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Monday, 29 October 2012
Page: 12286


Mr HOCKEY (North Sydney) (18:27): The Corporations Legislation Amendment (Derivative Transactions) Bill 2012 has been brought before the House to provide a legislative framework to meet Australia's G20 obligations in relation to over-the-counter derivatives reforms. The bill amends five existing pieces of legislation: the Australian Prudential Regulation Authority Act 1998; the Australian Securities and Investments Commission Act 2001, which I introduced; the Corporations Act 2001, which I introduced; the Mutual Assistance in Business Regulation Act 1992; and the Reserve Bank Act 1959, which was introduced by the coalition.

As background to this legislation, I want to briefly run through the different types of markets in derivative products. Derivatives are financial contracts whose value is linked to the price of an underlying asset or financial transaction, or to the occurrence or magnitude of an event based on an underlying asset or financial transaction. These financial products are known as derivatives, for the very simple reason that the price of the contract is derived from the price of something else. Derivatives are traded in two kinds of markets: formalised markets and over-the-counter markets. Derivatives traded on exchanges are homogenous products with specified clearing and settlement arrangements and, usually, high trading volumes. In fact, back in my days when I was at university I used to trade the SPI contract, the share price index contract, which was a derivative. In Australia, exchange traded derivative products, such as future contracts on bank bills or Commonwealth securities, are traded on the Australian Securities Exchange.

Most derivative exchanges have adopted electronic trading platforms that automatically match bids and offers from market participants to execute trades. Volumes and prices are transparent. Over-the-counter markets have different mechanisms for trading, settling and clearing transactions in derivative products. They are used for less standardised or bespoke instruments.

Over-the-counter markets are organised along several different lines. The first is what is called a traditional dealer market, where quotes and negotiation of execution prices are generally conducted over the telephone. The second is an electronically brokered market, which automatically matches bids and offers to execute trades. The third is a proprietary trading platform market, where derivative dealers set up their own electronic trading platform. These markets are much less transparent than exchange traded markets in the sense that trading volumes and prices are not readily available outside of the dealing parties. These markets also tend not to use centralised clearing and settlement arrangements.

Rapid growth in over-the-counter derivatives markets over the past decade and longer has been accompanied by an increased awareness of the systemic importance of these markets and of potential risks inherent in market practices. One of the problems is the difficulty in assessing the size of the outstanding exposures in these markets and who is holding the risk. These risks were most starkly demonstrated during the financial crisis when regulators could not quickly assess the size and distribution of the outstanding positions on a range of derivative products linked to US sourced mortgage backed securities. As a result, authorities have been developing a global regulatory agenda to improve the functioning of OTC derivatives markets.

The G20 leaders summit held in September 2009 resolved to address the risks involved in the OTC market. The following extract from the communique outlined the improvements to be made:

All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the Financial Stability Board and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.

As my colleagues here would well be aware, the three key G20 commitments this legislation seeks to focus on are: (1) the reporting of all OTC derivatives to trade repositories, (2) the clearing of all standardised OTC derivatives through central counterparties and (3) the execution of all standardised OTC derivatives on exchanges or electronic trading platforms where appropriate.

This bill implements the following framework. Firstly, the responsible minister will be empowered to prescribe a certain class of derivatives as warranting more formalised arrangements for trading, reporting or clearing. Secondly, a derivatives transaction rule may in turn be issued by ASIC to establish one or more mandatory obligations for reporting, clearing or execution for participants transacting. Thirdly, any rule must receive the consent of the minister before taking effect. The scope of the rules and other technical features of the scheme may be further limited by regulation. Finally, a new licensing regime will be introduced for a new kind of financial infrastructure entity—that is, trade repositories.

I note that the member for Moncrieff is here in the chamber. He is one of the few people in this chamber that would have any understanding of how the OTC derivatives markets work. As someone with a deep—and, some would suggest, liquid—understanding of the OTC derivatives market, I am sure he welcomes greater transparency and greater accountability in this process.

The establishment of the trade framework will not in itself introduce any trade reporting, central clearing or trade execution obligations for the transactions. Rather, the framework creates a mechanism by which such obligations may be implemented by the relevant regulatory authorities and the minister with supporting regulations and rules. So the rationale behind these changes is that reporting of trades will increase transparency to OTC derivatives markets and will improve risk management practices and that it will provide regulators and market participants with access to valuable data with which to assess the risks associated with the OTC market. It is further argued that the clearing of standardised OTC derivatives will reduce counterparty risk associated with the transactions.

Submissions to Treasury's inquiry into the framework for this bill show that it was generally well received by the banking sector. Major banks, including ANZ Global Markets, CBA Markets, Macquarie Bank, NAB and Westpac said:

In general, we are broadly supportive of the approach taken in the Consultation Paper and believe the course proposed will assist in meeting the G20 commitments. We have in subsequent pages provided responses to the questions asked. In approaching these questions the key themes remain ensuring the Australian framework is as consistent as possible with other international regulatory regimes, that requirements on the Australian market should not disadvantage or dislocate a functioning market.

