The Hong Kong Monetary Authority (HKMA) and the Hong Kong Securities and Futures Commission (SFC) have issued a joint consultation paper on their proposals to regulate the over-the-counter (OTC) derivatives market in Hong Kong. The consultation paper is a response to global efforts to enhance regulation of the OTC derivatives markets following from the global financial crisis in late 2008. Below we identify who the proposals affect, give an overview of the proposals and highlight important dates to keep in mind.
The consultation paper is available on both the HKMA's website (www.hkma.gov.hk) and the SFC's website (www.sfc.hk).
Who the proposals affect
The proposals affect locally-incorporated banks, overseas banks with a Hong Kong branch, brokers, investment managers, persons wishing to provide central clearing services for OTC derivatives and other “large players whose positions may pose systemic risk”.
Who qualify as “large players whose positions may pose systemic risk” will be determined by certain quantitative and/or qualitative criteria that will be published at a later stage. It may include the OTC derivatives activities of financial institutions not regulated by either the HKMA or the SFC, such as insurers, and commercial businesses that use OTC derivatives as part of their financial risk management.
Overview of the proposals
The regulatory framework
- The regulatory framework to regulate “OTC derivatives transactions” will be set out in the Securities and Futures Ordinance. Detailed requirements on reporting and central clearing, including which types of OTC derivatives are subject to the requirements, will be set out in subsidiary legislation.
- “OTC derivatives transactions” will be defined broadly. Securities, futures, structured products authorised for public offering and certain retail banking products will be excluded.
- Joint regulation by the HKMA and SFC. The HKMA will oversee and regulate the OTC derivatives activities of authorized institutions. The SFC will oversee and regulate the OTC derivatives activities of persons other than authorised institutions.
New regulated activity for dealers, advisers and clearing agents in the OTC derivatives market
- The regulators propose a new Type 11 regulated activity for dealers, advisers and clearing agents in the OTC derivatives market who are not authorised institutions.
- An intermediary will need to be licensed for Type 11 regulated activity even if none of its OTC derivatives activities give rise to reporting or central clearing obligations in Hong Kong.
- How the legislation will deal with overlaps between the existing regulated activities, such as dealing in securities, and Type 11 regulated activity is undecided.
Mandatory reporting requirements
- The HKMA is setting up a trade repository to receive reports on OTC derivatives transactions.
- OTC derivatives transactions of a specified type (reportable transactions) must be reported. The specified types will be set out in subsidiary legislation.
- The mandatory reporting requirements will initially apply to single currency interest rate swaps, overnight index swaps, single currency basis swaps and non-deliverable forwards. The regulators indicate they intend to extend the requirements to other types of OTC derivatives over time.
- There are different reporting requirements for:
- locally-incorporated authorised institutions and licensed corporations (who must report all reportable transactions),
- overseas-incorporated authorised institutions (who must report all transactions made or arranged through their Hong Kong branch or where they are a counterparty and the transaction has a “Hong Kong nexus”), and
- other Hong Kong persons who are counterparties to a reportable transaction.
Mandatory central clearing requirements
- Standarised OTC derivatives transactions of a specified type (clearing eligible transactions) must be cleared through a designated central counterparty where:
- one of the counterparties is either an authorised institution, a licensed corporation or a Hong Kong person, or an authorised institution or licensed corporation has originated or executed the transaction; and
- both counterparties have exceeded a specified clearing threshold.
- The specified types and clearing thresholds will be set out in subsidiary legislation.
- An OTC derivatives transaction will be exempt from the mandatory clearing requirement where:
- both counterparties are overseas persons, and
- either the transaction is centrally cleared under the laws of an acceptable overseas jurisdiction or is exempted from mandatory clearing under those laws.
- Regulatory proposals in the United States and the European Union have included an exemption from central clearing for non-financial counterparties that are hedging their commercial risks. The Hong Kong proposals do not contain a similar exemption.
- Designated central counterparties must be a recognised clearing house or licensed to provide automated trading services under the Securities and Futures Ordinance.
- The regulators are considering imposing higher capital charges and margin requirements for OTC derivatives transactions that are not centrally cleared.
30 November 2011
End of consultation period for the proposals in the consultation paper.
The HKMA and SFC intend to seek public comments on draft subsidiary legislation setting out the detailed requirements for the new regulatory regime during the first quarter of 2012.
1 January 2013
Proposed start date of the new regulatory regime. The actual start date will depend on external factors, including the progress of reform initiatives in other major markets, completion of the legislative process, and readiness of relevant market infrastructure and participants.
Once the new regulatory regime is in place, the HKMA and SFC propose:
- a 3 month grace period to comply with reporting requirements
- a 6 month grace period to report positions entered into previously and still outstanding
- a grace period to comply with mandatory clearing requirements, being the later of (i) 3 months from the date you first enter into the relevant type of OTC derivative, and (ii) 6 months from the start date of the new regulatory regime