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Chapter 3
Views on the bill
3.1
This chapter
summarises submitters' views on the provisions of the bill and proposes
recommendations to ensure that stakeholders' concerns are adequately addressed.
There are three areas of concern:
-
the exercise
of delegated power by the Minister;
- the
safeguards to ensure the proper exercise of delegated authority; and
- arguments put
by the electricity sector that they should be exempted from the OTC regulatory
framework.
3.2
Submitters
generally approved of the objectives of the G20 OTC derivatives reforms.
d-cyphaTrade commended the introduction of legislation to implement the G20
reforms in the Australian market.[1]
The Australian Financial Markets Association (AFMA) submitted that industry
supports international regulatory coordination, and endorsed the passage of the
bill.[2]
While not supporting the proposed application of the OTC reforms to the
National Electricity Market (NEM), representatives of the electricity sector
acknowledged that the bill provides the framework for Australia to honour the
G20 commitment to improve the operation of the derivatives market.[3]
3.3
Submitters
did not challenge the proposed timeframe for the commencement of the
legislative reforms. Rather, it was acknowledged that the end of 2012
commencement date is necessary to ensure that Australia fulfils its G20
obligations.[4]
Further, AFMA submitted that the draft legislation is required to promote
parity between Australian markets and international markets and, therefore, a
level playing field for Australian-based businesses.[5]
3.4
However,
concerns were raised with aspects of the legislative framework proposed by the
bill.
Exercise of delegated
power
3.5
Submitters to
the inquiry recognised that, if passed, the proposed legislation would not
impose new requirements on Australia's financial markets. Rather, submitters
acknowledged that the bill would provide a mechanism by which additional
requirements may be imposed.[6]
However, views differed as to the appropriate exercise of delegated authority
by the responsible Minister and the Australian Securities and Investments
Commission (ASIC).
3.6
AFMA endorsed
the proposed framework under which the scope and content of the OTC derivatives
reforms would be determined under delegated legislation. Noting that
'Australian authorities have been responsive and understanding of the issues
facing industry', AFMA supported the delegation of power.[7]
It argued that the contemplated framework provides the necessary flexibility to
appropriately respond to changing market conditions:
The
framework provides an open competitive environment for market infrastructure
while giving the regulators the tools to manage systemic risk. The framework
recognises the need for a flexible regime that can cope with the rapid
evolution that is occurring around the globe that enables market participants
to adopt appropriate risk management and business decisions based on cost and
liquidity.[8]
3.7
However, AFMA
questioned whether the extent of the proposed delegation to ASIC is
appropriate. Arguing that the scope and content of regulatory obligations are
matters to be determined by Parliament or the responsible Minister, AFMA
submitted that ASIC's authority should be limited to the administrative and procedural
aspects of the regulatory regime. Accordingly, AFMA recommended that the bill
be amended to allow regulations to determine the broad parameters for
derivative transaction rules such as clearing requirements, reporting
requirements and execution requirements.[9]
3.8
The
Australian Bankers' Association (the ABA) recognised that 'flexibility in the
regulatory regime is necessary to allow Australia to accommodate ongoing
international developments'.[10]
However, the ABA also questioned the extent of the delegated authority,
submitting that 'the primary legislation should set out the scope of the
regime'.[11]
3.9
Treasury
explained that the framework is necessary to allow Australia's financial
markets to evolve in response to changes to the international market:
This
flexibility is necessary to ensure the regime can be implemented in a
proportional and targeted way in Australia, and can be readily adapted overseas
to regulatory developments so as to ensure a coordinated approach to regulation
of global OTC derivatives markets between Australia's financial regulators and
international counterparts.[12]
3.10
Treasury
reiterated the view that the adaptability and flexibility that subordinate
legislation provides is necessary to ensure that Australian businesses can
effectively compete in international markets:
Consistent
implementation by all major economies is important to reduce systemic risk and
the risk of regulatory arbitrage that could arise if there are significant gaps
in implementation. International cooperation and flexibility will also help to
avoid unintended consequences of national laws such as the burden on businesses
