Application for Exemption under the Anti Money Laundering/Counter Terrorism Financing Act 2006 (Cth) (AML/CTF Act)

Transcription

1 31 January 2008 Ms. Liz Atkins General Manager Regulatory Policy Australian Transaction Reports and Analysis Centre PO Box 5516 West Chatswood NSW 1515 Dear Liz Application for Exemption under the Anti Money Laundering/Counter Terrorism Financing Act 2006 (Cth) (AML/CTF Act) 1. INTRODUCTION We refer to the Australian Financial Markets Association s (AFMA) submission of 17 September 2007 and AUSTRAC s Draft AML/CTF Rules exempting certain types of transactions relating to the over-the-counter (OTC) derivatives market in Australia in the wholesale price of electricity, gas or renewable energy certificates (AUSTRAC Exemption). 1.1 Exemption Applied For The exemption applied for is a full exemption from application of the Act where: OTC derivatives relate to electricity, gas or environmental products and the provider of the designated service is a wholesale client (as defined in the Corporations Act); The provider is a registered market participant with the Western Australian Independent Market Operator; The provider or its agent holds an Australian Financial Services Licence ( AFSL ) or is exempt from the requirement from holding an AFSL pursuant to section 134 of the Electricity Act 2004 (WA). 1.2 AFMA s Role in this Application AFMA represents Synergy and Verve Energy in the Western Australian Electricity Market (WEM). Altogether, there are six WEM participants: Synergy; Verve Energy; Perth Energy; Griffin Energy; Alinta; and Australian Financial Markets Association ABN Level 3, 95 Pitt Street Sydney NSW 2000 Tel: (61 2) Facsimile: (61 2)

2 Wesfarmers Energy. AFMA s key functions with respect to these electricity market members include: Coordinating the efficient operation and effective self-regulation of the OTC financial markets; Promoting high professional standards in the conduct of wholesale electricity financial markets; and Speaking for the wholesale energy financial markets on regulatory issues that affect these markets. 1.3 National Electricity Market (NEM) vs WEM While the NEM commenced in late 1998, the WEM only commenced operating in September There are a number of differences between the NEM and the WEM of which AUSTRAC should be aware, but which do not affect the appropriate application of the AUSTRAC Exemption to the WEM, as follows: Due to its location and distance from the eastern states, the WEM is a physically separate and discrete energy market; Therefore, the WEM is not a part of the National Electricity Market and participants are registered with the WA Independent Market Operator (IMO) and not with the National Electricity Market Management Corporation. However, the IMO and NEMMCO perform similar functions in operating and managing their respective markets; The market is administered and overseen by WA based bodies, the IMO, the market Rules Panel, the Energy Review Board, the Energy Regulation Authority and the WA Energy Minister. The functions performed by these bodies correspond with those of the regulatory bodies of the NEM; The WEM operates a net pool model based on bilateral contracts between retailers and generators and a short term energy market rather then the gross pool with a spot market which operates in the NEM; There are far fewer participants in the WEM than the NEM which, consequently, allows a high degree of transparency; Recognising the emerging and developing nature of the WEM and to encourage competition, ASIC has exempted participants from the NEM requirement that participants hold an AFSL. The WA government has promulgated regulations pursuant to section 134 of the Electricity Act 2004 (WA) to exempt WEM participants from holding an AFSL. The exemption applies until 19 March 2008 when it is expected to be extended for a further two years. Apart from the differences referred to above, the WEM and the NEM share many of the fundamental features that were key in AFMA s submission to AUSTRAC for exemption dated 17 September Accordingly, this exemption is sought for two reasons: The risk of money laundering and terrorist financing in the WEM is insignificant and is out of all proportion to the cost of compliance with the AML/CTF Act; and 2

