OTC Derivatives Market Reform Considerations 7. Licensing of Financial Market Infrastructure

7.1. Introduction

Australia's existing regulatory regime for FMIs is flexible and, for the most part, already able to accommodate FMIs that can support OTC derivatives markets. An exception is trade repositories, which are not currently contemplated within the existing regulatory regime.

Given the international nature of OTC derivatives markets, it is likely that many offshore FMI providers will wish to operate their services within Australia. A particularly challenging regulatory issue here is central clearing in Australia by offshore-based CCPs, and questions around this issue formed a key part of the Council's June 2011 discussion paper. Based on the results of this consultation and domestic and international regulatory developments, the Council does not propose that there should be any restriction on whether central clearing take place by domestic or offshore based CCPs. This would also be the approach to trade repositories and market operators.

7.2. Licensing of Trade Repositories

As an emergent type of financial market infrastructure, trade repositories are not currently contemplated as a class of entity within the Corporations Act. This is in contrast to the established licensing regime for other financial market infrastructures: Part 7.2 of the Act sets out the Australian Market Licence (AML) regime, and Part 7.3 sets out the Australian Clearing and Settlement Facility Licence (CSFL) regime. Both Parts 7.2 and 7.3 provide for domestic licences and alternative criteria for granting licences to overseas operators.

It is proposed that a licensing regime for trade repositories be added to Chapter 7 of the Act. The trade repository licence (TRL) regime would have a similar structure to Part 7.2 and Part 7.3, in that it would provide for domestic licences and alternative licensing criteria for overseas trade repository operators. The Council believes it is important that the Australian regulatory regime for trade repositories facilitates the offering of services by foreign trade repositories whose primary regulator is foreign. It is also important that the regime established for licensing and supervising any domestic trade repository meets international regulatory standards and expectations, not least to facilitate any Australian-based trade repository offering its services in foreign jurisdictions.

The Council proposes that the TRL regime would be established at a high level in the amended Act, with supplemental regulations and standards made for the purposes of the trade repository licensing legislation as is the case for the AML and CSFL regimes. This approach should enable the licensing regime to remain responsive to regulatory developments, and to ensure the consistency of Australia's regime with the regimes being developed overseas. In addition, it is not intended that the TRL regime prevent an existing CSFL or AML holder from also holding a TRL.

Should multiple trade repositories in a given asset class co-exist, this may lead to data fragmentation and reduce the overall effectiveness of trade repositories. To avoid these problems, while still accommodating the potential for competing trade repositories, regulators would propose setting certain data standards to facilitate information aggregation. This would be guided by international standards as appropriate.

It is likely that a domestic TRL will be asked to provide data to overseas regulators. It is proposed that a domestic TRL may share information with offshore regulators where there are appropriate information sharing and data access arrangements between Australian and offshore regulators, and that Australian regulators are assured of confidentiality protections for the data transmitted.

As is the case for AMLs and CSFLs, it is proposed that the TRL regime should provide alternative criteria for granting a licence for an overseas trade repository operator. In order for an overseas trade repository licence to be granted, the home regulatory regime, as it applies to the operation of the overseas trade repository in its home jurisdiction, must be sufficiently equivalent (in relation to the level of fairness and effectiveness of services it achieves, and promotion of financial stability) to the Australian regulatory regime for comparable domestic trade repositories.

In granting a license to an overseas trade repository, Australian regulators will recognise the home regulatory regime of the trade repository and its primary oversight by its home authorities. A necessary pre-requisite would be an assurance by the applicant of the confidentiality protections for submitted Australian data. Adequate cooperation arrangements between Australian regulators and the overseas trade repository applicant will need to be in place before an overseas trade repository licence could be granted. Australian regulators would put in place cooperative arrangements with the relevant home regulatory authorities prior to the granting of a licence. These arrangements would include appropriate information sharing and data access between Australian regulators and the trade repository's home regulator.

7.3. Licensing of Central Counterparties

Given the systemic nature of CCPs, most jurisdictions already have strong regulatory regimes in place to govern these activities. In order to operate a CCP in Australia, an operator must have an Australian Clearing and Settlement Facility Licence, 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.^[1] The granting and revocation of a clearing and settlement licence is at the discretion of a minister of the Australian government. A clearing and settlement facility must satisfy certain business conduct, governance, risk control, and resourcing requirements. As noted in section 4.4.2, ASIC and the Reserve Bank are guided by international recommendations set out by CPSS and IOSCO in undertaking the assessment and oversight of these facilities.

The characteristics of CCPs discussed in sections 2.3 and 5.4 mean that there are very strong economies of scale and scope in central clearing. Accordingly, it is likely that, absent regulatory constraints, OTC derivatives central clearing may tend to be concentrated in a small number of CCPs. Given the global nature of markets for many products, it will likely be the case that many of the OTC derivatives traded in Australia could be cleared by CCPs located in offshore jurisdictions. The possibility of an offshore-based CCP offering clearing services in Australia is explicitly contemplated in the existing Australian regulatory regime. Overseas based CCPs can provide clearing services in Australia subject to their home regulatory regime being sufficiently equivalent to that of Australia, and appropriate information sharing arrangements being in place between Australian regulators, offshore regulators and CCPs.

