The Power of Organization: An Australian OTC derivative class where good practice prevails

Risk management and proper practice has prevailed in one specific OTC derivatives asset class in Australia – the trading of wholesale electricity

Australia is well recognized among OTC derivatives firms worldwide as being a highly efficient jurisdiction in which to do business, a reputation which has gained it acclaim among many of the large FX companies who have gained an international client base from their respective Antipodean operations.

Whilst Australia’s FX industry is viewed as one of the most reputable in the world, its regulatory authority, ASIC, has uncovered a few risk management shortcomings and the occasional malpractice when handling client funds.

Whilst last year’s relatively few enforcements compared to FX firms in other jurisdictions served to reinforce Australia’s high quality business environment, it is more remarkable when considering ASIC’s nationwide practice of engaging in real time surveillance of all firms’ compliance-related activities via the use of several multi-faceted systems including First Derivatives’ Delta Stream, and the newly implemented Market Analasys and Intelligence algorithm-based system.

Bearing these factors in mind, as well as Australia’s commodity-orientated financial market structure, the country has become a nation which trades a wide variety of OTC derivatives aside from purely currency.

Wholesale electricity is one particular example, and regarding which ASIC has today published a report on the risk management policies which are employed by market participants pertaining to that specific OTC asset class.

Quite remarkably, considering ASIC’s highly automated monitoring systems, the report found that absolutely no areas of significant risk were identified whatosever, and risk management policies appeared to be appropriate to the nature, size and complexity of the financial services business being conducted.

The report also found that risk management practices varied among AFS licensees, but was well within the parameters laid out by ASIC’s regulatory procedure. 

ASIC Commissioner Greg Tanzer stated that “This is a good news story for this market sector. It indicates that, based on the written policies and documents that we were provided with, these AFS licensees generally comply with their legal obligation to have adequate risk management systems.”

Another outcome of the review was the development of the Benchmark Electricity Risk Management Calculator, or ‘BERC’. The BERC is a self-assessment tool that may be used by an AFS licensee to measure their risk management policies and practices against their peers. ASIC is providing the BERC for information and educational purposes only.

Mr Tanzer said, “Use of the BERC is entirely at the option of the licensee. We understand the close connection between the physical and financial services electricity markets and the risks that arise as a result. While we do not regulate the physical market, we hope our providing the BERC for our stakeholders’ voluntary use will bring some transparency to how the market we regulate manages their risk and be beneficial to the physical market also.”

The review was undertaken as part of ASIC’s regulation of AFS licensees who trade in these financial products. It is independent of the work of the Council of Financial Regulators in implementing Australia’s commitment to the G20 reforms to OTC derivatives markets.

Large-sized market participants, and market participants with a higher level of OTC derivatives activity, appear to understand that they can adopt a more sophisticated risk management system, including having additional measures and monitoring arrangements.

In addition to the practices mentioned in the report itself, ASIC details that the market’s views are that it is useful for the risk management policies of large-sized market participants to include some form of scenario testing in addition to stress testing (to monitor positions); arrangements to annually review credit limits (to determine if credit limits may create large exposures to one or more counterparties) and for management to review usage against credit limits. It was also gleaned that reviewing enhanced or additional practices identified by the BERC model should be employed to determine whether they are appropriate for their business.

With absolutely no remedial action required across the board, does the first class practice of Australia’s OTC electricity derivatives market participants serve to pave the way forward for the nation’s esteemed FX firms?

For the full report, including percentages of market participants which adhere to specific risk management practices by category, click here.

For more on the global Forex industry see the LeapRate-Dow Jones Forex Industry Report.

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