3 If an exemption is given to NEM participants, then failure to give an equivalent exemption to WEM participants would place WEM participants at a significant competitive disadvantage. Such a competitive disadvantage would operate to hinder the effective development of the WEM. Further, because the WEM is currently a developing market where all market participants are extremely well known to each other, the risks in terms of money laundering and terrorist financing are as low as in the NEM and the potential impact of the cost of compliance significantly higher than in the NEM. 2. INDUSTRY CONTEXT While the WEM operates a net pool rather than a gross pool as does the NEM, price volatility exists in the WEM and, as with NEM participants, WEM participants will look to hedge that price volatility by using derivatives. As with the NEM, WEM participants also transact in gas and environmental derivatives that are often associated with electricity market activities. (1) Electricity In Western Australia, generators and retailers enter into bilateral agreements for the supply of energy. It is generally expected that retailers will cover most of their electricity requirements through these bilateral arrangements with generators. Each day generators inform the Independent Market Operator (IMO) the amount of energy they will be supplying and the expected demand energy retailers will consume pursuant to those bilateral contracts, for each half hour period of the next day. The IMO administers and operates the WEM and, in particular, the Short Term Energy Market (STEM). The STEM enables participants to adjust their contract positions (based on their bilateral arrangements) before each trading day by submitting bid/offer prices to the IMO each morning. The IMO then runs a STEM auction and determines a single STEM price for each half hour period for the following day. Participants in the STEM can then enter into forward contracts to purchase energy from the IMO or sell energy to the IMO on the day before that energy is due to be delivered. Each day market participants are required to provide an amount of energy corresponding to their bilateral trades plus STEM trades. In reality, the actual energy that is provided may deviate from this net contract position. The balancing mechanism within the STEM provides the means for trading these deviations. The balancing price is that which is paid by participants who have deviated from their contract positions and will generally be equal to the STEM price. While the WEM is a relatively new market, it is expected that, over time a range of other derivative products independently engineered to hedge risks associated with physical electricity transactions on the WEM will be commonly traded. (2) Gas Gas derivatives are currently traded infrequently. Because such derivatives are usually tied to specific gas supply arrangements, it is difficult to see how they could be used for money laundering or terrorist financing. They have been included in this application so that market participants do not need to 3

4 comply with the AML/CTF Act in circumstances where only a few transactions are entered into each year. (3) Environmental Products AFMA refers to paragraph 3.1 (3) of our submission of 17 September 2007 and note that the environmental products market in Western Australia operates both within WA and in the Eastern States. Accordingly, the submissions presented by AFMA in the context of the NEM are equally applicable to this submission. 3. EXEMPTION SOUGHT This application for a full exemption from the application of the AML/CTF Act is in accordance with the AUSTRAC Guidance Note Exemptions and Modifications under the AML/CTF Act, paragraph 3.1 (c), and is made on behalf of Western Australian energy market participants with respect to electricity, gas and environmental products. Other than the operational differences between the WEM and the NEM expressed in this submission, AFMA submits that the basis for AUSTRAC granting an exemption is consistent with, and corresponds to, the reasons expressed in our submission of 17 September As with the application for exemption of the NEM, the relief sought from AUSTRAC is a full exemption from the application of the Act where OTC derivatives relate to electricity, gas or environmental products in circumstances where the provider of the designated service: Is a Market Participant under the Western Australian Market Rules (registered with IMO); and Holds an AFSL under section 913B of the Corporations Act that authorises the person to provide the designated service, or is exempt from the requirement to hold an AFSL pursuant to section 134 of the Electricity Act 2004 (WA). The WEM exemption applied for is, accordingly, the same relief sought with respect to that applying to the NEM. 3.1 Description of the Relevant Designated Service Section 6, Table 1, Item 35 of the AML/CTF Act provides that the provision of a designated service includes: Issuing or selling a security or derivative to a person, where: (a) (b) (ba) the issue or sale is in the course of carrying on a business of issuing or selling securities or derivatives; and in the case of an issue of a security or derivative the issue does not consist of the issue by a company of a security of the company or of an option to acquire a security of the company; and in the case of an issue of a security or derivative the issue does not consist of the issue by a government body of a security of the government body or of an option to acquire a security of the government body; and 4

