Keynote Address: ISDA Annual Australia Conference
A speech by Cathie Armour, Commissioner, Australian Securities and Investments Commission at the ISDA Annual Australia Conference, (Sydney, Australia), 23 October 2018
Thank you, Scott (O’Malia, CEO ISDA) for the introduction and for ISDA inviting me to speak today.
Let me begin by acknowledging the Traditional Owners’ ongoing connection to and custodianship of the lands on which we meet today, and to pay my respects to elders both past and present.
It is a great opportunity to give you an update on recent Australian derivatives market developments, and to provide you some ASIC perspectives on global market developments.
Wholesale market conduct
ASIC is focusing more deeply on the conduct of market participants in wholesale financial markets, including OTC derivatives markets. We have been enhancing our focus on these financial markets. I will outline several particular streams of work, but we have generally found that industry’s attention to wholesale market conduct issues has been lacking. We often see a lower level of maturity and intensity of control frameworks for wholesale markets than we find in exchange-traded markets. This is a focus for us, and we expect industry to ensure its control frameworks reflect the significant conduct risks that can arise in wholesale markets.
As a first example, since I spoke to you at last year’s conference, three major banks were found to have attempted to engage in unconscionable conduct in relation to the setting of our key interest rate benchmark, BBSW. These banks also entered into court enforceable undertakings with ASIC in relation to their bank bill trading businesses. In May, the Federal Court found that Westpac traded to affect the BBSW and engaged in unconscionable conduct. This is the culmination of many years investigation by ASIC into the conduct of Australian institutions here and overseas, as well as foreign financial institutions that are active in Australia. We have also, with other members of the Council of Financial Regulators, driven reform to the regulatory settings for benchmarks in Australia, and I will talk about that later.
ASIC is a strong supporter of the Global FX Code, of which RBA Deputy Governor Guy Debelle, who you will hear from shortly, was absolutely instrumental in putting into place. FX market conduct is an area that ASIC is increasing its focus on, and the Global FX Code is an essential starting point for firms to follow to improve their practices.
One area we have looked at recently is the practice in FX markets of ‘last look’, in which a liquidity provider has the ability to decide over a fraction of a second whether to accept or reject a trade request from a client. While ‘last look’ may help facilitate a liquidity provider’s legitimate risk management, it also introduces the potential to exploit confidential client trading intentions and to otherwise treat clients unfairly. We are also concerned around the quality of client disclosure about the practice, with many clients unaware of the practice. We have recently undertaken a review to better understand ‘last look’,and will publish our observations and findings in due course. We also intend to conduct surveillance on liquidity providers to check their disclosure and internal processes and procedures.
Another priority for ASIC on FX will occur as part of our enhanced use of on-site surveillance and inspections. ASIC has recently given notice to a number of financial institutions of our intention to undertake on-site reviews with a focus on the control frameworks in place for the FX business. This is the first round of sets of on-site reviews that will seek to improve compliance standards in wholesale markets.
ASIC is also joining on-site examinations being undertaken on Australian financial institutions by the United States National Futures Association, or NFA. A number of large Australian financial institutions are registered as swap dealers with the CFTC and are NFA members. These institutions are required to comply with NFA Rules and CFTC Regulations. We appreciate the NFA inviting us to participate in these reviews, and they will help us to develop our own program of on-site reviews.
Following on from these conduct concerns, 2018 has seen significant reforms to Australian and global benchmarks.
In July, ASIC established a comprehensive regulatory regime for financial benchmarks, following the passage of enabling legislation through the Parliament. This was a significant step in ensuring continued market confidence in Australian financial benchmarks. It ensures that these critical benchmarks will be subject to international standards of oversight, including by making manipulation of any financial benchmark, or products used to determine such a benchmark, a specific offence and subject to civil and criminal penalties.
In May, a new BBSW methodology took effect, which calculates the benchmark directly from market transactions during a longer rate-set window and involves a larger number of participants. We expected market participants to put in place procedures so that as much trading as possible happens during the rate-set window, given this is the most liquid period in the bank bills market.
We have been pleased that since May, on average 88% of bank bill transaction volume has been executed within the rate set window. This has meant that BBSW can be formed using VWAP 93% of the time in 6-month tenor, and 78% of the time in 3-month tenor. This has helped ensure the market’s trust in the robustness and reliability of BBSW. However, it should be said that the frequency of VWAP formation in other BBSW tenors has been less, and so market participants should carefully consider whether derivatives and other transactions referencing BBSW is being benchmarked against the most liquid tenors.
I’d also like to recognise the significant amount of work the Reserve Bank has done in ensuring BBSW remains robust, and I’m sure Guy will provide his perspectives on this during the conference.
I’d like to turn to the global upheaval of benchmarks. The statements by FCA Chief Executive Andrew Bailey that firms must end their reliance on LIBOR by the end of 2021 have been clear and unequivocal. Market Participants should be under no misconceptions that LIBOR will continue to exist after this. While ASIC is confident that the work done to ensure the resilience of BBSW will ensure BBSW remains a key benchmark in the years ahead, Australian market participants have significant reliance on LIBOR and should be planning for a post-LIBOR world.
We welcome the work done by ISDA in launching a market-wide consultation on technical issues related to new benchmark fallbacks for derivatives contracts that reference the IBORs, and we look forward to learning the results of this consultation. It is vital that Australian market participant begin preparing for the end of LIBOR, and ensure their voices are heard in the development of alternative risk-free rates.
