Today’s article is our third piece on OTC derivatives regulation in Australia. In today’s piece, we take a look at the new Treasury Laws Amendment (2016 Measures No. 1) Act 2017 (the Amendment Act), which was passed in to law in April of this year. This new law strengthens the regulatory regime for entities that trade over-the-counter (OTC) derivatives to retail clients.
By Dr. Drew Donnelly, Compliance Quarter.
The Amendment Act has a transition period of 12 months so that industry and regulators can getup to speed.
Background: lack of protection for retail clients
We have already mentioned the difference between the regulatory environment for financial products (such as derivatives), that are traded in financial markets, and those that are traded OTC (see OTC derivatives trading in Australia – are you playing by the rules?). Another important distinction is that between financial products marketed to wholesale clients and those marketed to retail clients.
Under the Corporations Act 2001 there are a range of tests for determining whether an entity counts as a ‘wholesale client’ or a ‘retail client’ (see primarily chapter seven, division 2 of that Act), but in general, wholesale clients tend to deal in expensive customer products, be large entities and/or sophisticated investors.
In most cases, those with Australian Financial Services licenses (licensees) have special obligations to protect the interests of retail clients. However, until the passage of the Amendment Act, there were no such rules in place with respect to the OTC derivatives of retail clients. One area of particular vulnerability for retail clients, were the old rules with respect to retail client money.
For most financial products, licensees were required to hold client money on trust, and could not use that money for their own purposes (for example, as working capital) or for the purposes of other clients. But there was no such restriction for licensees that wished to use money of retail clients of OTC derivatives.
This lack of restriction (which was out of step with overseas jurisdictions such as the US and UK), meant a significant risk for retail clients: If their money was used for some other purpose and the licensee went insolvent, the client would have had a hard time getting their money back
The client money reforms
The Amendment Act does two key things:
- First, it requires that, in general, licensees hold retail OTC derivative client money on trust. Note, there is an exception which has generally been overlooked by commentators to date. If the derivative is ‘cleared’ through an authorised clearing and settlement facility, then then old rules apply, rather than the ones in the new amendment Act (for further explanation of ‘clearing’ see our earlier piece at https://compliancequarter.com.au/otc-derivatives-trading-australia/).
- Second, it gives the Australian Securities & Investments Commission (ASIC) the power to issue client money reporting and reconciliation rules. This is intended to ensure that ASIC will have the power to monitor and enforce the new limitations on the use of client money. For example, it will allow ASIC to see whether client money has been used for a non-permitted purpose.
For further details, see the Amendment Act itself at http://parlinfo.aph.gov.au/parlInfo/download/legislation/bills/r5791_aspassed/toc_pdf/16206b01.pdf;fileType=application%2Fpdf.
See also, the explanatory memoranda prepared by Treasury at
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