EXPLANATORY STATEMENT

Select Legislative Instrument 2007 No. 364

Issued by the authority of the Minister for Superannuation and Corporate Law

Corporations Act 2001

Corporations Amendment Regulations 2007 (No. 14)

Subsection 1364(1) of the Corporations Act 2001 (the Act) provides that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed by regulations or necessary or convenient to be prescribed by such regulations for carrying out or giving effect to the Act.

Section 1368, among other things, provides that the regulations may, subject to any prescribed terms and conditions, provide that specified provisions of Chapter 7 (which relates to financial services and markets) do not have effect in relation to a specified class of transactions entered into by a specified person.

The purpose of the Regulations is to make a technical amendment to the Corporations Regulations 2001 (the Principal Regulations) in order to correct an unintended consequence arising from amendments made in 2002.

The Corporations Amendment Regulations 2002 (No. 7) specified CLS Bank International (CLS), based in the United States of America, and certain transactions undertaken by CLS, for the purposes of Chapter 7 of the Act. However, other amendments made by Corporations Amendment Regulations 2002 (No. 5) have subsequently been found to have an unintended consequence in relation to CLS.

These Regulations restore the original intention of the Principal Regulations; especially, that CLS is exempt from the operation of Part 7.3 of the Act in respect of its settlement of non-cash payment obligations between parties that are participants of its settlement system and arise from foreign exchange derivative contracts.

Further details of these Regulations are outlined in the Attachment.

CLS is a multi-currency bank, holding an account for each participant and an account at each eligible currency’s Central Bank, through which funds are received and paid. CLS provides a continuous linked settlement service that simultaneously settles payments on both sides of a foreign exchange transaction - for example, A and B may have agreed to exchange A$50 million for US$25 million. The service eliminates the risk that can occur when each leg of a foreign exchange transaction is settled separately - that is, one payment could be made and the corresponding payment not received.

CLS commenced operations in September 2002 across seven eligible currencies, which included the Australian dollar, with the support of 66 of the world’s largest financial groups as its shareholders. CLS now supports transactions in 15 eligible currencies and has 71 shareholders from across the US, Europe and the Asia Pacific who collectively account for more than half the value transferred in the world’s foreign exchange market. On 13 November 2007, CLS reported that it had settled a daily record of more than 1 million payment instructions with a gross value of US$6.5 trillion.

CLS is regulated by the United States Federal Reserve System, in consultation with a number of international central banks, including the Reserve Bank of Australia. At a December 2007, CLS currently settles payment instructions in the following currencies: Australian Dollar, Canadian Dollar, Danish Krone, Euro, Hong Kong Dollar, Japanese Yen, Korean Won, New Zealand Dollar, Norwegian Krone, Singapore Dollar, South African Rand, Swedish Krona, Swiss Franc, UK Pound Sterling and US Dollar.

Under the Corporations Agreement 2002 (the Agreement), the State and Territory Governments referred their constitutional powers with respect to corporations regulation to the Commonwealth. The Agreement requires the Commonwealth to consult with and, unless an exemption exists, receive approval from the Ministerial Council for Corporations before making amendments to certain provisions of the Corporations Regulations.

The responsible Ministers of the States and the Territories were consulted about the proposed Regulations. Responses were received from three States, all of which supported the proposed amendments.

The Regulations are a legislative instrument for the purposes of the Legislative Instruments Act 2003.  The Regulations commenced on the day after they were registered on the Federal Register of Legislative Instruments.

Attachment

The purpose of regulation 9.12.02, inserted by Corporations Amendment Regulations 2002 (No. 7), was to exempt specified operations of CLS from the provisions of the Act that regulate clearing and settlement facilities on the basis that regulation under these provisions was inappropriate.  Such regulation was considered inappropriate because the proposed operations of CLS that were exempted are in the nature of a payment system, rather than a clearing and settlement facility.  An example of a typical clearing and settlement facility is a facility that assists in the transfer of cash and securities to settle securities transactions entered into on a stock exchange.

Subregulation 9.12.02(1) exempted certain operations of CLS from:

•                 Part 7.3 of the Act which requires that clearing and settlement facilities be licensed; and

•                 section 794E of the Act, which empowers ASIC to give directions to a clearing and settlement facility which provides services to a licensed market where there is disorderly trading.

