Survey of the OTC Derivatives Market in Australia – May 2009 Executive Summary

In April 2008, the Financial Stability Forum (FSF)[1] released its Report on Enhancing Market and Institutional Resilience,[2] analysing the sources of emerging turbulence in financial markets and making recommendations to increase the resilience of the financial system. One of the recommendations was to ensure a sound legal and operational infrastructure for the OTC (over-the-counter) derivatives market, in part drawing on the conclusions of an earlier report of the President's Working Group.[3]

A number of initiatives are already underway internationally in this area. Building on enhancements to the infrastructure supporting the credit derivatives market in recent years, major market participants have committed to further streamlining operational practices across OTC derivatives products, with a particular focus on increasing use of electronic systems to automate trade and post-trade processes, and expanding central counterparty clearing where feasible. Other live regulatory initiatives are considering issues around transparency, disclosure, leverage and investor suitability in these markets.

Further to the publication of the FSF report, the three Australian financial authorities – the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and the Reserve Bank of Australia – formed a working group to monitor international industry developments and assess the conduct of business in the Australian OTC derivatives market in the context of the FSF recommendations. In developing policy in this area, a first step for the working group has been to carry out a survey of OTC derivatives market participants in Australia (the Survey), focusing particularly on risk management and post-trade processing practices.

This report summarises the key findings of the Survey and identifies a number of areas in which practices in the Australian OTC derivatives market might be enhanced.

The scale of activity and magnitude of outstanding exposures in the Australian OTC derivatives market are relatively low by international standards and, with the exception of interest rate and foreign exchange products, are also quite low in absolute terms. Nevertheless, the market plays an important role in the overall functioning of the Australian financial system and any disruption to activity could have wide-ranging implications. For instance, while the Australian OTC derivatives market generally remained robust to the turbulence that followed the bankruptcy of Lehman Brothers in September 2008, there was widespread uncertainty among participants. This contributed to an increase in price volatility and deterioration in liquidity conditions across products. To help ensure market resilience in the face of such shocks, it is therefore important that market practices promote transparency, the legal robustness of trades, effective management of counterparty credit risks, and efficient and reliable provision of information to risk-management systems and regulators.

There have been a number of important developments and enhancements in each of these areas in the Australian market in recent years. These reflect general industry-wide improvements in risk management over time, in part driven by international regulatory initiatives. Furthermore, in response to the turbulence in financial markets, senior executives have focused more attention on risk-management issues. Among the most notable developments in Australia revealed by the Survey are:

  • a shift to ‘vanilla’ business in recent months, as demand for complex or structured products has declined;
  • increased acceptance, over time, of the importance of timely execution of industry standard documentation, more recently often including tighter close-out options to manage counterparty risks;
  • a continuing trend towards collateralisation of exposures, underpinned by the negotiation of Credit Support Annexes (CSAs) attached to Master Agreements, with these also increasingly incorporating lower unsecured thresholds and more frequent use of initial margining; and
  • a gradual shift towards increased straight-through processing and use of centralised third-party platforms for key post-trade processing functions, largely driven by overseas banks.

While acknowledging these developments, Australia's financial authorities have concluded that there remains scope for further enhancement to the operational and risk-management practices in the Australian OTC derivatives market to ensure that they meet international best practice. Perhaps reflecting the smaller scale of activity in the Australian OTC derivatives market, and the fact that existing processes have to date proved to be scalable and resilient to shocks, market participants have pursued enhancements to risk-management and operational practices with somewhat less urgency than has been the case internationally. Some sell-side participants suggested that additional support from the authorities would accelerate progress towards more automation and straight-through processing.

Given these considerations, the Australian financial authorities encourage industry participants to consolidate and build on recent enhancements to practices in this area and in particular to take the following steps, working with the authorities as appropriate:

  • Promote market transparency: The industry is encouraged to work towards improving the efficiency and transparency of the OTC derivatives market, including: the standardisation of contract terms where feasible and appropriate; the use of electronic trading platforms where available; and the provision of data to regulators (and, where appropriate, to other participants) on trading activity, pricing, and the size and location of exposures. Furthermore, where OTC derivatives instruments retain complex features, market participants should be able to clearly document their key characteristics and communicate these to regulators, also demonstrating their contribution to risk exposure with reference to relevant scenarios. It is acknowledged that developments in these areas should not unduly constrain flexibility in structuring, negotiating and executing OTC contracts to facilitate tailored risk and portfolio management and hedging of exposures.
  • Ensure continued progress in the timely negotiation of industry-standard legal documentation: Where appropriate, Australian industry participants are encouraged to review existing processes to ensure that the volume of trade undertaken in the absence of completed documentation is minimised. Where trades are executed without the appropriate documentation in place, industry participants are encouraged to ensure that potential legal risks are minimised (eg, by agreeing long-form confirmations; setting exposure limits; and/or agreeing early termination options).
  • Expand the use of collateral to manage counterparty credit risks: Australian industry participants are encouraged to expand, where practicable to do so, the use of CSAs attached to Master Agreements and review the application of initial margin, unsecured thresholds and minimum transfer amounts. Where collateralisation is not appropriate, alternative risk mitigants should be in place (eg, position/exposure limits; termination and ‘right-to-break’ clauses in Master Agreements; and/or negotiation of charges over balance sheet assets).
  • Promote Australian access to central counterparties for OTC derivatives products: Australian industry participants are encouraged to make use, where appropriate, of existing and emerging central counterparty facilities for OTC derivatives. Where Australian-based participants and Australian dollar products are not currently served, participants are encouraged to work with the financial authorities to promote Australian access to such facilities.
  • Expand the use of automated facilities for confirmations processing: Australian participants are encouraged to work towards industry standards for connecting to automated facilities for confirmations processing and, where available, to make use of trade data warehouse facilities and linked settlement services. This will promote straight-through processing, minimise delays in confirming trades and ensure a reliable data feed to risk-management systems. There is also a case for considering the use of ‘economic affirmation’ of the key economic terms of a trade soon after execution to mitigate risks arising prior to confirmation.
  • Expand the use of multilateral ‘portfolio compression’ and reconciliation tools: Australian industry participants are encouraged, where appropriate, to make more extensive use of multilateral portfolio compression services, ie, facilities which are designed to identify trades held on participants’ books that could be terminated without altering the participants’ economic exposure beyond a stated tolerance. Participants are also encouraged to move towards emerging industry standards for the frequency and automation of portfolio reconciliation to help ensure a reliable data feed to internal risk-management systems.
  • Increase Australian influence in international industry fora: Through active engagement with international industry committees, Australian market participants should take all opportunities to ensure that the interests of the Australian market are adequately reflected in industry debate on the evolution of market practices.

Australia's financial authorities will initiate discussions with industry participants on each of these topics in the near future, with a view to prioritising efforts, and developing arrangements to monitor progress over time.


The Financial Stability Forum was re-established in April 2009 as the Financial Stability Board (FSB), with an expanded membership and a strengthened mandate. The FSB brings together senior representatives from central banks, finance ministries and supervisory agencies from the major developed and emerging economies, and representatives from various international organisations. [1]

See <> [2]

This group comprises the US Department of the Treasury, the Federal Reserve Board of Governors, the Securities Exchange Commission, and the Commodity Futures Trading Commission. See Policy Statement of the President's Working Group on Financial Markets, 13 March 2008: <> [3]