Financial Stability Board (FSB), Implementing OTC Derivatives Market Reforms (Financial Stability Board, 25 October 2010) (available at www.financialstabilityboard.org/wp-content/uploads/r_101025.pdf), iii.

BCBS-IOSCO Margin Requirements, 3.

Key Principle 5 of the BCBS-IOSCO Margin Requirements provides that: 'Because the exchange of initial margin on a net basis may be insufficient to protect two market participants with large gross derivatives exposures to each other in the case of one firm's failure, the gross initial margin between such firms should be exchanged. Initial margin collected should be held in such a way as to ensure that (i) the margin collected is immediately available to the collecting party in the event of the counterparty's default, and (ii) the collected margin must be subject to arrangements that protect the posting party to the extent possible under applicable law in the event that the collecting party enters bankruptcy. Jurisdictions are encouraged to review the relevant local laws to ensure that collateral can be sufficiently protected in the event of bankruptcy'.

BCBS-IOSCO Margin Requirements, 5 (Key Principles 3 and 4).

For example, market participants may use the ISDA English law Credit Support Annex.

See e.g. the Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements ('EU Financial Collateral Directive') and the Financial Collateral Arrangements ( No 2 ) Regulations 2003 (as amended by the Financial Markets and Insolvency ( Settlement Finality and Financial Collateral Arrangements )( Amendment ) Regulations 2010 ) ('Financial Collateral Arrangements Regulations').

See e.g. Articles 6 and 7 of the EU Financial Collateral Directive and Regulation 12 of the UK Financial Collateral Arrangements Regulations.

The legislative protections provided to financial market documentation such as the 1992 and 2002 ISDA Master Agreement, Global Master Securities Lending Agreement and Global Master Repurchase Agreement and any associated credit support arrangement which operate by way of absolute transfer (e.g. the English law governed Credit Support Annex published by ISDA in 1995) as close-out netting contracts are vitally important in allowing market participants to effectively manage their risks. Since the PSN Act was introduced in 1998, the legislative definition of 'close-out netting contract' has proved to be an adaptable definition that has remained relevant and helpful to market participants despite the evolution of financial markets which has occurred since this time.

Please also refer to the discussion in other parts of this paper in respect of the restrictions on granting security imposed on the trustees of Superannuation Funds and life companies.

For example, subsection 13A(3) and section 16 of the Banking Act and section 86 of the Reserve Bank Act 1959 .

Section 11F of the Banking Act.

Subsection 116(3) of the Insurance Act. Section 116A of the Insurance Act deals with assets and liabilities in Australia.

Section 440B of the Corporations Act. A restriction on the exercise of third party property rights even applies in respect of possessory security interests. The exemption available in respect of possessory security interests (section 440JA) may not be applicable in all possible circumstances regarding dealings in OTC derivatives.

Sections 442B, 442C, 442CA of the Corporations Act.

For example, certain claims mandatorily preferred at law (e.g. employee entitlements) may take priority over certain secured parties' rights. Partial priority regimes are also set out in various sections of the Corporations Act, including section 433 (property subject to circulating security interest - payment of certain debts to have priority), section 443E (Right of indemnity has priority over other debts). The PPSA also sets out a priority regime which applies in respect of security interests (see e.g. Part 2.6 of the PPSA).

For example, section 267 or 267A of the PPSA and section 588FL of the Corporations Act.

See, for example, section 443F of the Corporations Act (lien to secure indemnity). To secure a right of indemnity granted to an administrator under section 443D, the administrator has a lien on the company's property, subject to the priority regime set out in subsection 443F(2).

Financial Stability Board, 'Key Attributes of Effective Resolution Regimes for Financial Institutions' (15 October 2014), paragraphs 4.1 to 4.3.

Reference is also made to article 71(1) of Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014, which provides that, 'Member States shall ensure that resolution authorities have the power to suspend the termination rights of any party to a contract with an institution under resolution from the publication of the notice pursuant to Article 83(4) until midnight in the Member State of the resolution authority of the institution under resolution at the end of the business day following that publication, provided that the payment and delivery obligations and the provision of collateral continue to be performed'.

The effect of the Zero Hour Rule, if it applies, is to provide that when an event is specified to have occurred on a particular day then that event takes place at the earliest point in time after midnight on the commencement of that day. The alternative to this rule is that the event occurs at the moment in the day that it actually took place. For example, if a court orders the winding up of a company at 3:30 pm on a particular day, there is doubt about whether the winding-up commences immediately after midnight on the day that the order is deemed by the Corporations Act to take place (as would be the case if the Zero Hour Rule applies); or whether the winding-up commences at the time the time the order is made (i.e. 3:30 pm) - see re Red Robin Milk Bar Limited [1968] NZLR 28 at 29 per McGregor J; re Seaford ( deceased ) Seaford v Seifert [1967] 2 All ER 458, and on appeal at [1969] 1 All ER 482 at 486; John Serafino ex parte : Classic Manufacturing Pty Limited , No P1358 of 1988 (unreported); Bankruptcy Act 1966 section 57A; re Pollard ; ex parte Pollard [1903] 2 KB 41.

