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Collateral:Securities Lending, Repo, OTC Derivatives and Future of Finance

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Australian OTC Derivatives Central Clearing House Considered

Posted: 20 Jul 2011

Market participants and stakeholders are pondering the implications of creating a domestic central clearinghouse for OTC derivative trades in Australia.

Last month, the Council of Financial Regulators, a representative group made up of the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investment Commission (ASIC), The Reserve Bank of Australia and the federal Treasury, released a discussion paper to outline the options available. Australia, as part of the G20, committed to centrally clearing all derivatives by the end of 2012. The majority of Australian OTC derivatives instruments traded are interest rate and foreign exchange derivatives.

The paper explores two options – creating a new, domestic central counterparty (CCP) arrangement, or using an offshore clearing solution – as part of four key considerations for the market. The paper notes that there is no central clearing of OTC derivatives in Australia at this time, and that offshore clearing solutions are configured for large European and US markets rather than the smaller markets such as Australia. The paper further notes that cross-border linkages enhance the depth and efficiency of the domestic Australia market and that overseas market and regulatory developments are “an important force in shaping the Australian market.”

The paper further states that central clearing will have implications for financial security – while on the one hand, a central clearinghouse can enhance market resilience through “reducing some interdependencies of market participants, as well as providing a centralised mechanism to assist in resolving participant defaults and other crisis management arrangements,” the shift to centrally cleared arrangements will inherently create more concentrated risk in the CCP itself, risk that can be mitigated but not eliminated. Finally, the configuration of a CCP arrangement could have important effects on the OTC derivative market in terms of netting opportunities and collateral efficiencies.

In considering whether to use an offshore clearing solution or building a domestic solution, the paper says that if Australian regulators don’t act to create a domestic CCP, a domestic solution may not emerge and would induce Australian-based participants to use an overseas CCP, which would be beyond the Australian regulators’ auspices, another source of risk.

“For this, and other public policy reasons, the council agencies have reservations about a mandatory clearing requirement that resulted in a systemically important domestic market being cleared though offshore CCPs,” the council says.

Furthermore, the council said that because they consider the market for Australian dollar-denominated interest rate derivatives as systemically important given the number of participants using these instruments, the representative agencies “are considering the case for a requirement that activity in Australian dollar-denominated interest rate derivatives be centrally cleared and whether this should take place domestically. A mandatory clearing requirement to that effect would generally apply to financial institutions acting in the domestic market (such as Authorised Deposit-taking Institutions and Australian Financial Services Licensees); the council agencies would expect that some market participants would be exempt from this mandatory requirement, depending on their size or class.”

Even though it has been nearly a month since the council released the discussion paper, stakeholders are still working to digest the implications of creating a central clearinghouse, and to frame their responses.

“We are still in the process of formulating our position on the proposal, and consulting with our members on this issue,” says Duncan Fairweather, executive director of the Australian Financial Markets Association (AFMA). “It’s quite fundamental to the way the markets will operate and big questions have been asked.”

AFMA, like other market participants, will have to first decide on what they see as the preferred option – a domestic clearinghouse or an overseas clearinghouse, Fairweather says.

“The key issue for AFMA is the one that’s being addressed – should Australia rely on centralised/global clearing arrangements or a clearing facility here in Australia,” Fairweather said. “The concentration of risk and the dispersion of risk are central to the issue.”

Stakeholders have until September 1 to submit comment to the council.

If you have any comments about this story or news tips, contact Christopher Gohlke in New York at cgohlke@globalcustodian.com or Janet Du Chenne in London at jduchenne@globalcustodian.com.