On Wednesday 25 July 2012, the Australian Government released an exposure draft of the Corporations Legislation Amendment (Derivatives Transactions) Bill 2012, which will establish a framework for the introduction of substantial reforms to Australia's over-the-counter (OTC) derivatives industry.
The Bill follows the Government's April consultation paper outlining its proposed framework to meet Australia's G20 commitments on derivatives regulation (see our article explaining the elements of the proposed framework).
The purpose of the Bill is to create a legislative framework to allow the following mandatory obligations to be imposed on derivatives transactions:
- reporting of derivatives through trade repositories;
- clearing of derivatives through central counterparties; and
- executing derivatives on exchanges or electronic trading platforms.
The Bill raises a number of issues for the Australian derivatives industry to consider.
The legislative framework will be enacted via amendments to the Corporations Act 2001 (Cth). The Bill itself will not impose any obligations on market participants. Rather, it will give the Minister for Financial Services and Superannuation and the Australian Securities and Investments Commission (ASIC) the power to make rules and enact future regulations relating to the reporting, clearing and trading of particular types of derivatives.
In keeping with the framework proposed in April, the mandatory obligations under the Bill will not be enlivened until the following has occurred:
certain classes of OTC derivatives have been prescribed by the Minister in relation to one or more of the mandatory obligations; and
ASIC has made derivatives transaction rules (DTRs) that impose reporting, clearing and/or execution requirements (and matters incidental to those requirements) for participants transacting in the prescribed class of OTC derivatives. ASIC may also make DTRs specifying the particular trade repositories, clearing counterparties and trading platforms that market participants must deal with to comply with the rules.
When exercising its rule-making power, ASIC must consult with the public and other regulatory bodies. In addition, all DTRs must be approved by the Minister.
The Minister may pass regulations to limit the classes of persons and transactions to which the DTRs apply. It is expected that the Minister will pass regulations for a particular class of OTC derivatives at the time those derivatives are prescribed. When exercising the regulation-making power, the Minister must have regard to the likely impact on the Australian economy and financial system, the likely regulatory impact and any other relevant matter. The Minister must also consult with ASIC, the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA).
Failure to comply with the DTRs triggers the civil penalty provisions in the Corporations Act. However, failure to comply with a DTR does not invalidate the relevant derivative transactions themselves.
The appropriate exercise of rule and regulation-making powers
The new framework is built on a very broad legislative setting that relies heavily on the appropriate exercise of rule and regulation-making powers to ensure that the framework does not overreach its policy objectives.
For example, the range of "derivative transactions" that could be subject to the framework is by definition very broad, being defined as:
the entry into of an arrangement that is a derivative;
the modification or termination of such an arrangement; or
any other transaction relating to a derivative.
The policy consideration behind the broadness of this definition is to give the Government and ASIC sufficient flexibility to address anti-avoidance behaviour and allow for greater harmonisation with equivalent overseas regimes as these develop.
The April consultation paper contemplates that the rule and regulation-making powers will be exercised in a way which ensures that the scope of the mandatory obligations is appropriate. This is reinforced by the Bill through its inclusion of specific criteria that the Minister and ASIC must have regard to when exercising their respective regulation and rule-making powers (see above).
However, at this stage, the potential footprint of the mandatory obligations is still uncertain and no further guidance is given in the explanatory document accompanying the Bill beyond what was canvassed in the April consultation paper.
Although the April consultation paper stated that mandatory trade reporting may be introduced as early as this year, the Bill does not provide any further indication as to when the Government plans to impose the mandatory obligations.
ASIC's rule-making capacity
The framework is unusual in that ASIC not only has a supervisory role but it also has significant rule-making power through its role in issuing the DTRs. In fact, submissions in response to the April consultation paper expressed concern about the degree of rule-making power conferred upon ASIC under the legislative framework.
Notwithstanding this, the Government has made it clear that the flexibility inherent in ASIC's rule-making is paramount, and that the constraints in the Bill, including the requirement for Ministerial approval of DTRs, are intended to provide protection in this regard.
The Bill is silent on the jurisdictional reach of the mandatory obligations. The April consultation paper contemplated that the jurisdictional reach of the framework would be clarified by the regulations, with potential for further refinement in the DTRs.
The consultation paper also indicated that the jurisdictional reach may be considered separately for reporting, clearing and execution obligations. Market participants can expect further consultation on this crucial aspect of the new regime.
Licensing regime for trade repositories
The draft legislation provides for the creation of a licensing regime for derivative trade repositories. This is modelled on the current licensing regimes for Australian market and clearing and settlement facility licence holders under Parts 7.2 and 7.3 of the Corporations Act, respectively. Regulations and DTRs will flesh out the details of the regime.
The Government has adopted a framework approach for licensees to ensure that the rules, when made, are sufficiently equivalent to major overseas jurisdictions to facilitate mutual recognition of licensed trade repositories by overseas regulators. ASIC will supervise both domestic and overseas licensees, but will be able to take into account the regulation of the overseas licensees in their home jurisdictions.
Subject to limited exceptions that will be prescribed by regulation, trade repositories will be required to disclose trade data to ASIC, APRA, the RBA or another trade repository licensee upon request. The regulations may also require licensees to provide statistical information to certain persons specified in the regulations.
The Bill seeks to provide some level of protection for trade data confidentiality by prohibiting licensees from disclosing trade data, including trade data provided by other licensees, except as required or permitted by law or as necessary for the provision of the trade repository services.
Interested parties are invited to comment on the draft legislation. Submissions are due by 20 August 2012. If you are interested in contributing to the consultation process and would like our assistance, please contact Graeme Dennis.
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