For example, the following payment systems, each operated by Australian Payments Clearing Association Limited (APCA) have been approved as approved netting arrangements: Australian Paper Clearing System (APCS), Bulk Electronic Clearing System (BECS), Consumer Electronic Clearing System (CECS), High-value Clearing System (HVCS) and Issuers and Acquirers Community Framework (IAC). Austraclear (in Fallback mode) and ASX Settlement have also been approved under section 12.

Committee on Payments and Market Infrastructures (CPMI) and IOSCO, Recovery of financial market infrastructures (October 2014), 1 and 14.

Please refer to paragraphs 1.57 and 1.244 for further detail regarding approved RTGS arrangements.

Please refer to paragraphs 1.62 and 1.244 for further detail regarding approved netting arrangements.

In this comparison table, the references to a party being able to close-out transactions under a contract or arrangement, when used in respect of the PSN Act, mean that obligations may be terminated, termination values may be calculated and a net amount may become payable in accordance with the contract or arrangement.

Paragraph (b) of the definition provides that a close-out netting contract also means 'a contract declared by the regulations to be a close out netting contract for the purposes of the' PSN Act. This is subject to certain exclusions in paragraphs (c) to (e) of the definition.

This technical issue has arisen in English cases such as National Westminster Bank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785 and Re Charge Card Services Ltd [1987] 1 Ch 150. It should be noted that the position has now be resolved in England by BCCI ( No 8 ) ( Morris v Agrichemicals ) [1996] Ch 245, in which it was stated, albeit in obiter, that "charge-backs", as they are known, are not conceptually impossible. Despite a trend in Australia towards this position, there has not been any clear resolution of this issue in Australian case law.

Section 26 of the PPSA provides for the conditions which must be satisfied in order for a person to have control of an intermediated security that is credited to or recorded in a securities account. Also, it is noted that section 57(1) provides that a security interest in collateral that is currently perfected by control has priority over a security interest in the same collateral that is currently perfected by another means.

For example, section 11F and subsection 13A(3) of the Banking Act and subsection 116(3) of the Insurance Act.

The reference to "to the extent that those rights relate to the interests in that property or the rights to payment or delivery of that property" (as used in the Bill) is intended to ensure that the person's rights in the account which are related to "non-financial property" assets should not constitute "financial property" merely because of the intermediation through an account. However, the mere fact that interests in assets which are not "financial property" are debited and credited to an account does not mean that the entire account does not constitute "financial property".

For example, sections 555 and 556 of the Corporations Act set out a priority regime which would otherwise apply on the insolvency of a grantor of security under a close out netting contract which is a company registered, or taken to be registered, under the Corporations Act. Similarly, Part 2.6 of the PPSA (and other provisions of the PPSA) sets out a priority regime which could result in a secured party losing priority.

Financial Collateral Arrangements Regulations, explanatory note.

It is understood that there are no circumstances in which section 267A of the PPSA or section 588FL of the Corporations Act could ever apply before subsection 14(2) of the PSN Act could operate, in respect of any person (individual or body corporate).

The Bill also includes several new definitions (including definitions of 'APRA', 'Business Transfer Act', 'derivative', 'direction stay provision'). [ Schedule 1 , Part 1 , item 1 , section 5 ]

One such market structure in which there may be uncertainty as to the application of the existing legal definition of control is tri-party custodian arrangements in which the grantor retains certain rights, including the right to receive and withdraw income from secured financial property such as shares and the right to withdraw excess financial property.

In this regard, reference is made to the Financial Markets Law Committee paper entitled Issue 1 : Collateral Directive - Analysis of uncertainty regarding the meaning of ' possession or ... control' and ' excess financial collateral' under the Financial Collateral Arrangements ( No . 2 ) Regulations 2003 , dated December 2012.

It is anticipated that a secured party may be a controller which is not a receiver, receiver and manager or managing controller for the purposes of the Corporations Act.

See Explanatory Memorandum to the Payment Systems and Netting Bill 1998, paragraph 73 of the notes to clauses.

Under section 5 of the PSN Act, 'a person goes into external administration if:

(a)

they become a body corporate that is an externally administered body corporate within the meaning of the Corporations Act; or

(b)

they become an individual who is an insolvent under administration; or

(c)

someone takes control of the person's property for the benefit of the person's creditors because the person is, or is likely to become, insolvent.'

Under insolvency law, liquidators may 'claw-back' payments made to particular creditors in certain circumstances. For example, sections 588FE and 588FF of the Corporations Act.

For example, section 13A of the Banking Act empowers APRA to appoint a statutory manager to an ADI if:

1)

the ADI informs APRA that the ADI considers that it is likely to become unable to meet its obligations or that it is about to suspend payment; or

2)

APRA considers that, in the absence of external support:

(i)

the ADI may become unable to meet its obligations; or

(ii)

the ADI may suspend payment; or

(iii)

it is likely that the ADI will be unable to carry on banking business in Australia consistently with the interests of its depositors; or

(iv)

it is likely that the ADI will be unable to carry on banking business in Australia consistently with the stability of the financial system in Australia; or

3)

the ADI becomes unable to meet its obligations or suspends payment.