of duplicated or conflicting rules and the cost of reduced access to
international markets.[13]
Checks
and balances—industry consultation processes
3.11
Some
submitters questioned whether the bill contains appropriate safeguards to
ensure the proper exercise of delegated authority. Representatives of the
energy sector strongly questioned whether the bill would facilitate appropriate
industry consultation on regulatory requirements. The National Generators Forum
(NFG), notably, challenged the appropriateness of not specifying in the
legislation detailed consultation processes that would require the views of all
stakeholders to be properly canvassed.[14]
Origin submitted that the bill 'lacks appropriate checks and balances around
the Minister's and ASIC's discretionary decision-making powers'.[15]
It argued that the bill would 'leave open the very real possibility that
decisions impacting on the energy sector could be made without adequate
consultation with industry or energy market institutions'.[16]
It was put to the committee that the bill would not ensure that the responsible
Minister and ASIC would give due regard to the circumstances unique to the NEM.[17]
3.12
Representatives
of the energy sector argued that the absence of a requirement to consult
properly would create an uncertain market environment.[18]
The extent of concern is evident in ESAA's assertion that the sector would be
'facing the prospect that it could be brought within the scope of the mandatory
obligations on the Minister's whim at any time'.[19]
3.13
Accordingly,
representatives of the energy sector recommended that the bill be amended to require
industry consultation. The NFG recommended that scoping studies be undertaken
before determinations are made.[20]
Origin went further, calling for the bill to be amended to give joint authority
to the Minister for Resources and Energy for derivative decisions affecting the
NEM.[21]
3.14
More broadly,
several measures were recommended to expand the consultation requirements.
Norton Rose recommended that proposed section 901J be amended to require ASIC
to undertake public consultations prior to adopting OTC derivatives rules.[22]
The importance of consultation to gauge the regulatory and financial impact of
proposed regulations and rules was also noted, with the Finance and Treasury
Association (the FTA) and TRUenergy recommending that a cost benefit analysis
be undertaken prior to the enactment of new regulatory requirements.[23]
The FTA strongly advocated for industry consultation on the basis that
successful registry development and implementation 'must involve experts of the
industry and representative bodies rather than regulators operating in
isolation'.[24]
Similarly, the ABA submitted that the minister should be required to undertake
public consultation before prescribing classes of derivatives.[25]
3.15
Clearly, it
is important that the proposed consultation process entails appropriate
industry consultations. Treasury advised that the bill, and the Minister's and
ASIC's intended administration of the OTC derivatives framework, would provide
for proper consideration of market risks and stakeholders' views. The
committee's attention was drawn to Part 3 of the Legislative Instruments Act
2003,[26]
which requires all appropriate and reasonably practicable consultation to occur
prior to enacting regulations or rules that will affect business or restrict
competition.[27]
Treasury also advised that, as disallowable instruments, the regulations would
be subject to Parliamentary scrutiny. Further, as the bill requires regulatory
impact analysis to be undertaken, the financial impact of the proposed
regulations and rules will be assessed prior to their enactment.[28]
3.16
In response
to industry concerns, in evidence before the committee an undertaking was given
to ensure that the Minister for Resources and Energy is consulted regarding
decisions affecting the energy sector:
The Government
will further ensure that should any future decision be taken by the Minister
for Financial Services in relation to either the making of regulation, the
mandating of a derivative or the consent to an ASIC rule, this will require the
written approval of the Minister for Resources and Energy, where that decision
relates to the energy sector. [29]
Checks
and balances – confidentiality of registry data
3.17
Submitters
also questioned whether the bill would impose sufficiently robust processes to
ensure the confidentiality of data held on trade repositories. Origin argued
that the trade reporting requirements 'could expose the commercial decisions of
individual companies'.[30]
Similarly, International Power–GDF Suez Australia expressed 'serious concerns'
that the reporting requirements would result in the release of commercially
sensitive information and, thereby, undermine market competition.[31]
The FTA commented that licenses to operate trade repositories should not confer
on licensees property rights over trade data.[32]
