the many CMAs should effectively be “pooled” into four pools, representing the four different product lines of MFGA (futures contracts, CFDs, margin FX and online FX); 
  • each client’s “entitlement” to money in the CMAs was to be calculated according to the terms of the relevant contract between MFGA and the client. A client’s entitlement was to be calculated based on the “gross liquidation value” of the client’s accounts using mark-to-market prices as at 31 October 2011 (being the last trading day before the appointment of administrators early on 1 November 2011). Subsequent events (such as actual close-out prices) were to be disregarded for the purposes of this calculation; 
  • in contrast to the submissions put by one representative defendant, the  entitlement of clients who had a “cash only” position at the time of appointment of administrators (i.e. had no open positions at that time) was to be calculated in the same way as other clients and such clients were not to be preferred to clients who had openpositions at the time of appointment of administrators.
The decision has particular significance for Australian financial services licensees who handle client money. In particular, the decision sheds light on the interpretation of the provisions in the Corporations Act and Corporations Regulations which regulate the handling of client money and the operation of client money accounts, and also on the way in which parties to over-the-counter derivatives should regard monies they receive from counterparties.
Following the enactment of new Future of Financial Advice legislation earlier this year, the Australian Securities and Investments Commission (ASIC) has been consulting with industry about the manner in which it will approach its regulatory responsibilities in relation to the new legislation. The new legislation includes, among other things, a new obligation on financial advisers to act in the “best interests” of clients, a ban on conflicted remuneration including commissions and volume-based payments being paid in relation to recommendations given on most financial products, and an opt-in obligation that requires advice providers to renew their clients’ agreement to ongoing fees every two years. The reforms are generally due to commence on 1 July 2013, subject to particular transition arrangements. Please click through to our briefings below for a summary of key points.
Consultation has included:
  • August 2012 – ASIC issued a consultation paper on the best interests duty and scaled advice, that is, how an adviser should consider giving limited rather than full financial product advice addressing all of a client’s financial objectives and needs.
  • September 2012 – ASIC issued a consultation paper on conflicted remuneration, in which ASIC gives examples of the types of benefits which could amount to conflicted remuneration, including examples of bonus arrangements and non-cash benefits.
  • October 2012 – ASIC issued a consultation paper on how it will approach approval of codes with which an adviser may become bound and obviate the need to see its clients’ agreement to renewal each two years of ongoing fee arrangements. ASIC noted in its media release that approval of a code might take months rather than weeks and it would not consider a code until its regulatory guidance was finalised.
For further information, please contact:
Jonathan Gordon, Partner, Ashurst

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