malcolm edey : the challenge of central clearing in otc derivatives markets1 address by mr malcolm edey, assistant governor ( financial system ) of the reserve bank of australia, to the isda annual australia conference, sydney, 20 october 2011. * * * good morning, and thank you to isda for the opportunity to speak here today. this conference is taking place at an interesting and challenging time for the global financial system. obviously a good deal of attention right now is focused on europe, particularly on the problem of sovereign debt sustainability and its interaction with the condition of the european banking system. this is a source of significant uncertainty for the rest of the world. policymakers are working hard to find solutions that will rebuild confidence, but the situation is still fluid and it remains an area that will need to be closely watched. in australia meanwhile the financial system is continuing to perform relatively well. the broad outlines of that story are, i think, well known. during the gfc australia avoided a recession and a banking crisis. our banks are profitable and well capitalised, and their overall asset quality remains good. we can ’ t of course expect the australian system to be entirely immune from the unfolding events in europe, but a couple of points are worth emphasising. the first is that the australian banks have only limited direct exposures to sovereign debt in the countries that are most at risk. so potential effects on australian banks ’ overall asset quality are not an issue. the second point is that, since the height of the gfc, the australian banks have done a lot to strengthen their funding positions. they have increased their use of domestic deposits as a funding source, lengthened the average term of their wholesale funding, and correspondingly reduced their reliance on short - term wholesale debt. these things will help to make them more resilient to the uncertainties that are now affecting international credit markets. as important as these current challenges are, financial regulators around the world have been focusing not just on those, but also on longer - term regulatory reforms. the reform effort is proceeding on a number of fronts, aimed at building more robust financial systems for the longer term and thereby reducing the risk of future crises. many of these efforts are being coordinated internationally through the g20 process, through the financial stability board, and through standard - setting bodies like the basel committee. in all of these bodies australia is actively represented. in broad terms, the various reforms draw on the lessons that emerged from the gfc,

needs. settlement risk the gfxc has also focused on settlement risk. the most recent triennial survey of global fx market activity by the bis, suggested that the value of trades not being settled on a paymentversus - payment ( pvp ) basis remained significant and may have actually been increasing as a share of total trades. the risks associated with fx settlement are potentially very significant and more work is being done to understand and monitor how these risks are being managed. the next bis triennial survey in 2022 will contain more questions on settlement methods and many central banks – 3 / 4 bis central bankers'speeches including the rba – will begin collecting similar data in their regular, semi - annual surveys of their local markets. recognising the importance of this issue, the gfxc agreed that the code ’ s guidance on settlement risk should be strengthened. the code now places greater emphasis on the use of pvp mechanisms where they are available. it also provides more detailed guidance on the appropriate management of settlement risk where pvp settlement is not used. in the local market, the afxc ’ s assessment is that there is good awareness of settlement risk and how it can be mitigated, including among buy - side participants. the available data seems to suggest that this is being put into practice. but as i mentioned, further work will be done in this area, and we should soon have better data with which to monitor industry trends. in the meantime, i would encourage everyone to assess their settlement practices against the new text in the code. conclusion more broadly, it is important that all market participants review the updated code and think through the implications for their own activities. this includes both sell - side and buy - side participants. the amendments to the code ’ s principles will affect certain parts of the market, and certain types of participants, more than others. for those that are most affected, a positive signal that they have aligned their practices with the updated code would be to renew their statement of commitment. reaching this point may take time, perhaps as long as 12 months. at the reserve bank, we will be asking all our fx trading counterparties to provide us with renewed statements in due course. we will also be undertaking an internal review of our practices and publishing a refreshed statement when that process is complete. finally, for all market participants, there is work to be done not only to enhance disclosures, but also to make good use of the information being disclosed