Origin called for the bill to be amended to expressly require strict data
handling procedures.[33]
3.18
Proposed
section 904B would limit the disclosure of registry data. As noted in the
Explanatory Memorandum (EM) to the bill, the use and disclosure of information
would generally be permitted for the purpose of providing trade repositories
services.[34]
Accordingly, as stated in the EM, the bill would not absolutely prohibit the
commercialisation of trade data.[35]
However, as explained in the EM, it is anticipated that the regulations may
impose additional limits on the use and handling, including the disclosure, of
data.[36]
Further, as indicated in the note to proposed subsection 904B(5), unauthorised
disclosure would be an offence. Under section 1131 of the Corporations Act, the
offence would be subject to a maximum penalty of 1000 penalty units, or 5000 penalty
units in the case of a body corporate. The EM advises that this is a
'significant penalty'.[37]
Committee
view
3.19
The bill
implements the G20 commitment that responds to clear evidence that financial
markets were exposed to systemic risk at the international level by
inappropriate domestic regulation of OTC derivative transactions. The G20 view
is clear: international stability requires international coordination. The committee
is satisfied that the delegated legislative framework proposed is the
appropriate mechanism to ensure continued international coordination and
ultimately promote market security.
3.20
However, the
committee acknowledges industry concerns regarding the consultation process for
the development of subordinate regulations and rules. For regulatory
requirements to provide necessary safeguards, the requirements must actually
reflect the market. An accurate understanding of the market requires industry
analysis and consultation. The committee commends the government's commitment,
indicated in its evidence to the committee, to include industry in the
regulatory development process. To ensure stakeholders can effectively engage
with the process, Treasury and ASIC should publish guidance material that
outlines the consultation process and provides contact details for the relevant
officers. This material should be available by the commencement of the proposed
amendments to the Corporations Act 2001.
Recommendation
1
3.21
The committee
recommends that Treasury and the Australian Securities and Investments
Commission publish guidance material outlining the consultation process for the
development of OTC derivatives regulations and rules. The material should be
released by the commencement of the Corporations Legislation Amendment
(Derivative Transactions) Act.
3.22
Stakeholder
education is fundamental to ensuring the effective operation and administration
of regulatory requirements. The effectiveness of the new regulatory framework
will be dependent on industry understanding its new regulatory requirements.
Accordingly, the committee emphasises the need for ASIC to release a regulatory
guide detailing the new OTC derivative rules.
Recommendation
2
3.23
The committee
recommends that the Australian Securities and Investments Commission release a
regulatory guide explaining the derivative transactions and trade repository
rules.
3.24
Under section
243 of the Australian Securities and Investments Commission Act 2001 the
committee is authorised to inquire into, and to report to both Houses of
Parliament on, ASIC's activities. Accordingly, the committee regularly inquires
into ASIC's activities and related matters. The committee will monitor the
exercise of ASIC's delegated authority as part of the committee's ongoing ASIC
oversight process.
Recommendation
3
3.25
The committee
recommends that the Australia Securities and Investments Commission provide
regular updates on the development of OTC derivatives rules and the market's
response to the new regulatory requirements. Updates can be provided as part of
the committee's ongoing ASIC oversight process.
3.26
The committee
notes the concerns expressed by some stakeholders regarding the confidentiality
of data held on OTC derivative trade repositories. Unauthorised disclosure and
misuse of data would undermine the principles of commercial certainty and
security that the bill is seeking to uphold. On the basis of information
provided to the committee, it does not appear that express amendments to the
bill are warranted. However, the committee considers that it would be
appropriate for ASIC to develop guidance material on the use of data by
derivative trade repository licensees. Additionally, ASIC should closely
monitor the licensees use of data. The committee notes the advice in EM that
ASIC may revoke a derivative trade repository licence if ASIC has declared the individual
to be unfit.[38]
The committee is of the view that it would be appropriate for ongoing
monitoring of licensees' use of data to be taken into account when determining
whether a licensee continues to be fit to operate a trade repository.
