Proposed regulatory oversight of OTC derivatives in Singapore - 10 things you need to know

On 13 February 2012, the Monetary Authority of Singapore (MAS) introduced two consultation papers on the “Transfer of Regulatory Oversight of Commodity Derivatives from the International Enterprise Singapore” (IES) and “Proposed Regulation of OTC Derivatives” (the Papers). The recommendations contained in these Papers seek to vest the overall regulatory supervision of derivative contracts in MAS, with the IES relinquishing its supervision of commodity derivatives. These recommendations are in response to the initiatives of the G20 and the Financial Stability Board (FSB) to strengthen regulatory oversight in respect of the OTC derivatives markets.

The SFA currently covers only securities and futures contracts. It is proposed that its ambit be expanded to include the main asset classes where OTC derivatives activity primarily exists, namely, derivative contracts in respect of credit, equities, foreign exchange, interest rates and commodities. Generally speaking, only derivative contracts in respect of tangible commodities will be regulated; derivative contracts in respect of intangible commodities and physically-settled commodity forward contracts are proposed to be excluded from regulation. The extra-territorial reach of the SFA will mean that market operators and clearing facilities operating outside Singapore which offer services in Singapore will nonetheless fall within the SFA.

Unlike proposals in the US and Europe, MAS will not require trading of OTC derivative contracts to be on exchanges or electronic trading platforms, taking the view that such a move would not confer any significant benefits beyond those envisaged from other proposals dealing with standardisation, central clearing and reporting of derivative contracts to trade repositories (TRs).

Operators of derivative contract markets (including commodity derivative markets) will be regulated under the present two-tier framework for operators of securities and futures markets. Operators of systemically important markets will be supervised as Approved Exchanges while other operators will be regulated as Recognised Market Operators (RMO). MAS will differentiate its treatment in respect of domestic and foreign RMOs - additional requirements which are now currently imposed only on domestic RMOs will be imposed on foreign RMOs and MAS will utilise its co-operation network with foreign regulators to supervise foreign RMOs.

The SFA currently regulates only clearing facilities in respect of securities or futures contracts transactions. This will be expanded to include clearing of derivative contracts, even if the trades are executed on markets not regulated by MAS. Akin to market operators, MAS proposes to implement a two-tier framework under which systemically-important clearing facilities will be regulated as Approved Clearing Houses (ACH) and subject to more rigorous supervision - clearing facilities performing central counterparty roles will be deemed systemically important. Other clearing facilities will be regulated as Recognised Clearing Houses (RCH) and subject to a lower threshold of obligations which MAS may, in its discretion, re-calibrate as appropriate.

Obligations imposed on a foreign RCH will be deemed satisfied if the foreign RCH is subject to ‘comparable’ obligations in its home jurisdiction, its home regulator has signed a Memorandum of Understanding with MAS and the foreign RCH submits self-assessment reports on a regular basis. For foreign RCHs that perform central counterparty roles, a comparable regime is one that subjects the foreign RCH to standards equivalent to those imposed on an ACH in Singapore. MAS will retain the discretion to require, where appropriate, a foreign RCH to incorporate locally as a domestic RCH or an ACH.

In line with international moves towards clearing on central counterparties (CCPs) to reduce counterparty risk in OTC derivatives transactions, legislation mandating central clearing of OTC derivative contracts on regulated CCPs will be introduced. Products-wise, a dual ‘bottom-up’ and ‘top-down’ approach is being mooted to ascertain products suitable for mandatory central clearing by a CCP. With regard to derivative contracts, if at least one limb of the contract is booked in Singapore and either both parties to the contract are resident (or have presence) in Singapore and are subject to the clearing mandate or one party is resident (or present) and the other party would have been subject to the clearing mandate if it had been resident (or present), central clearing would be required.

MAS is not proposing to require domestic clearing; it will regulate clearing with foreign CCPs by way of a recognition framework.

There are certain circumstances under which clearing will not be required. These include the following:

• Financial Institutions (FIs) regulated by MAS as well as non-FIs above specified thresholds will be required to clear derivative contracts centrally unless their exposure to derivative contracts is minimal. In relation to non-FIs, MAS will likely exclude hedging transactions;
• central banks, certain government bodies as well as supra-national organisations will be exempted from the clearing mandate;
• intra-group trades may be exempted from the clearing obligation but could be subject to appropriate collateralisation requirements.

Where clearing by a CCP is not required, MAS expects that appropriate risk mitigation measures (including adequate capital and margins) should be maintained.

A critical concern in foreign clearing houses extending their facilities to Singapore-based customers has been the non-availability of the insolvency protection rules set out in Division IV, Part III of the SFA which are currently accorded only to Designated Clearing Houses (DCHs, to be re-termed Approved Clearing Houses) which, at present, are only the domestically-based clearing houses - the SGX Derivatives Clearing Limited, the SMX Clearing Corporation and the Central Depository. The existing framework does not allow non-DCH facilities to enjoy insolvency protection, a situation which the Papers are seeking to remedy by extending insolvency protection in future to all Approved Clearing Houses and Recognised Clearing Houses.

Mandatory reporting of OTC derivative contracts to regulated TRs will be introduced - while derivative contracts across all asset classes will be reportable, this will be rolled out in phases by product or asset class, priority being given to interest rate, foreign exchange and oil derivatives. In addition, all contracts booked or traded in Singapore should be reported. Where reports are mandated, they should be made within one business day of the underlying transaction to domestic or foreign TRs (whom MAS intends to oversee by way of a recognition framework).

TRs which facilitate market participants’ compliance with reporting mandates will need to be authorised by MAS. Trading platforms and clearing facilities which are separately regulated by MAS but which perform TR roles will nonetheless require authorisation as a TR. A similar two-tier framework is proposed - domestic TRs will be regulated as Approved TRs while foreign TRs will be regulated as Recognised TRs but subject to the same standards as Approved TRs. Unlike in the US, MAS will not require foreign regulators to provide an indemnity to an Approved TR, Recognised TR or to MAS prior to obtaining data from such TR.

Non-bank intermediaries dealing in derivative contracts are currently outside MAS’ regulatory purview. This will change with proposals that non-bank intermediaries will require a capital markets services licence from MAS to deal in derivatives where the underlying contract relates to equities, interest rates, foreign exchange credits or commodities. Similarly, fund managers managing funds that invest into derivative contracts will also need to apply for a capital markets services licence in respect of fund management.

Brokers in derivative contract transactions will be exempted from licensing requirements so long as they do not take on any principal position, hold any customer position, margin or account and deal only with institutional investors.

We are currently working with clients in providing feedback to the Papers. The deadline for providing feedback is 26 March 2012 with the proposed transfer of regulatory oversight of commodity derivatives from IES to MAS targeted for Q4 2012.