G20 OTC Derivative Reforms
Let’s turn now to Australia’s implementation of the G20 OTC derivative reforms. We have just passed the fifth anniversary of the implementation of the trade reporting requirement in Australia, and we added a central clearing mandate in 2016. We continue our work to ensure the reforms achieve their intended goal of reducing the risks posed by OTC derivatives markets.
Mandatory OTC derivative trade reporting has significantly improved the ability of ASIC to identify conduct and risk issues in these markets. ASIC is in a somewhat unique position globally given our equities market surveillance responsibilities, and our sophisticated MAI - Market Analysis Intelligence – System. Trade repository data is being fed into the MAI system, and we have recently enhanced our analytical capacity through the development of our own MarketsData Analytics Hub. This allows for advanced aggregation and analysis of the data.
We have recently made some important changes to increase the use of Legal Entity Identifiers, or LEIs in Australia. From April next year, exemptive relief will end which will result in a wider range of OTC derivatives transaction needing to be reported using LEIs. The LEI has been an established standard for five years now, run by a global non-profit foundation and mandated by major jurisdictions such as the EU and US. Last year at this conference I said ASIC was keen to see greater use of LEIs for OTC derivative trade reporting to ASIC. There are now over 1.2 million LEIs issued, and 11,000 issued in Australia. Australian market participants have had plenty of time to obtain an LEI, and so now is the time to end the exemptive relief and require all reports to trade repositories to be made using an LEI.
Mandatory clearing of certain interest rate derivatives has been in effect since early 2016, and Australia dollar interest rate derivatives are now subject to a clearing mandate in Australia, the EU and the US. With the increased use of clearing as a result of the mandate and other regulatory incentives, regulators, including ASIC and the Australian Council of Financial Regulators, have enhanced our focus on the potential systemic risk that CCPs can place on the financial system. Work to implement a resolution regime for financial market infrastructure will continue to be a focus for us.
The final 2009 G20 commitment was to ensure that all standardised OTC derivative contracts are traded on exchanges or electronic trading platforms, where appropriate. A decision to mandate platform trading would be designed to address market transparency and integrity concerns as it can improve pre-trade and post-trade transparency and facilitate market supervision. Globally, platform trading obligations have been implemented in the United States from 2014, Japan from 2015, and the European Union from 2018. Other jurisdictions such as Hong Kong, Singapore and Canada are also actively considering the implementation of a platform trading mandate.
In 2015, ASIC, APRA and the RBA outlined how we will assess the case for introducing a platform trading mandate. We identified our key considerations, being the level of standardisation of a product’s contractual terms and operational processes, and a product’s liquidity. We are now reassessing whether any products meet this criteria and would be appropriate for a platform trading mandate in Australia. ASIC will begin meetings in the coming months with stakeholders and publish its findings in due course.
Reflection on global market developments
Global market and regulatory developments have a significant impact on the Australian derivatives market. I’d like to talk about some recent regulatory developments that will impact on global markets, including the Asia-Pacific region. It is important that regulators of major financial markets in the Asia-Pacific work together to ensure we support the interests of APAC markets, market participants, and regulators as major global regulatory initiatives approach. ASIC engages closely with our regulatory peers in Asia to ensure we respond quickly and collectively to regulatory issues that impact our region.
In the European Union, a significant amount of work went into the commencement of MiFID 2 at the start of the year. ASIC remained closely engaged with Australian market participants and EU authorities to ensure there were no disruptions to markets in Australia. The EU is now turning to revising EMIR, including changes to the oversight of EU and third country CCPs. We, along with our CCP supervisory colleagues at the RBA, are carefully following this piece of legislation to ensure Australian CCPs can continue to provide services to EU clients, and Australian market participants can continue to clear with EU CCPs.
Meanwhile, Brexit looms large. I can probably add very little given the uncertainty around the political outcome, however the Australian regulators are alive to risks from Brexit. We are in regular dialogue with EU and UK authorities to ensure disruption is minimised next March.
Finally, I read with interest the cross-border white paper released earlier this month by CFTC Chairman Chris Giancarlo. Five years ago, I spoke at this conference and provided some thoughts on the cross-border implementation of OTC derivatives reforms. I don’t think much has really changed since then. I noted at that time that “[d]eveloping appropriate regulation that achieves equivalence or substituted compliance will have the effect of putting Australian participants and markets under the Australian regulatory framework, rather than needing to comply with the requirements in foreign jurisdictions.” And that “[t]his will allow the Australian regulators to most appropriately tailor the regime to the needs of the Australian market.”
The SEF regime had only been in place for two weeks when I spoke. At the time I noted the risk that “Australian participants may not be able to access all market liquidity at the point where these markets split into a SEF and a so-called ‘non-SEF’.” Well of course, this is exactly what has eventuated. To the extent that Chairman Giancarlo proposes to take necessary steps to end the current division of global swaps markets into separate U.S. person and non-U.S. person marketplaces, we support that.
Of course, Chairman Giancarlo’s white paper is just the start of a process. The Chairman has indicated he will direct CFTC Staff to propose a new rule to deal with a range of cross-border issues, and then will seek bipartisan consideration and adoption. We appreciate the Chairman Giancarlo’s goal of improving the CFTC’s cross-border rules, and we look forward to engaging with the CFTC as they develop and consider their proposed rules.
Thank you again to Scott, Eric (Litvack, ISDA Chairman) and the team for inviting me to speak today, and we look forward to continuing to work with industry to help Australian financial markets thrive.