Recommendation
4
3.27
The committee
recommends that ASIC issue guidance material on the confidentiality of data and
trade repositories, and the use to which data may be put. ASIC should closely
monitor the activities of derivative trade repository licensees regarding the
use and disclosure of repository data.
Exemptions from the OTC
G20 derivatives requirements
3.28
Both the
non-financial and the energy sectors put to the committee that the bill should
be amended to exempt their industry from the OTC derivatives regulatory
requirements. In both instances, it was argued that the rationale underpinning
the G20's recommendation and, therefore, the bill, is not applicable to its use
of derivative transactions. Similarly, the ABA also sought to limit the kinds
of derivatives that may be included within the OTC derivatives regulatory
framework, arguing that the policy intent underlying the legislation may be
achieved without all classes of derivatives being captured by the regulatory
framework.
Use
of OTC derivatives by non-financials (particularly corporations)
3.29
The FTA
submitted that derivative transactions undertaken by non-financials,
particularly corporations, should be excluded from the new OTC derivatives
framework. It argued that as OTC derivatives by non-financials are 'a tiny part
of the derivative market here and abroad', the industry does not present a
systemic risk to market stability. Accordingly, it claimed that additional
regulatory safeguards are not required.[39]
Classes
of derivatives other than AUD interest-rate swaps
3.30
The ABA
submitted that classes of derivatives, outside AUD interest-rate swaps, should
be exempt from the proposed OTC derivatives regulatory regime. The ABA
identified that the Council of Financial Regulators did not highlight any risks
posed by classes of derivatives outside AUD interest-rate swaps. Accordingly,
the ABA argued that the intent of ensuring market stability and transparency
would be achieved were the OTC derivative rules to be limited to AUD
interest-rate swaps.[40]
Arguments
to exempt the electricity derivatives market from the bill
3.31
Representatives
of the electricity sector strongly opposed the application of the new OTC
derivatives regulatory requirements to participants in the NEM. They gave the
following arguments.
3.32
First, it was
claimed that the electricity market does not pose a systemic risk to market
stability. The NGF highlighted that electricity derivatives 'were not
identified as a concern warranting regulation through the Australian
government's commitment to the G20'. Further, it noted that the consultation
process did not raise concerns with the stability and integrity of the
electricity derivatives market.[41]
3.33
Second, it
was argued that the NEM is a sophisticated market that operates well within
existing regulatory safeguards. International Power GDF SUEZ stated that 'the
sector has developed and applied sophisticated risk management practices to
manage financial risk'.[42]
The NGF claimed that there is recognition among Australia's regulators that
existing arrangements 'are working'. It cited the view of the Australian Energy
Market Commission which found that the financial relationships and markets that
underpin the efficient operation of the NEM generally robust, and there is
likely to be a low probability of financial contagion occurring in NEM.[43]
3.34
Third, it was
argued that standardisation of the electricity OTC derivatives market would
reduce the capacity for contracts to be tailored to minimise risk. ESAA
commented that 'any attempt to standardise the electricity derivatives market
would result in electricity market participants losing the ability to enter
into bespoke contracts to manage the risk'.[44]
3.35
Fourth, the committee
heard that Australia's energy market is different to that in most other G20
countries. ESAA argued that for an energy-only market, it is 'particularly
important that prices are allowed to rise and fall with as little constraint as
possible'. It noted that without occasional very high prices, there are not the
signals for new investment and the possibility for generators to recover their
long-term costs. ESAA surmised that in many other markets around the world, the
impact of restrictions on the electricity derivatives market 'would not be on
anywhere near the same scale as here in Australia'. Accordingly, it put to the
committee that there 'is a case...to exempt the energy sector which would be a
'very defensible position for Australia to put to its G20 colleagues'.[45]
3.36
Fifth, it was
argued that if the energy sector is subject to OTC derivative regulations,
there would be a negative impact on competition in the NEM. The NGF claimed
that when a new entrant enters the retail market, it may be able to get the
support of a generator to cover the new entrant and leave the volume and the