5 (d) (e) in the case of an issue of a security or derivative the issue is not an exempt financial market operator issue; and such other conditions (if any) as are set out in the AML/CTF Rules are satisfied. Western Australian electricity market participants use derivatives in respect of the wholesale electricity market, gas and environmental instruments. Accordingly, they are involved in the provision of a designated service and the relevant designated service to which this application applies is issuing a derivative to a person in the course of carrying on a business of issuing derivatives. 3.2 Description of the Particular Circumstances in which the Designated Service is Provided This application for exemption is sought where the designated services described above are provided in the following circumstances: It relates to the wholesale price of electricity, gas or the price or value of environmental instruments; and The provider of the service, or an agent acting on behalf of the provider of the service, holds a relevant AFSL, or is exempt from holding an AFSL; and Financial settlement of the designated service set out in Item 35 of Section 6, Table 1 of the AML/CTF Act is effected through the Sydney Futures Exchange Austraclear system. The exemption sought is by way of an instrument similar to the draft exemption issued by AUSTRAC in respect of the NEM. That is, it would apply where the circumstances described above apply, rather than to a list of named organisations. 4. REASONS FOR EXEMPTION APPLICATION The rationale for this exemption application: The risk is as insignificant as that described in AFMA s submission of 17 September 2007 (please see paragraphs 2.3 and 3.5 of that submission), as applicable to the highly regulated environment of the WEM and would constitute a disproportionate compliance cost without perceivable benefit; and On the basis that an AUSTRAC exemption were to be granted to NEM participants, then absence of a corresponding exemption to WEM participants would place such participants at a material competitive disadvantage and potentially have serious deleterious effects on the WEM as a newly created and developing market. In terms of risk, our submission is in essence the same as that presented in the AFMA submission for an exemption in respect of the NEM, in that the electricity and gas industry in Western Australia is highly regulated. The difficulties associated with money laundering or terrorist financing through OTC electricity, gas and environmental product derivatives are so great, that an exemption should be granted. Like the NEM, it is almost inconceivable that the WEM would be used for money laundering and terrorist financing. If 5

6 appropriate conditions are imposed on the exemption, the AML/CTF risk is virtually non-existent. As with the NEM, the physical money transfers in the WEM are performed by banks (who have comprehensive AML/CTF monitoring). Accordingly, in the highly unlikely event that money laundering and terrorist financing was capable of being undertaken on the WEM, the transfers of funds would be subject to the banks AML/CTF requirements and monitoring. The WEM is a new, highly regulated, transparent and developing market with only six participants and is not amenable to money laundering and terrorist financing. Further, because of the new and developing nature of the WEM, the costs associated with compliance with WA legislative and market regulatory requirements are considerable. AFMA submits that the matters raised with respect to AML/CTF compliance costs in the circumstances of the NEM apply equally to the WEM and AUSTRAC should take them into account and treat them equally. In terms of comparative disadvantage, it would not be commercially reasonable to expect Western Australian energy market participants to incur the costs associated with an AML/CTF program for such low-risk circumstances, particularly when their Eastern States counterparts would not be subject to such costs. Further, like their Eastern State counterparts, participants in the WEM will be subject to bank AML/CTF programs and the actual money flows are direct transfers between bank accounts. In addition to operational differences between the WEM and the NEM identified in this submission, it is anticipated that over time, a range of electricity based derivatives products will be entered into between participants in the WEM, just as they are in the NEM. Were the WEM not to receive the same relief that the NEM may receive in view of AFMA s submission of 17 September 2007, the consequences could potentially hinder the proper development of the WEM as a competitive market. 4.1 Risk Assessment Like the NEM, the key factors that make WEM unamenable to money laundering or terrorist financing occurring through electricity, gas or environmental products are as follows: Highly regulated industry; Profile of the participants; Settlement arrangements; Small number of known participants; Disincentives for the use of OTC derivatives; and Uncertainty of cash flow. Each of these factors is explained in more detail below. (1) Highly Regulated Industry Due to the small number of participants and the developing nature of the WEM, participants have been exempted from holding an AFSL. 6