It is noted that the protections under the PSN Act provided in respect of approved RTGS systems, approved netting arrangements and market netting contracts have effect despite any other law (including the specified provisions and the specified stay provisions), such that a party to such a contract or arrangement may close-out for the matters described in the specified stay provisions.

The reference to a 'non-direction stay' is used interchangeably with the term 'a specified stay provision (other than direction stay provision)' and, generally, means the provisions of the Industry Acts which restrict the close-out of transactions on the grounds of the appointment of a statutory manager or judicial manager, the taking of actions to facilitate recapitalisation and events related to compulsory transfers of business.

As discussed in the Glossary, a Resolution Event, in this explanatory memorandum, is any of the following occurrences: the appointment of a statutory manager or judicial manager, the statutory manager or judicial manager taking action to facilitate recapitalisation or certain events occurring in relation to a compulsory transfer of business. I.e. the events contemplated in the non-direction stay stays.

These types of provisions of an Industry Act are also referred to in the PSN Act as a non-direction stays (see, for example, the heading to section 15A of the PSN Act).

E.g. I-Annex 5 - Temporary stay on early termination rights of the FSB Key Attributes, which provides that a temporary stay of the exercise of early termination rights should be subject to a number of conditions, including that the 'stay be strictly limited in time (for example, for a period not exceeding two business days)'.

See, for example, section 70C of The Bank Recovery and Resolution Order 2014 (UK).

For example, section 70C of the Banking Act provides that the Treasurer (with the Finance Minister's approval) may authorise the making of contracts or arrangements for the purpose of protecting the interests of depositors of ADI's and protecting financial system stability in Australia up to $20 billion. Similar authorisations are present in the Insurance Act (section 131A) and the Life Insurance Act (section 251A).

FSB, Key Attributes (15 October 2014), I-Annex 5 - Temporary stay on early termination rights.

A standard master agreement (together with each transaction entered into under that master agreement) is considered a single close-out netting contract.

As noted in the Objectives section of the Explanatory Memorandum to the Payment Systems and Netting Bill 1998.

See the Status quo section of the Explanatory Memorandum to the Payment Systems and Netting Bill 1998.

See paragraph 59 of the Explanatory Memorandum to the Payment Systems and Netting Bill 1998.

CPMI and IOSCO, Recovery of financial market infrastructures (October 2014), page 1.

CPMI and IOSCO, Recovery of financial market infrastructures (October 2014), section 3.3.5.

In finance, a derivative is a contract that derives its value from the performance of an item (such as commodities, currencies or securities) in the underlying market. Derivatives can be used in a range of ways, including hedging (insuring against price movements), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets. Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Derivatives are one of the three main categories of financial instruments, the other two being stocks (i.e. equities or shares) and debt (i.e. bonds and mortgages).

Australian Prudential Regulation Authority (APRA), 'Discussion Paper - Margining and risk mitigation for non-centrally cleared derivatives', 25 February 2016, http://www.apra.gov.au/CrossIndustry/Documents/160225-CPS-226-discussion-paper-FINAL.pdf

Central clearing of OTC derivatives is a process whereby the derivatives (but only standardised contracts) are still negotiated between two counterparties bilaterally, but they are then novated or otherwise cleared through a central counterparty (also known as a clearing house). The trade is booked to the clearing house which, generally, becomes the counterparty to the all trades.

Australian Prudential Regulation Authority (APRA), http://www.apra.gov.au/MediaReleases/Pages/16_08.aspx

Report on the Australian OTC Derivatives Market, July 2013, available at http://www.cfr.gov.au/publications/cfr-publications/2013/report-on-the-australian-otc-derivatives-market-july/index.html.

Report on the Australian OTC Derivatives Market, April 2014, available on the same website of the Council of Financial Regulators (CFR).

Report on the Australian OTC Derivatives Market, November 2015, available at http://www.cfr.gov.au/publications/cfr-publications/2015/report-on-the-australian-otc-derivatives-market-november/pdf/report.pdf.

For example, by the five big banks in Australia being registered as swap dealers in the US.

The equivalence or not of regulatory requirements in foreign jurisdictions is determined by the local regulator through a formal assessment. Where equivalent obligations are identified relief from local requirements is then granted to foreign entities subject to those requirements in the overseas jurisdiction.

In general terms, initial margin is provided on entering into a transaction to cover potential future exposures in respect of the transaction.

The Financial System Inquiry Final Report, Box 4, page 20-21, http://fsi.gov.au/publications/final-report/executive-summary/

Improving Australia's financial system - Government response to the Financial System Inquiry, available at http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/Publications/2015/Government%20response%20to%20the%20Financial%20System%20Inquiry/Downloads/PDF/Government_response_to_FSI_2015.ashx.

https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/FinancialServices/investmentmanagement/2014_otc-derivatives_deloitte_ireland.pdf

This includes variation and initial margin placed, capital charges on the margin placed, reporting and foreign compliance costs, and additional costs due to limited/hampered access to global capital markets.

Available at http://www.cfr.gov.au/publications/cfr-publications/2015/report-on-the-australian-otc-derivatives-market-november/pdf/report.pdf.