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Monday, 2 May 2016
Page: 4026


Mrs GRIGGS (Solomon) (17:39): I rise to speak on the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016. At the 2009 Group of Twenty, or the G20 as it is better known, meeting at the Pittsburgh Summit, the Australian government joined other jurisdictions in committing to substantial reforms to practices in over-the-counter—or OTC—derivative markets. According to the Australian Securities and Investment Commission website, three of the key G20 commitments for OTC derivatives were:

reporting of all OTC derivatives transactions to trade repositories

clearing of all standardised OTC derivatives through central counterparties, and

execution of all standardised OTC derivatives on exchanges or electronic trading platforms, where appropriate.

The overarching objectives of the OTC derivatives reforms are to:

enhance the transparency of transaction information available to relevant authorities and the public

promote financial stability, and

support the detection and prevention of market abuse.

These commitments aim to bring transparency to these markets and improve risk management practices. These changes provide a framework for the regulation of OTC derivatives reporting, clearing and trade execution.

The legislation forms part of Australia's response to the 2009 G20 commitments, as I said. By way of background, 'derivative' is a security instrument whose price is dependent upon or derived from underlying assets such as stock, bonds, commodities, currencies, interest rates and market indexes. Derivative products have traditionally been traded through bilateral agreements between parties or over the counter, which is the OTC, and not through a central clearing exchange like a stock exchange or trading platform.

Leading up to the 2008 global financial crisis, there was a lack of transparency concerning the risk profile of participants and the value of their transactions. The Australian legislative framework to implement these reforms commenced in January 2013, when the new part 7.5A of the Corporations Act 2001 became effective. Under part 7.5A:

… the Minister has the power to prescribe certain classes of derivatives as being subject to an ASIC rule-making power in relation to mandatory reporting to a derivative trade repository, mandatory clearing by a central counterparty (CCP), or mandatory execution on a trading platform.

A decision by the minister prescribing a class of derivatives under the framework will be based on advice from the Council of Financial Regulators, or the CFR, which is comprised of ASIC, the Reserve Bank of Australia and the Australian Prudential Regulation Authority. ASIC has responsibility for implementing derivative transaction rules and derivative trade repository rules in Australia as part of Australia's G20 OTC derivative commitments.

In general, the reason for which a stock is traded over the counter is usually because the company is small, making it unable to meet exchange listing requirements. Also known as 'unlisted stock', these securities are traded by brokers or dealers, who negotiate directly with one another over computer networks or by phone. But small companies may not always remain small and the power of over-the-counter trading should never be underestimated. United States retail giant Walmart was founded in 1962 and began trading over-the-counter stocks. By 1969 Walmart was incorporated and in 1972, with stores in five American states, Walmart had earned over US$1 billion in sales—the fastest company to ever accomplish this—and was listed on the New York Stock Exchange.

Experts believe the role of over-the-counters in contributing to that 2008 global financial crisis was hidden because of the more high-profile real estate bubble which spectacularly burst in the United States and elsewhere. In 2010, on-line magazine Business Insider Australia stated:

Although media attention continues to focus on the political theme of economic recovery and residential real estate, the true cause of what came to be known as the credit crisis continues unabated, outside the purview of the central banks and governments.

Business Insider Australia's analysis of the wrecking-ball capacity of OTCs if not properly regulated paints a sobering picture. It said:

Derivatives on different underlying assets are traded in the absence of clearing houses, i.e., in unregulated markets. Since they are not exchange traded, derivatives, such as CDS, are not widely understood. In OTC markets, counterparty default risk generates a network of interdependencies among market actors and promotes risk volatility. The resulting emergent property of the financial system is systemic risk, which became apparent in 2008 when Lehman Brothers Holdings, Inc. failed.

Officially, roughly $604.6 trillion in OTC derivative contracts, more than 10 times world GDP ($57.53 trillion), hang over the financial world … but to the average investor the derivatives bubble is invisible. From the perspective of those outside the bubble, the explosion of OTC derivatives is a mania.

Business Insider Australia contends that the inherent lack of transparency in OTC markets impairs price discovery and undermines the contention that financial instruments are always priced correctly. It therefore follows that OTC derivatives and the risks associated with them may be priced incorrectly.

In response to a request by the Australian government to ascertain how its G20 commitments might best be implemented, the CFR developed an extensive report which concluded that the volumes and types of OTC derivatives transactions undertaken in Australia are small by global standards, comprising only two per cent of global notional turnover.

Further, as is the case in most countries, participants in the Australian-located OTC derivatives market undertake a large amount of cross-border activity. The CFR report states that financial institutions use a wide variety of derivatives in the Australian market, and some participants use simple single-currency interest rate derivatives to hedge interest rate risks. Others use a range of single and cross-currency derivatives, foreign exchange derivatives and credit derivatives to manage exposures. Corporates use derivatives covering single and cross-currency interest rates, FX and commodity derivatives.

In response to the G20 agreement and the GFC, many other industrialised countries, including the United Kingdom and other members of the European Union, have enacted similar legislation to clarify their securities laws to provide for rapid and non-formalistic enforcement procedures in order to safeguard financial stability and limit effects in case of a default of a party to certain financial markets contracts. In doing so, they both reduce possible risks for parties to certain contracts in respect of which margin is provided and remove impediments to the international competitiveness of their local financial institutions. For example, these reforms will reduce the risk that a secured party which had based its evaluations of its counterparty credit risk on the expectation that its exposures were appropriately secured actually loses priority to other parties on the counterparty's default.

This bill amends six existing pieces of legislation: the Payment Systems and Netting Act 1998, the Banking Act 1959, the Financial Sector (Business Transfer and Group Restructure) Act 1999, the Insurance Act 1973, the Life Insurance Act 1995, and, finally, the Private Health Insurance (Prudential Supervision) Act 2015. The bill will create a more resilient and stable financial system and allow our financial institutions to continue to be effective participants in international markets.

The bill delivers on the government's commitment in response to the Financial System Inquiry to 'clarify domestic regulation to support globally coordinated policy efforts and facilitate the ongoing participation of Australian entities in international capital markets'. The bill also delivers on Australia's commitment, as part of the G20, to address systemic risks associated with over-the-counter derivatives markets post the GFC. It complements a series of reforms already in place that make these markets more transparent and accountable. It also creates a regime which will allow financial institutions in Australia to meet international OTC derivative margining requirements, which are due to be phased in from 1 September 2016, and any corresponding prudential standards set by the Australian Prudential Regulation Authority or APRA. It also resolves other issues of concern to regulators and industry participants in Australian financial markets. For example, this bill strengthens the protection of certain payment systems, settlement systems, exchanges and central counterparties, in all market conditions.

It has been developed in careful consultation with APRA, the Reserve Bank, ASIC and industry stakeholders. Stakeholders have been broadly supportive of the reform, and recognise the considerable cost to business of maintaining the status quo.

The bill will allow Australia to maintain its position as a regional financial centre with a strong regulatory and legislative framework. Some of the reforms set out in the bill adopt similar concepts to those used, as I said, in other developed countries. It is really good to see that Labor are supporting this legislation. With that, I commend this bill to the House.