7 On 15 March 2006, ASIC issued an exemption from the requirement to hold an AFSL for the benefit of the IMO and various market participants in respect of transactions entered into between the IMO and those participants (see ASIC exemption 06/0783). This exemption applies until 19 March The Western Australian government has the power to promulgate regulations pursuant to section 134 of the Electricity Industry Act 2004 (WA) to exempt participants in the WEM from a requirement to have an AFSL. Such regulations are anticipated to be promulgated and operative on and from the expiration of the ASIC exemption. The majority of organisations who deal in electricity, gas and environmental derivatives are registered with the IMO as a market participant. Market participants must: Comply with the obligations set out in the WA Market Rules; Be resident in, or have a permanent establishment, in Australia; Not be an externally administered body corporate, or under a similar form of administration under any laws applicable to it in any jurisdiction; Not be immune from suit in respect of obligations under the WA Market Rules; Be capable of being sued in its own name in a court in Australia; Be an Austraclear participant; Be subject to prudential requirements, which generally requires the provision of credit support (in the form of a guarantee of unconditional payment) to cover its credit limit (which is the maximum net amount that the Market Participant is likely to owe the IMO within the maximum two month period between being scheduled and being settled in the market); and Comply with technical performance requirements. There is ongoing monitoring and oversight by the IMO of continual compliance with these requirements. Environmental products are closely linked to associated certificates (such as Renewable Energy Certificates), such that they are (in a de facto sense) regulated by the relevant state and federal agencies. These agencies register the creation of certificates and monitor their surrender and transfer. (2) Profile of the Participants As with the NEM, several WEM participants are government owned entities (Synergy and Verve Energy). The other participants are large corporations who would not want to be exposed to the reputation risk that would arise from being associated with money laundering or terrorist financing. (3) Settlement Arrangements Obligations in the WEM are settled through the ASX Austraclear system (which is a feeder system into the Reserve Bank s RITS/RTGS payment system). In order to participate in Austraclear, an organisation needs to be sponsored by a bank and must otherwise satisfy Austraclear s participation 7

8 requirements. Because of the requirement for bank sponsorship (to effect payments through Austraclear), the settlement of obligations in the WEM involves bank-to-bank transfers. These transfers would be subject to the AML/CTF programs of Austraclear and the relevant participating banks. (4) Small Number of Known Participants The WEM is a one-state only wholesale market. It has a much smaller number of participants than the NEM. All participants in the WEM are very well known to each other. New entrants are highly visible, and would be heavily scrutinised by existing market participants before transactions with the new entrant are entered into. (5) Disincentives for the Use of OTC Derivatives The OTC electricity market presents a number of commercial disincentives for its use in money laundering and terrorist financing. Counterparties in this market usually require the execution of an ISDA Master Agreement and a high credit standing of the counterparty (or it provides appropriate credit support). For this reason, it is unlikely that OTC electricity derivatives would be effectively utilised to engage in money laundering and terrorist financing. (6) Uncertainty of Cash Flow Although electricity derivatives in the WEM and environmental products are (currently) less volatile than derivatives in the NEM because of the differences between the operations of a net verses gross pool, the same underlying principle applies; namely, that because the market cash flows are unpredictable in nature these instruments are an unattractive mechanism for money laundering and terrorist activity. 5. THIRD PARTY RIGHTS As with the NEM, the effect of granting the proposed exemption in favour of the WEM would have a neutral impact on the rights of third parties such as regulators, market rule makers, Austraclear and brokers. However, AFMA submits there would be a material benefit to Western Australian energy consumers in that energy prices would not be increased to cover increased AML/CTF compliance costs. Please contact Patrick Searby on (02) or at psearby@afma.com.au if you have any questions in relation to this submission. Yours sincerely Patrick Searby Senior Policy Executive 8