13 Aug 2012

New NTA test for CFD and FX dealers

ASIC's new financial requirements for issuers of retail OTC derivatives significantly raise the bar for them, and could push some players out of the market all together. Louise McCoach and Matthew Daley run through what the new rules are, and their likely effect on the industry, before going through the to-do list to prepare for the first 31 January.


New NTA test of CFD and FX dealers
David Bushby, BRR Media
Louise McCoach, Partner, Clayton Utz
Matthew Daley, Partner, Clayton Utz

David Bushby
Today BRR Media speaks with Louise McCoach. She heads up the derivatives banking team at Clayton Utz here in Sydney, and joining her is Matthew Daley who is a partner in the financial services team at Clayton Utz. Thanks for joining us.

Louise, just kicking off, ASIC's announced new financial requirements for issuers of contracts for different and foreign exchange services for retail clients.

Louise McCoach
Yes it’s a new development that we’re monitoring quite closely; it will supplement the existing minimum financial requirements imposed on all retail OTC derivative issuers under the AFSLs. It will apply to all entities that aren’t regulated by APRA currently, other than market or clearing participants. So it’s quite wide-reaching in terms of the non-regulated market.

The most significant change is a new NTA test or Net Tangible Asset Test which is going to phased in over a two-year period. During the initial phase-in period, which commences on 31 January next year, an issuer’s NTA will need to be the higher of $500,000 and 5% of its average revenue. The second phase-in period requires the NTA to list to $1 million and it’s the higher of that and 10% of its average revenue.

The important point here is that it’s going to replace the current AFSL condition which applies to issuers at the moment, and this is based on an adjusted surplus fund requirement, which really is a test which looks at the cash outflows as opposed to an issuer’s average revenue. So that’s quite a different shift if you like.

And just very briefly there’s another related change which is the introduction of a new liquidity role, which essentially requires the issuers to hold 50% of the required NTA and cash or cash equivalents and the balance in liquid assets. 
And finally just to run through briefly the change to the cash flow projections, currently issuers are required to prepare quarterly cash flow projections over a three month period. The new requirements will extend these projections to cover a 12 month period and they will need to be based on assumptions which are disclosed and approved by the relevant issuer’s board. So it sort of ups the ante in terms of the cash flow work that they need to do as well.

David Bushby
The ASIC has been consulting with industry on these requirements since 2011. Do you think they ended up striking the right balance?

Louise McCoach
Well, that's a good question. I think the starting point is to ask what is the balance that they're trying to strike, and I think they're trying to ensure that issuers have sufficiently rigorous risk management frameworks and resources to support their business operations on one hand, but also needing to balance the fact that they need to ensure that those new requirements don't impose on reasonable cost burdens which could create unjustifiable barriers to entry.

Now it's interesting, if you canvass some of the media on this, the larger players are saying that they actually think the bar's hit at the right place. They actually have even suggested it could be set higher, and of course their concern is to make sure that these requirements protect the market's reputation against issuers that are undercapitalised or poorly governed. But of course there are obviously going to be additional costs and I think the smaller players are obviously going to feel this and find it more challenging.

David Bushby
Well, they do want to explore that side of things and Matt, I might bring you in here. Could these requirements push some of those smaller players out of the market?

Matthew Daley
Certainly, David. What we're seeing here is a shift as Louise has mentioned from a calculation based on adjusted liabilities, a cash outflow basis calculation, to one being based on average revenues. As Louise mentioned there's an increase in the baseline if you like for the new NTA requirements, so they're lifting the minimum cash requirements. It's certainly a very great possibility for those smaller undercapitalised players in the market to be put under significant pressure in terms of holding the appropriate capital.

ASIC has issued a regulation impact statement as it normally does with new reforms and in it provides indication there of a number of issuers that would consider exiting the market, and based on that survey which was undertaken in August of last year, ASIC's found that up to 25% of all affected issuers might well consider exiting the market base on those new requirements.

David Bushby
And it's a pretty large chunk of the market, I mean if those participants exit I mean is that really satisfying the needs of the broader market when there are fewer players in the market?

Louise McCoach
David can I just jump in there, I think one of the other facts which ASIC published in its Regulation Impact Statement was that in fact the market’s actually quite concentrated amongst four key players, and those four key players between them represent 65% of the client relationships in the market. So although by number 25% may obviously feel the pressure the vast majority of the market is represented by those key players. It’s likely to be quite a stable force in the market notwithstanding these changes.

David Bushby
I guess just finally, is there work to be done for the players in the market in the lead-up to that 31 January next year deadline when these first requirements kick in?

Matthew Daley
Well I guess there David the bulk of the work will obviously be around assessing whether you meet the capital requirements which are going to be imposed, so they obviously require an audit of your current revenues and expect the revenues going forward to understand whether or not you’re going to be in a position to meet the new requirements.

An important issue there is that Net Tangible Assets or NTA has a particular definition and it’s not quite as simple as assets less liabilities. You know for example assets excludes intangible assets, so those issuers who have grown by a number of acquisitions, and so have a very large goodwill component on their balance sheet, won’t be able to count that goodwill as an asset for the purposes of their NTA requirements. There’s a good example there of the position being perhaps a little different to what you might have thought, so having a very healthy balance sheet doesn’t necessarily mean you’re going to be able to get across the line.

The second thing too of course is that the new requirements impose a number of notification and sign-off procedures, principally that the directors of the issuer must sign off on the cashflow projections each quarter and so of course we’ve learnt our lesson from the likes of the Centro cases and the James Hardie cases that those matters which the directors are responsible for signing off on ought not or cannot rather be delegated, so in that respect it’s important that issuers factor in those new sign-off procedures into their current protocols.

David Bushby
Well, there are certainly big changes for the industry, and we'll look forward to seeing how they are being handled. Thanks again for your time today, Louise and Matt.

If you have any queries please email Matthew on [email protected].

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