Monday, 2 May 2016
Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016; Second Reading
Mr Deputy Speaker, thank you for this opportunity to outline Labor's position on the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill. In a week that will be dominated by some fairly willing and high-profile debates on economic policy, the very technical changes in this bill are unlikely to attract the same attention, but that does not mean that they are not very important for the stability of our financial system. Though we may find much to disagree on in this place and beyond in the next week over the budget and indeed over the next 61 days, I think it is important to mark that, when it comes to this bill and when it comes to financial resilience and living up to our international obligations, both sides of the House do agree in this instance.
The bill makes changes to the regulation of over-the-counter derivatives that come out of international agreements made after the global financial crisis. Clearly the GFC made us rethink a whole host of regulatory measures in our financial system. The legislation being discussed today relating to OTC derivatives is one such example.
Labor has always played a productive role in supporting the development and improvement of Australia's financial regulation. The floating of the dollar, the sale of the Commonwealth Bank, deregulating the banking system, ending centralised wage fixing and the beginnings of Reserve Bank independence: all were key features of the legacy of the Hawke and Keating governments. Of course the last Labor government took decisive action to keep Australia on the path of growth during the last financial crisis. It is extraordinary that we have had a quarter century of uninterrupted economic growth in this country when you consider that within that period there was the sharpest synchronised downturn in the global economy since the Great Depression in the 1930s. This is something we should all be proud of.
Our decisive action during the global financial crisis included being instrumental in the development and elevation of the G20, which was key to the international response to the crisis. I did get to work on some of these issues in a former role here. I think the part played by Australia is, as I said, something that all Australians should be proud of. Certainly both sides of the parliament, the business community and every Australian have cause to be proud of what Australians achieved together during the global financial crisis, including the role that we played in the big international forums and principally the G20. We are pleased now to be supporting this bill, which comes out of one of those international agreements—in this case, the one on margining requirements for derivatives. It was part of a process kicked off by the G20.
The effect of this bill will be to improve the stability of the financial system and to bring Australia's derivative-trading sector into line with internationally agreed standards. It is expected that these measures will ease the financial burden of compliance with international standards by $3.9 million annually.
This bill implements the agreement between the Basel Committee on Banking Supervision and the board of the International Organization of Securities Commissions on margin requirements, which are being phased in internationally from 1 September this year. The agreement came out of several major pieces of work by the G20. It goes back to about 2009. With input from the then Treasurer, the member for Lilley, the G20 committed to improving transparency, mitigating system risk and protecting against market abuse in derivatives markets. By 2011, it was recognised that not all derivatives are suitable for central clearing, so the G20 called for uniform margin requirements for OTC derivatives. Australia has already indicated its support for this international agreement, and that is a good thing. In November 2015 our own Council of Financial Regulators announced its intention to implement the Basel-IOSCO framework for margining and in February this year APRA released its proposed margining requirements, which will become effective by 1 September 2016 and be phased in over several years.
Participants in non-cleared derivatives markets have traditionally transferred margin, otherwise described as collateral or credit support, by way of absolute transfer rather than by way of security. The new requirements will likely mean most participants transfer margin by way of security instead.
APRA's margin requirements will only apply to institutions with significant activity in OTC derivatives, where the institution or the group it is a part of has average month-end notional outstanding OTC derivatives of greater than A$3 billion. The Council of Financial Regulators has indicated it will consider the approach for non-APRA regulated institutions this year. Several other developed countries, including the UK and EU members, have enacted similar legislation to clarify their own securities laws.
Labor supports measures to improve the stability of the financial system, noting the negative impact that unsecured derivative contracts had on the deepening of the global financial crisis. That is why we support this bill and why we support responsible steps to bring our derivative-trading sector into line with internationally agreed standards.
It is pleasing to speak this afternoon on the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016. Why is this bill needed? From September 2016, regulators in many key jurisdictions will phase in margining requirements for trading in over-the-counter derivatives. Without legislative change, entities subject to Australian law might not be able to fully comply with margin requirements that are imposed upon them or their counterparties by domestic or foreign regulation. This could significantly restrict the ability of Australian entities to participate in certain financial markets or to trade with particular counterparties. The bill creates a facilitative regime that will allow financial institutions in Australia to meet margining requirements and deliver on the government's commitment, set out in its 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 resolves a number of inconsistencies in Australian law to provide legal certainty about the operation of termination rights, often referred to as close out rights, under certain financial market transactions and of real time gross settlement payment systems, approved netting contracts and netting markets in all market conditions.