profile fairly flexible to encourage that new entrant.[46]
It claimed that if this is not possible, it is less likely that there will be new
entrants into the market, thereby affecting competition.[47]
3.37
Sixth, the
energy sector argued that OTC derivative regulations would increase its costs
and the costs for consumers. In terms of the costs to the industry, NGF
identified the cost of increasing compliance complexity and collateral costs to
the extent that good risk management decisions are impaired.[48]
The NGF also told the committee of its concern that, in addition to the current
and future upward cost pressures facing the industry, regulations may 'flow
through to an additional price increase on top of that'.[49]
The
nature of the electricity sector's concern with the bill
3.38
The committee
asked the NGF the precise nature of its concerns given that the proposed
legislation only establishes a framework for regulation, as opposed to actually
applying any regulations. It responded:
The
nature of the legislation provides the power to the minister to direct ASIC to
inquire into the need for regulation of a particular type of derivative and see
that as a fairly quick response to result in ASIC concluding that there may be
a need for regulation of that particular derivative and see at this stage that
legislation being drafted is far broader than the policy it was intended to
achieve. So we would like to see that this legislation has minimal effective
regulation for the policy principles it is seeking to achieve, without any
concern having been raised around electricity derivatives specifically. It
would not seem appropriate that legislation covering electricity derivatives
would be introduced and passed by parliament.[50]
3.39
The same
question was put to ESAA. It gave the following response:
...we are
subject to a whole range of inquiries at the moment, some of which may lead to
further regulations being imposed on the industry and our experience has often
been that many such inquiries and many such subsequent regulations have been
carried out possibly in response to political issues, rather than sound
underlying policy drivers, and that from time to time they have been carried
out with limited or insufficient consultation. So we are perhaps predisposed to
be very wary of even the possibility of additional regulation on the sector. I
would also observe that the matter could be equally well considered in reverse,
and that if the government has no plans to regulate the sector there would seem
to be little harm to be done by exempting the sector.[51]
Support for including
the electricity sector in the legislation
3.40
Not all
submitters shared the view that the bill should expressly exempt the
electricity sector. d-cyphaTrade argued that, as an essential service, it is
necessary for the electricity derivatives market to come within the broader G20
OTC derivatives regulatory framework.[52]
d-cyphaTrade did not share the view that the market is currently subject to
adequate safeguards. It strongly argued that 'regulations are needed to prevent
systemic default risk because the multimillion dollar OTC electricity
derivatives market is dominated by non-bank, non-regulated OTC issuers'.[53]
3.41
It is clear
in evidence before the committee that, as at the time of this report, the
government does not intend to prescribe the electricity sector as a class of derivatives
to which the new OTC derivatives framework would apply. Treasury advised that
'the government has no plans to make rules relating to the energy sector.' However,
it is further evident that the government does not support amending the Bill to
exempt the electricity sector. Treasury noted that '[n]o particular derivative
market has been written out of the regime that will be supported by the
proposed amendments'. Treasury noted in its submission that while the
Government has no plans to make rules relating to the energy sector, it is
important that electricity derivatives be included in the legislative
framework:
Applying
the legislative framework to all derivatives (including electricity
derivatives) ensures that the ongoing market assessment being conducted by the
financial regulators is on clear legislative footing.[54]
3.42
Treasury
submitted that amending the bill to expressly exclude the energy sector from
the OTC derivatives regulatory framework would not be best practice, and would
restrict regulatory capacity to respond to changing market conditions:
The bill
establishes the legislative underpinnings of what will be an ongoing process.
Over time reassessments may occur in response to changing regulatory or
marketing environment. The appropriateness of any regulatory approach that has
been adopted may be reassessed and adjusted accordingly. The bill seeks to set
up a regime that does not merely reflect industry practice or regulatory arrangements
at one point in time.
