SFC and HKMA publishes OTC derivatives markets consultation in Hong Kong

Publication | 17 October 2011

On 17 October 2011, the Securities and Futures Commission (SFC) and Hong Kong Monetary Authority (HKMA) published a consultation paper on the proposed regulatory regime for OTC derivatives in Hong Kong (the Consultation Paper). This follows a joint announcement on 10 December 2010 stating the intention not only to build a regulatory regime but also that the HKMA would establish a Trade Repository (TR) and Hong Kong Exchange and Clearing Limited would set up a central counterparty (CCP).

The Consultation Paper addresses:

  • The introduction of mandatory reporting, clearing and trading obligations, in line with the 2009 G-20 Pittsburgh Summit commitments, together with the establishment and regulation of the necessary infrastructure through which mandatory obligations must be fulfilled; and
  • The introduction of appropriate prudential and conduct requirements for key players in the OTC derivatives market as well as large players whose positions may pose systemic risk.

In doing so, the SFC’s current thinking, on which it is consulting, includes:

  • Extending the scope of the Securities and Futures Ordinance (SFO) to cover the new derivatives regime via amendment to the SFO, and introducing new subsidiary legislation;
  • Introducing a wide definition of “OTC derivatives transactions”, being “structured products” as currently defined in the SFO (since May 2011) with certain carve outs, and limiting application via subsidiary legislation. For example, mandatory reporting and clearing (see below) is proposed to initially only apply to interest rate swaps and non-deliverable forwards;
  • Applying the new regime to Authorised Institutions (AIs) and Licensed Corporations (LCs), as well as, subject to certain exemptions, “Hong Kong persons” being persons who operate from Hong Kong or otherwise have a connection with Hong Kong. This could include commercial entities and high net worth individuals based in Hong Kong. Broadly, the HKMA will oversee and regulate the OTC activities of AIs and the SFC persons other than AIs;
  • Proposing mandatory reporting by locally incorporated AIs and LCs on all reportable transactions where they are counterparty to or that they have “originated or executed”. Hong Kong persons as counterparty to a transaction are proposed to be subject to a “specified reporting threshold” below which a report will not be triggered. Overseas incorporated AIs are also proposed to report reportable transactions in certain circumstances including where the transaction involves their Hong Kong branch or they are a counterparty and the transaction has a "Hong Kong nexus";
  • Proposing mandatory clearing for certain OTC derivative transactions through a designated CCP where locally incorporated AIs or LCs are a counterparty, subject to meeting certain specified clearing thresholds; and likewise for an overseas incorporated AI where they are a counterparty through their Hong Kong branch. There are proposed carve outs from mandatory clearing where the AIs and LCs have "originated or executed" the relevant transaction;
  • Proposing recognized clearing houses or authorized automated trading service providers to be designated CCPs through which certain transactions must be cleared;
  • Introducing a new Type 11 regulated activity for non-AIs (other than end users) that carry on business as dealers or advisers or clearing agents in the OTC derivatives market. The SFC is currently considering whether a license would relate to a broad definition of ”OTC derivatives transactions”, i.e. not limited to those that require mandatory reporting or clearing, and how to address overlap between other regulated activities; and
  • Potential regulatory oversight for large players, including financial institutions, commercial entities and others not regulated by the HKMA or AIs that meet certain criteria and due to their significance may be required to comply with certain obligations and requirements.

The SFC deadline for comments on the consultation paper is 30 November 2011, in preparation for the roll out of the TR and the CCP by the end of 2012.

View Consultation paper on the proposed regulatory regime for the over-the-counter derivatives market in Hong Kong

View Consultation begins on proposed regulatory regime for OTC derivatives market

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