Specifically, the bill will do three things. First, it will:
enable entities subject to Australian law to give, and enforce rights in respect of, margin provided by way of security in connection with certain financial market transactions in a manner consistent with international requirements —
and therefore let them meet international margin requirements due to be introduced from September this year. Second, it will:
clarify domestic legislation to support globally coordinated policy efforts and provide certainty about the operation of Australian law in relation to the exercise of termination rights (also known as close out rights) under certain financial market transactions.
And, third, it will:
enhance financial system stability by ensuring legal certainty for the operation of approved Real Time Gross Settlement … systems, approved netting arrangements and netting markets (more specifically, market netting contracts) in all market conditions.
The bill amends six pieces of existing legislation—namely, the Payment Systems and Netting Act 1998, the Banking Act 1959, the Financial System (Business Transfer and Group Restructure) Act 1999, the Insurance Act 1973, the Life Insurance Act 1995 and the Private Health Insurance (Prudential Supervision) Act 2015.
Although this legislation is important and is in reaction to the GFC, we must make sure that in the international response to the GFC—where we are trying to get, or governments around the world are putting in additional legislation to try to create, greater stability—we do not tell the legislative pendulum too far on the side of stability. Business transactions involve risk. We do not know what the future holds. Things are uncertain. We need entities taking risks and experimenting with new ideas if we are going to get the innovation to continue to drive our prosperity. So we must be very careful that we do not implement too many of these regulations that tie people's hands in red tape and deter some of that risk taking.
The member for Rankin said that Australians should be very proud about our response to the GFC. Anyone who thinks that Australia was saved from recession because the previous government spent money installing pink batts in people's roofs and then pulling them out, building overpriced school halls or wasting billions on failed border protection simply needs to wake up.
What saved Australia from the GFC was the demand and the buying from China, but we are still paying the penalty for that Labor government's reckless spending. That spending during the GFC ran up a debt; all those pink batts, all those school halls they paid two and three times the price they should have, and those failed border protection policies they tried to fix—all of this was done with billions of dollars of borrowed money. When we borrow money, we have an ongoing obligation to pay the interest until such time as we pay it back. Someone who earns $80,000, which I think is around average male full-time earnings, this year will pay $628 in tax on the interest that has been run up on all those things. The supposed response to the GFC of putting the country deep in debt has a cost, and that cost for the person on $80,000 is $628 in interest this year. And guess what? That goes on, year after year after year after year, until we eventually get the budget balanced. We have the long, hard haul to pay that borrowed money back.
The irresponsible response to the GFC, the reckless and wasteful spending of the previous Labor government, is costing this country now and it will cost this country for decades to come. They were the mistakes that we made in the past. All governments have to learn from those mistakes made with that reckless and wasteful spending. This is one of the small steps that we are taking so that another financial crisis has less chance of happening in the future. With that, I commend this bill to the House.
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:
The overarching objectives of the OTC derivatives reforms are to:
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.
I would like to thank those members who have contributed to this debate on the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016, in particular the member for Solomon. Following the global financial crisis, the GFC, G20 leaders agreed to 'implement sweeping reforms to reduce the risk that financial excesses will again destabilise the global economy'. Imposing margin requirements for non-centrally cleared derivatives is central to this agenda. Margin requirements are the next significant wave of regulatory reform in over-the-counter derivatives markets. They are designed to reduce the kind of contagion and spillover effects seen in the GFC by ensuring that collateral is available to offset losses caused by the default of a derivatives counterparty.
This bill allows financial institutions operating in Australia to meet international margin requirements for trade in over-the-counter derivatives, which are due to be phased in from September 2016. It removes impediments in current Australian law which may otherwise prevent our institutions from transacting with international counterparties. This bill will also resolve an inconsistency in Australian law which arose in 2008 by clarifying the way in which certain rights—particularly early termination rights, or 'close-out rights'—may be exercised by counterparties against an Australian regulated financial entity when it becomes subject to resolution measures such as authorised deposit-taking institution statutory management or judicial management. This amendment will clarify domestic legislation to support globally coordinated policy efforts and provide certainty about its operation. This bill proposes an approach which is broadly consistent with international best practice, as set out in the Financial Stability Board's Key attributes of effective resolution regimes for financial institutions and International Swaps and Derivatives Association Inc.'s ISDA 2015 Universal Resolution Stay Protocol. Finally, this bill also enhances the stability of the financial system by providing legal certainty for the operation of approved real-time gross settlement systems, approved netting arrangements and netting markets—more specifically, market netting contracts—in all market conditions. These systems, arrangements and markets are vital to the smooth functioning of the Australian financial system.
The bill is the product of careful and rigorous consultation with the Council of Financial Regulators—the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and the Australian Treasury—and a range of market participants, industry associations, and professional advisers. The submissions received during the consultation process broadly supported the reforms set out in this bill. I commend the bill to the House.
Question agreed to.
Bill read a second time.