Australia’s OTC Derivative Reform: Central Clearing and Single-Sided Reporting

Reform

The Australian Treasury recently announced that the Corporations Amendment (Central Clearing and Single-Sided Reporting) Regulation 2015 (Cth) (the Regulation) has now been promulgated. The Regulation will come into effect on 1 October 2015. The purpose of the Regulation is to implement central clearing of prescribed classes of over-the-counter interest rate derivatives and to confirm the long-awaited “single-sided trade reporting relief” for certain entities. The issue of the Regulation follows months of extensive consultation with key industry stakeholders and provides the final building block before the trade reporting regime becomes fully operational in October 2015. Participants in the Australian OTC derivatives market, particularly those that are able to avail themselves of the single-sided reporting exemption, will now be able to make concrete plans regarding compliance with the derivatives trade reporting regime and how they will be able to rely on any relevant exemptions. Below we outline the significant provisions of the Regulation.

Single-Sided Reporting

In July 2013, ASIC published the ASIC Derivative Transaction Rules (Reporting) 2013 (the Reporting Rules), which required both sides of an OTC derivative transaction to report information about the transaction to a prescribed trade repository (known as double-sided reporting). In December 2014, the Australian Government announced that it would provide relief from the trade reporting requirements by allowing ‘single-sided reporting’ for Phase 3B entities¹, provided that the relevant counterparty to the transaction was either required to report the trade themselves or had agreed to do so.

The Regulations implement this relief by introducing single-sided reporting for a phase 3B entity as defined in the ASIC class order, being a reporting entity that is either an Australian ADI, AFS licensee, a CS facility licensee, exempt foreign licensee or a foreign ADI, with less than $5 billion gross notional outstanding OTC derivative positions, as at 30 June 2014.

It is worth noting that under the Regulations, an entity can move in and out of being a phase 3B reporting entity, depending on changes in the size of its derivatives portfolio as at the end of a calendar quarter.  For example, the Regulations require that an entity remains below the $5 billion threshold for two consecutive quarters in order to gain the benefit of the exemption, but it also has to remain above the threshold for two consecutive quarters in order to lose the exemption. This approach prevents changes in status occurring because of a short-term increase or decrease in the level of an entity’s OTC derivatives’ activities.

The Regulations provide that phase 3B entities will start benefiting from the exemption on the day after the “quarter day”, defined as 31 March, 30 June, 30 September or 31 December, following two successive qualifying quarters for the entity and will lose the benefit at the end of the quarter day that next follows two successive disqualifying quarters.

Reporting counterparty

The Regulations introduce the concept of a “reporting counterparty”. The Regulations provide that a phase 3B reporting entity is exempt from the provision of the Reporting Rules if:

     (i) it is a phase 3B reporting entity in relation to the OTC derivative transaction; and

     (ii) the other party to the OTC derivative transaction  is a reporting counterparty in relation to the phase 3B 
          reporting entity and the information.

Australian and foreign entities

The Regulations provide a clear delineation between entities with Australian reporting obligations, and foreign entities that do not have an Australian reporting obligation but who may choose to ‘voluntarily’ report.

The Regulations provide that the exemption is available to phase 3B entities where the counterparty is a foreign entity that is not a reporting entity under the Reporting Rules, and the counterparty has made the following representations to the exempt entity:

     (i) that the counterparty will report the OTC derivative transaction under substantially equivalent foreign 
          reporting requirements to a prescribed facility or licensed trade repository; and

     (ii) that the counterparty will designate or ‘tag’ the information so that the facility or trade repository knows 
          that it can be provided to ASIC.

The Regulations provide that the phase 3B entity is entitled to rely on the representations made by the counterparty on the basis that the entity makes regular enquiries reasonably designed to determine whether the foreign entity is discharging its obligations under the representations and the entity has no reason to suspect that the foreign entity is not complying with its representations.   

The Regulations demonstrate a shift towards a more relaxed position. Submissions on the Exposure Draft called for a regime that reduces outlays and the regulatory burden for phase 3B reporting entities when engaging with both domestic and international counterparties.

The Explanatory Statement provides that what is considered to be ‘reasonable’ will be determined by the circumstances relating to the phase 3B entity, the level of its OTC derivatives activities and the counterparty. Similarly, the frequency of the enquiries required will depend on the circumstances, with enquiries regarding smaller phase 3B entities that have few transactions with little to no changes, likely to be undertaken as infrequently as once or twice a year.  

Central Clearing

Another feature of the new regulations is the introduction of mandatory clearing for interest rate derivatives denominated in AUD, USD, EUR, GBP and JPY.

The Regulations provide that the following entities will be subject to the central clearing requirements:

• Australian Clearing Entities: a domestic authorised deposit-taking institution (ADI) or an Australian financial services (AFS) licensee that is incorporated or formed in Australia and holds $100 billion or more total gross notional outstanding OTC derivatives positions. The term also includes entities that have opted to be treated as Australian clearing entities in accordance with the draft ASIC Derivatives Transaction Rules (Clearing) 2015 (Draft Clearing Rules), which are yet to be finalised.
• Foreign Clearing Entities: foreign ADI, AFSL holders or exempt foreign licensees which provide financial services relating to derivatives to wholesale clients only and are regulated by an overseas regulatory authority, that are incorporated or formed outside Australia and exceed the threshold of $100 billion. Also included are entities that opt into the regime in accordance with the Draft Clearing Rules.
• an entity that is acting in a representative capacity as a responsible entity for a registered scheme or as a trustee of a trust, in circumstances set out in the Draft Clearing Rules.

The Regulation prescribes five overseas central counterparties (CCPs) to be interposed into each transaction, including CME Clearing Europe Limited, Eurex Clearing AG, Japan Securities Clearing Corporation, NASDAQ OMX Clearing AB and OTC Clearing Hong Kong Limited.

The Regulations also carve out a range of foreign public entities from the imposition of the clearing requirements, including central banks, Government debt offices, multilateral development banks and the Bank for International Settlements and other similar organisations.

Transactions subject to mandatory clearing

The Regulations prescribe specific circumstances in which clearing requirements can be imposed, namely in relation to a derivative transaction  entered into between:

• two Australian Clearing Entities;
• an Australian Clearing Entity and a Foreign Clearing Entity;
• an Australian Clearing Entity and a foreign internationally active dealer (being an entity that is registered or provisionally registered as a swap dealer with the US Commodity Futures Trading Commission or as a security-based swap dealer with US Securities and Exchange Commission);  
• two Foreign Clearing Entities, the test of which is to be clarified by finalisation of the Draft Clearing Rules;
• a Foreign Clearing Entity and a foreign internationally active dealer, also to be delineated in the Draft Clearing Rules.