One of the objectives of the Council's June 2011 discussion paper was to better understand the implications of a greater use of offshore CCPs by Australian participants. In particular, the Council would wish to ensure that clearing arrangements are sufficient for Australian interests to be protected in the event of a serious disruption to an offshore CCP. A number of regulatory developments over the past year have increased the Council's comfort in this. In the first instance, the interests of smaller jurisdictions such as Australia are being given weight through the work of the FSB in designing safeguards around a global CCP regime. The FSB's work around resolution regimes should also provide increased protections and certainty for users of CCPs.

Domestic regulatory developments have also increased regulators' comfort around offshore CCPs. To ensure that the regulatory regime for FMIs in Australia remained fit-for-purpose, in October 2011 the Council released a consultation paper on this issue.^[2] This paper contained a number of proposals, spanning enhancements to directions powers and sanctions, step-in powers, ‘fit and proper’ standards for directors and officers, listing rules and securities exchange compensation arrangements. Perhaps most relevant in the context of OTC derivatives regulation is a proposed amendment to legislation to provide explicitly for ‘location’ requirements to be imposed on an FMI, where appropriate, to mitigate the risk of disruption to markets served by that FMI and the Australian financial system more broadly. Since a potential outcome in OTC derivatives markets is for participants in the Australian market to clear via a CCP based overseas, this proposed reform is particularly important in the context of regulatory policy on the clearing of OTC derivatives in Australia.

There is a balance to be struck between the efficiency costs of imposing location requirements and the stability benefits for the Australian market. To facilitate a choice of central clearing arrangements being available to the Australian market, the Council would wish to accommodate offshore-based CCPs. However, domestic regulators would have a particularly keen interest in the activities of an offshore CCP clearing markets and products that are of particular systemic importance in Australia, with a view to:

• minimising potential disruption and loss to Australian financial institutions, financial markets and the real economy in the event of a clearing participant's default or other financial stress to the CCP
• ensuring continuity of provision of FMI services to the most systemically important Australian financial markets
• ensuring that Australian regulators (and Australian participants) have effective oversight of the CCP and can exercise sufficient influence to ensure that it meets domestic and international standards for systemic risk management, provides its services in a fair and effective way, and offers due protections to Australian participants.

The intent of the proposals would be to give Australian regulators a capacity to impose geographical or legal situs requirements on aspects of an offshore CCP's operations to ensure these outcomes. These might cover areas such as financial risk management arrangements, operational arrangements, and regulatory and legal frameworks as they applied to Australian participants' activity. It would be expected that any such requirements would be tailored in a flexible, proportional and graduated way, and might conceivably change over time as markets evolve. If adopted, the intended approach of regulators would be set out by guidance that was as detailed as possible, though it is unlikely that this would include hard triggers or thresholds. Ultimately, if an overseas facility became integral to the smooth functioning of the Australian financial system, it might be required to incorporate in Australia and obtain a domestic licence, thereby becoming subject to primary regulation by ASIC and the Reserve Bank.

Importantly, imposing location requirements does not imply overriding an overseas facility's rules or unduly disrupting its risk management procedures. It also does not imply any intention to displace an overseas facility's home regulator – any consideration of a location requirement would be undertaken with thorough consultation with the facility's primary regulator. Rather, a core aim is to ensure protections for Australian market participants and to mitigate risks to the Australian financial system should offshore-based CCPs play a larger role in the domestic market.

7.4. Licensing of Trading Venues

Some jurisdictions have introduced changes to their existing regimes for licensing or recognising electronic platforms and exchanges, as part of their OTC derivatives regulatory reform agenda. However, it is not currently proposed that any changes be made to the Australian licensing regime for markets in Part 7.2 of the Corporations Act, since this provides an existing framework for regulating operators of electronic trading platforms. Part 7.2 explicitly contemplates the prospect of an offshore market operator being licensed in Australia, subject to that operator's home regulatory regime being sufficiently equivalent to that of Australia. It is proposed that, if any obligation was in place for the purposes of trade execution, eligible trading venues would need to be either licensed under or exempt from Part 7.2 of the Corporations Act.

In other jurisdictions the relevant regulator has been empowered to impose rules around the market microstructure which should apply to mandatory trading (for example in relation to thresholds for pre-trade transparency expectations such as block trade thresholds and reporting delays). The Council recommends that similar powers be available in any mandatory regime established in Australia.

It is expected that foreign-based trading venues offering trading in OTC derivatives will invite Australian participants to trade through their facilities. In some cases these operators may have been registered or recognised as a new category of entity under foreign regulatory regimes. The Council considers that the existing framework for licensing and exempting markets in Part 7.2 of the Corporation Act can accommodate these foreign operators.

Footnotes

ASIC (2010), Clearing and Settlement Facilities: Australian and Overseas Operators, ASIC Regulatory Guide 211, April. Available at <http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/rg211.pdf/$file/rg211.pdf>. The Reserve Bank's approach is set out at <https://www.rba.gov.au/paymentssystem/clearing-settlement/standards/>. [1]

Council of Financial Regulators (2011), Review of Financial Market Infrastructure Regulation, October. Available at <http://www.treasury.gov.au/contentitem.asp?NavId=&ContentID=2201>. [2]