Central Clearing of OTC Derivatives in Australia – June 2011 Annex

The Current Regulatory Regime for OTC Derivatives in Australia

The Australian regulatory regime provides a comprehensive framework underpinning the soundness of the domestic OTC derivatives market. Financial intermediaries are required to be licensed with respect to their interactions with counterparties, and most are prudentially regulated as well. Centralised trading platforms and other infrastructure that are used by market participants are also overseen by regulators.

Market intermediaries

Under the Corporations Act 2001, firms or persons that carry out financial services within Australia are generally required to have received an Australian Financial Services Licence (AFSL) from ASIC. Alternatively, they may rely on an exemption from the requirement to hold an AFSL – this arrangement is in place for many overseas-based entities providing financial services to Australian wholesale clients, where ASIC considers that the overseas financial service provider is subject to equivalent regulation in its home jurisdiction. In relation to OTC derivatives, the types of services that a firm might be providing could include (though may not be limited to) financial product advice, dealing in a financial product, making a market in a financial product, or custodial or depository services. In order to receive and maintain an AFSL, entities need to demonstrate that they satisfy a range of business conduct, governance, risk control, and resourcing measures. The specific requirements will greatly depend on the scale of an entity's business and the type of counterparties it is dealing with: higher requirements will typically apply where its business is more complex or its counterparties are less sophisticated.

In general, the AFSL regime sets only minimum financial requirements, and does not impose prudential standards. Instead, APRA administers Australia's prudential regime, through which the ongoing adequacy of intermediaries' financial resources are measured against the market, credit, liquidity and operational risks they face. As discussed in Section 3.2, the main OTC derivatives dealers in Australia are members of domestic or foreign banking groups. Domestically incorporated banks are fully regulated by APRA; local branches of foreign banks are also regulated, though a greater reliance is placed on these banks' home-country regulators.

Although local branches or subsidiaries of foreign banks may be the licensed entity acting as a dealer in the Australian market, it is often the case that the local entity is not the name of the legal entity in which an OTC derivatives transaction is booked. Instead, a transaction might be booked in the name of a foreign bank's headquarters (or a major subsidiary). In this way, an internationally active bank can consolidate large parts of its global derivatives activity in a single entity, which can provide significant netting and capital benefits. For transactions undertaken in Australia, though, this can mean that a significant amount of domestic activity is booked against a counterparty not domiciled in Australia. The AFSL licensing regime provides some protections around this by requiring that an Australian AFSL holder entering into derivatives as a principal must meet minimum financial requirements imposed by ASIC, while market participants will typically undertake creditworthiness checks and ensure contractual and collateral arrangements are legally robust. Well-established cross-border banking and securities transfer arrangements also mean that exchanges of collateral against market movements typically proceed smoothly. However, as demonstrated by events of recent years, in times of market turmoil – and particularly in the event of an offshore counterparty default – this cross-border interdependence can be problematic.

Market infrastructure

Since a large part of the attractiveness of OTC derivatives is their capacity to be carefully tailored to an individual counterparty's needs, traditionally this market has not made much use of centralised infrastructure. However, for some more standardised products, the benefits of trading platforms have become apparent to some market participants. In general, under Part 7.2 of the Corporations Act, a market facility such as a trading platform will need to be granted an Australian Market Licence (AML) for it to operate in the domestic market. Exemptions from the requirement to hold an AML have been granted, however, for certain types of facilities that are used solely by wholesale market participants. As with the AFSL regime, for a market operator to be licensed, certain business conduct, governance, risk control, and resourcing requirements must be met, and the operator must demonstrate that its market is fair, orderly and transparent. In the first instance, ASIC has responsibility for considering an application for a market licence, and is also responsible for the ongoing assessment of an operator. But the granting and revocation of an AML is a decision of a minister of the Australian government which is made subject to the minimum requirements set out in the Corporations Act. Over time, and given international trends, it is likely that the OTC derivatives market will make greater use of these sorts of market facilities.

In order to operate a CCP in Australia, an operator must have an Australian Clearing and Settlement Facility Licence (CSFL), as set out under Part 7.3 of the Corporations Act or receive an exemption from this requirement. The regulation of these facilities is jointly overseen by ASIC and the Reserve Bank, whose role is to consider the potential effects of clearing and settlement facilities on overall financial and payment system stability. The granting and revocation of a CSFL is at the discretion of a minister of the Australian government. As with market operators, a clearing and settlement facility must satisfy certain business conduct, governance, risk control, and resourcing requirements. In undertaking the assessment and oversight of these facilities, ASIC and the Reserve Bank are guided by international recommendations set out by CPSS and IOSCO; a new version of the ‘Principles for Financial Market Infrastructures’ is currently open for consultation.[47] In part, the revisions to these principles reflect the increasing recognition of the systemic importance of clearing and settlement facilities; with respect to CCPs, it also acknowledges that their systemic importance is growing due to measures (such as the G20 commitment) that encourage or mandate the use of CCPs.


See CPSS-IOSCO (2011). [47]