Specifically, CLS was exempted from the requirement to obtain a clearing and settlement facility licence in relation to its settlement of non-cash payments between participants flowing from certain transactions in financial products mentioned in paragraphs 764A(1)(a), (b), (ba), (c), and (j) of the Act.

An intention of regulation 9.12.02 was to exempt CLS from Part 7.3 obligations in relation to, inter alia, settlement of non-cash payments arising from foreign exchange contracts that were foreign exchange ‘derivatives’ (paragraph 764A(1)(c) financial products).

The foreign exchange derivatives exemption relied on the definition of a foreign exchange derivative in Corporations subregulation 7.1.04(1)(b) which, prior to 14 June 2002, was a foreign exchange contract which was settled in a period not less than two days. At the time, CLS considered that it would only be facilitating payments in relation to foreign exchange derivatives with settlement terms of two or more days, and therefore, the then proposed Part 7.3 exemption was thought adequate.

However, Corporations Amendment Regulations 2002 (No. 5), which became effective on 14 June 2002, amended the definition of a foreign exchange derivative under the Act to be a foreign contract which was settled in a period not less than three days, rather than two days.

Consequently, CLS’s exemption in relation to foreign exchange derivatives has been largely ineffective since inception, with many of the underlying foreign exchange derivative transactions having a settlement period of two days rather than three days.  That is, many of the foreign exchange transactions underlying CLS payment settlements are not derivatives for the purposes of Part 7.3 of the Act. Accordingly, they are not covered by the exemption established under Corporations Amendment Regulations 2002 (No. 7).

In this situation, there may have been legal uncertainty as to whether CLS operates a clearing and settlement facility in relation to its settlement of non-cash payments arising from transactions in foreign exchange contracts that are not derivatives as defined by paragraph 7.1.04(1)(b) of the Principal Regulations. In such circumstances, and in the event of a failure of a participant of CLS to meet its obligations, affected parties might have sought to establish in litigation that CLS should, inter alia, have been licensed as an Australian clearing and settlement facility licensee, which is not a view shared by CLS or the Commonwealth.

These Regulations restore CLS’s intended regulatory exemption from the operation of Part 7.3 of the Act by amending paragraph 9.12.02(1)(b) to include financial products mentioned in paragraph 764A(1)(k) of the Act.

This means that payment settlements by CLS in relation to all foreign exchange contracts are now exempt from the operation of Part 7.3 of the Act, either through the exemption for paragraph 764(1)(c) derivatives (those with settlement after three or more days) or the exemption for paragraph 764A(1)(k) foreign exchange contracts.

In making these Regulations, the Commonwealth, comprising The Treasury, the Australian Securities and Investments Commission and the Reserve Bank of Australia, consulted extensively with CLS’s solicitors by corresponding over a period of six months as to defining the issue, possible solutions and the form of proposed regulations. No bodies, other than CLS and its participants, who are subject to and agree to CLS’s rules, are affected by these Regulations.

In accordance with its obligations under paragraph 9.12.02(5)(c) of the Principal Regulations, CLS also advised that, subject to receiving all necessary regulatory approvals, including from its principal regulator, the Board of Governors of the Federal Reserve System of the United States of America, it will add to the existing scope of its operations. The new operations will include the settlement of non-cash payments obligations in relation to non deliverable forward foreign exchange transactions, foreign exchange option transactions and credit derivative transactions (‘new financial products’). In contrast to CLS’s existing payments service, the resulting payments will be one-way payments, rather than simultaneous two-way payments.

Each of the ‘new financial products’ will either be foreign exchange contracts within the meaning of paragraph 764A(1)(k) of the Act, or derivatives within the meaning of section 761D of the Act and Corporations regulation 7.1.04.

Regulations were also made in 2002 to declare CLS's system for the settlement of payment instructions arising from foreign exchange transactions to be a netting market for the purposes of Part 5 of the Payment Systems and Netting Act 1998. Further regulations made under Payment Systems and Netting Act 1998 extend CLS’s declaration as a netting market to also include its settlement of payment instructions arising from derivative transactions.