Amen, I say: amen. The threat is that regulation or overregulation is going to sap the liquidity of the market, and electricity and energy providers have expressed some concerns. This was the primary focus of the coalition for the Parliamentary Joint Committee on Corporations and Financial Services inquiry into this bill. Overall, coalition members of the committee inquiry were pleased that the majority report recognised that the electricity sector has a range of legitimate concerns in relation to the new regime. The Australian Energy Regulator offered in response:

The inclusion of electricity derivatives under the scheme would be a contentious issue, with the potential for both significant costs and benefits. The potential benefits include enhanced market transparency and a reduction in counterparty risk; for example, this may reduce the risk of a catastrophic event such as a cascading generator-retailer failure. Conversely, the inclusion of electricity derivatives under the scheme may impose compliance costs.

The AER has not yet reached a definitive view on the merits of this issue, but wishes to note its significance.

The National Generators Forum argued against regulating the market. It pointed to flexibility in current market practice that helps OTC derivatives to officially manage risk in the electricity industry. I understand that. It also observed that contracts in the energy OTC derivatives market differ between regions and are not speculative but are used predominantly as a risk management tool, which is the case with many derivatives—they are actually used as a risk management tool. In this environment, the NGF argued, the electricity OTC derivatives market does not have the economies of scale necessary to recoup costs of central clearing and trade execution. I would suggest it is not a particularly liquid market. The NGF argued that there was no reason to support the prescribing of trade reporting, central clearing or trade execution of electricity derivatives.

TRUenergy was also wary of the proposals, arguing:

We believe that policy makers should apply a detailed cost benefit analysis before enacting any of these changes to the OTC electricity trading market. The implementation of this policy framework, without demonstrated net benefits, would represent a poor policy outcome.

Whilst recognising these concerns, the coalition recognises that this new regime will increase transparency of OTC derivative markets and improve risk management practices. We are pleased that government members of the PJC inquiry into this bill recognised the real concerns of the electricity sector and adopted at least part of the Electricity Supply Association of Australia's proposed approach, which recommended a requirement that, for matters related to the energy sector, the Minister for Resources and Energy be consulted prior to the making of regulations, the mandating of derivatives or consenting to an ASIC rule. In this parliament, we are asked to trust the judgement there of the member for Batman, which I am quite prepared to do in his case, and obviously that would influence the Minister for Financial Services and Superannuation, who does need guidance on these sorts of issues—no doubt about it.

Today we have learned that the government will be moving an amendment to the bill before the House which seeks to address the concerns raised by the coalition, which were highlighted in the PJC inquiry. It will come as no surprise to you, Mr Deputy Speaker Lyons, that the coalition has offered a sensible amendment. Common sense prevails from time to time—just from time to time with this government—and on this occasion it has, and I say amen. This amendment seek to put in place measures which are a step towards ensuring that all the issues of the energy sector will be properly considered prior to the imposition of new obligations in relation to quantity based derivatives.

The coalition will support the bill and the government's amendment. The bill is a step forward in meeting our G20 obligations regarding the transparency of over-the-counter derivative markets. In our view, the bill does not impose onerous regulation and it should not lead to a massive amount of further regulation—and, if the government is not vigilant, we will be. Rather, the bill grants powers to the respective regulatory bodies to examine over-the-counter markets and to recommend actions to the minister to increase the transparency of market mechanisms should they deem that to be necessary to enhance the integrity and safety of the markets, in particular, and of the financial system more broadly. However, I issue this warning to ASIC and indeed to anyone else who might be involved. You cannot use this as a Trojan Horse for a vast amount of new regulation.

It is one of my enduring political regrets that, when I introduced the Financial Services Reform Act, I was not there to oversee the implementation of the vast amount of regulation, which was excessive and prescriptive, coming out of ASIC, in particular, at the time. I warn that we will be vigilant in relation to this area so that there is not the temptation for regulators and public servants, for ministers and parliamentary secretaries, to regulate away the liquidity of an important market. I do not want to see that. The coalition does not want to see that.

A market is a market. It should be transparent. It should also be liquid. The rule of law must prevail but we should not be in a position where we are constantly pushing against overregulation of markets to such an extent that effectively the lack of liquidity makes the market unattractive, and therefore what is a very important market, the OTC derivatives market, is of such an illiquid nature that people are tempted to carry out transactions overseas in a different jurisdiction, where there is the light hand of regulation but still a reasonable level of transparency and accountability in the marketplace. So please—it starts as a plea to ASIC, APRA and all other regulators that are involved—do not regulate away these important markets with overly prescriptive rules and regulations.