Although
the electricity derivative market, based on information currently available, is
traded largely between electricity generation, transmission and retailing
entities, this may change in the future...It will therefore be important to have
the capacity to better understand and respond to any changes in the market for
electricity derivatives.[55]
Current inquiries into
the electricity sector
3.43
The committee
draws attention to several current inquiries into the electricity sector. The Senate
Select Committee on Electricity Prices is due to report in November this year. In
addition:
There are three processes currently underway that will
further the understanding of the Australian OTC derivatives energy market.
The AEMC has been asked to provide
advice to the Standing Council on Energy and Resources (SCER) on the resilience
of the financial relationships and markets that underpin the operation of the
National Electricity Market (NEM). The AEMC expects to consider OTC electricity
derivatives markets as part of this assessment in the first half of 2013.
The AEMC released an issues
paper on 8 June 2012. While the AEMC states that their initial view is that
financial relationships in the NEM are generally robust, there may be risks to
system security created through the financial interdependencies between market
participants.
APRA, ASIC and the RBA initiated a
targeted survey of derivatives markets participants on 6 July 2012, as part of
a market assessment of Australia’s derivative markets. This survey is expected
to provide for increased understanding of the bilateral risk management
practices and exposures of derivatives markets participants. This survey
extends to electricity derivative markets.
On 4 May 2012 ASIC commenced
consultation on revised financial requirements for market participants in
wholesale electricity markets dealing in OTC derivatives, to ensure that they
make adequate provision for expected expenses and carry sufficient financial
resources to mitigate against operational risk that could lead to unexpected
losses or expenses.
It is expected that each of these market assessments will be
completed by the end of the first half of 2013 and together they should provide
for a greater understanding of the bilateral risk management practices and
exposures in the OTC electricity derivatives markets.[56]
3.44
The committee
believes that it is important for these inquiries to reach their conclusions.
These findings will be important to understand the exact nature of the
pressures facing the energy sector, and in particular its cost structure, competitive
tension, prudential needs and risk profile.
Committee view
3.45
The makes the
following four observations about the electricity sector's claims to be
exempted from the bill.
3.46
The first relates
to the issue of extraterritoriality. Treasury has noted that the electricity
market should be included in bill given the strong likelihood of international
regulations applying to electricity derivatives. These regulations would have
extraterritorial effect and require a further domestic legislative response.[57]
The committee finds this argument convincing and does not support the NGF's
position that if Australia is party to an international commitment to regulate
electricity derivatives, this should be done through separate legislation.[58]
3.47
Second, the committee
emphasises the point made by d-cypha that the electricity market is a central
and essential service and as such, electricity derivatives should properly fall
within the broader G20 OTC derivatives regulatory framework. It is appropriate
that the electricity sector is subject to the provisions of the legislation.
3.48
Thirdly, the
committee has confidence in the process established in the bill to delegate
power to the Minister and ASIC. It agrees with AFMA's assessment that
Australian authorities have been responsive and understanding of the issues
facing industry. Further, the committee believes that in any future
consideration of whether OTC derivative regulations should apply to the
electricity market, there will be a careful assessment of the possible impact
on the industry.
3.49
Finally, the
committee notes the comments of ESAA that it would be 'useful' for the legislation
to reference the integrated nature of the physical and derivatives market in
the case of electricity. ESAA argued that one way to do this would be to specifically
include the Energy Minister as chair of the Standing Council of Energy and
Resources in the decision-making process.[59]
The committee agrees that this approach would be prudent and recommends
accordingly.
Recommendation
5
3.50
The committee
recommends that for matters relating to the energy sector, the Minister for
Resources and Energy be consulted prior to the making of regulations, the
mandating of derivatives or the consent to an ASIC rule.
Recommendation
6
3.51
The committee
recommends that the bill be passed.
Ms
Deborah O'Neill
Chair
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