Financial market infrastructure regulation: Proposals for reform in Australia

In June 2011, the Australian Council of Financial Regulators, comprising the RBA, ASIC and APRA, published a discussion paper, "Central Clearing of OTC Derivatives in Australia", in which they discussed proposals for mandating central clearing of OTC derivatives in Australia. In that paper, the Council noted that central clearing activities may be undertaken by central counterparties located in foreign jurisdictions in respect of which “Australian regulators would not be likely to have primary oversight responsibilities.”

More recently, the Council issued a consultation paper on Financial Market Infrastructure Regulation in October 2011. While the paper deals with regulatory issues beyond the OTC derivatives market, it expressly recognises that the issues it raises, particularly the adequacy of regulatory oversight and powers, will be relevant to the reforms previously proposed by the Council for the mandatory clearing of OTC derivatives through CCPs.

So, what does the Council’s paper tell us about the possible future direction of OTC derivatives regulation in Australia? A number of key points emerge.

• While the Council believes that the risk of a CCP default is remote, it also believes that the potential for systemic disruption due to the failure of a CCP to be just as great as the potential for systemic disruption that would arise as a result of a bank failure. Accordingly, a certain minimum degree of oversight by Australian regulators is warranted.
• This should not prevent CCP facilities being provided to the Australian OTC derivatives market by a foreign entity provided that certain of its key operations, such as those relating to margin requirements and default resources, are located in Australia.
• Regulators should have the ability to make “listing” or “market” rules relating to the types of derivatives that may be subject to central clearing in Australia. This is to ensure that certain minimum standards are maintained in the event that a foreign controlled or domiciled CCP does not take steps to ensure that the clearing facilities that it makes available to the Australian market are adequate from a regulatory oversight perspective.
• Regulators should also have the power to appoint a statutory manager to a CCP providing clearing facilities to the Australian market, where the CCP is in financial stress or not meeting minimum operational standards, regardless of whether the CCP is located domestically or offshore.

Accordingly, it seems that one of the key issues that will drive the shape of regulatory reform in the Australian OTC derivatives markets will be a desire on the part of Australian regulators to ensure that mandatory clearing of OTC derivatives does not come at the expense of maintaining Australian regulatory control over the OTC derivatives markets and structures (particularly where central clearing services are provided by foreign entities).

That said, key issues will still need to be resolved. For example, it will be imperative to the stability of the financial markets that the appointment of a statutory manager to a CCP, and the exercise of any powers conferred on it (including to cancel and/or suspend transactions) do not disturb the existing legal framework in Australia that supports the enforceability of OTC derivatives. In addition, in light of the Council's view that it is desirable to impose "location" requirements on CCPs that are systemically important to Australia, where the CCP is located offshore there will be scope for the Australian "location" requirements to be in direct conflict with other foreign regulations that may apply to the offshore CCP.

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