18 July, 2015
1. Introduction
The Monetary Authority of Singapore (“MAS”) has issued a consultation paper on 1 July 2015 proposing the draft Securities and Futures (Clearing of Derivatives Contracts) Regulations (the “Regulations”) for the mandatory clearing of over-the-counter (“OTC”) derivatives. The proposed Regulations are in line with the G20 objectives and Financial Stability Board recommendations on OTC derivatives reforms.
Various policy proposals relating to the regulation of OTC derivatives, including the mandatory clearing of OTC derivatives, were given effect to in the Securities and Futures (Amendment) Act 2012. The draft Regulations will effect Part VIB of the Securities and Futures Act (Cap. 289) (“SFA”) on the mandatory clearing of OTC derivative contracts and sets out, among others, the types of OTC derivative contracts to be cleared, circumstances under which clearing is mandatory, exemptions from clearing obligations and other implementation details.
2. Specific derivatives contracts to be cleared
OTC derivative contracts are assessed for mandatory clearing based on factors set out in section 129G(2) of the SFA. These factors include, amongst others, the level of systemic risks posed by the product, the depth and liquidity of the product, and the availability of MAS regulated Central Counterparties (“CCPs”) such as approved clearing houses and recognised clearing houses. MAS has said that it intends to commence mandatory clearing by asset class, starting with interest rate derivative contracts. According to MAS, the clearing of interest rate swaps (“IRS”), which constitutes more than 90% of interest rate derivative contracts booked in Singapore, would in turn reduce systemic risks in the Singapore financial system significantly. IRS are also highly standardised contracts which are likely to pose minimal operational concerns for clearing. Further, MAS has noted that the industry is committed to high degrees of standardisation of electronic execution and confirmation of OTC interest rate derivatives, and that market participants have already begun clearing some IRS on CCPs.
MAS has proposed to subject, at a minimum, the Singapore-dollar (“SGD”) fixed-to-floating Swap Offer Rate IRS and the U.S. dollar (“USD”) fixed-to-floating London Interbank Offered Rate IRS to clearing obligations. According to MAS, these are the most liquid IRS traded and comprise about 50% of gross notional IRS trades in Singapore. They are currently cleared by the Singapore Exchange Derivatives Clearing Limited (“SGX-DC”). MAS has indicated that it expects to approve or recognise more CCPs before the clearing obligations begin.
MAS has sought views on whether IRS denominated in Euro (“EUR”), Pound Sterling (“GBP”) and Japanese Yen (“JPY”) should be subject to mandatory clearing obligations, given that these form a significant proportion relative to IRS dominated in other currencies. Furthermore, other major jurisdictions have already mandated or are proposing to subject EUR, GBP and JPY IRS to mandatory clearing.
Generally, the wider the range of contract specifications for IRS to be cleared, the greater the margining efficiencies achieved by market participants. MAS has sought feedback as to whether subjecting more types of SGD, USD, EUR, GBP and JPY IRS – such as basis swaps, forward rate agreements or overnight index swap – to clearing obligations would, on balance, allow market participants to achieve greater margin efficiencies.
3. Circumstances under which contracts are to be cleared
Following from the above, MAS has proposed to subject IRS trades that are booked in the Singapore-based operations of both transacting counterparties (i.e. a Singapore-incorporated company or a Singapore branch of a foreign entity) to clearing obligations. According to MAS, doing so will address the risks residing in the Singapore system from the trades booked in Singapore, given that IRS are predominantly traded in Singapore by local banks and local branches of foreign banks. Such an approach also avoids potential conflicting requirements by taking into account the fact that foreign counterparties in jurisdictions without mandatory clearing regimes may not be obliged or ready to clear their OTC derivative trades.
MAS has considered that our proposed clearing mandate will not result in any conflicts in relation to cross-border transactions conducted with US or EU persons that may be subject to their respective clearing obligations, given that approved or recognised CCPs would likely meet the U.S. Commodity Futures Trading Commission or the European Securities and Markets Authority requirements on mandatory clearing.
According to MAS, transactions which are traded in Singapore but booked overseas, such as in foreign subsidiaries of branches of local banks, will be subject to MAS’ oversight through its consolidated supervision of local banking groups. MAS will continue to engage banks regularly on their policies regarding booking of OTC derivative contracts and risk controls, as well as assess risks based on trade data reported to the licensed trade repositories.
4. Specified persons to be subject to clearing obligations
Section 129B of the SFA defines “specified persons” as including all banks and other financial institutions (“FIs”) such as insurers and capital markets services licence holders. These “specified persons” are subject to clearing obligations upon commencement of the mandatory clearing regime. MAS has noted however, that it may not be commercially feasible for smaller FIs, including banks with low levels of OTC derivatives activities, to enter into client clearing arrangements or taking up direct clearing memberships on CCPs.
Thus, MAS has proposed to exempt from mandatory clearing obligations:
- (a) all banks, as long as they do not exceed a maximum threshold of S$20 billion gross national outstanding derivatives contracts booked in Singapore for each of the last 4 calendar quarters; and
- (b) initially, all other “specified persons” that are not banks.
According to MAS, the proposed exemptions ensure that banks with high levels of OTC derivatives activities and large counterparty credit risks would continue to be subject to clearing obligations.
5. Exemptions from clearing obligations
In line with other jurisdictions, MAS has proposed to exempt intra-group transactions from clearing obligations, as such transactions do not transfer risks in or out of the corporate group and would be better managed by the corporate groups themselves. MAS has also proposed to exempt public bodies from clearing obligations so as not to constrain their policy functions.
6. Implementation of clearing obligations
MAS has said that it intends to issue the Regulations by end 2015, and will provide at least 6 months’ notice before the clearing obligations take effect. Banks that exceed the S$20 billion threshold will be required to clear contracts subject to mandatory clearing which are entered on or after the effective date.
Moving forward, MAS has said that it will continue to review and expand the scope of our mandatory clearing regime when appropriate, taking into account industry readiness as well as international developments. In particular, MAS has said that it will be considering the following options, amongst others:
- increasing the range of products subject to clearing obligations, possibly with the most liquid products in the next largest asset class (i.e. foreign exchange OTC derivatives);
- lowering the maximum threshold for exemption from clearing obligations and/or include more active non-bank FIs trading OTC derivatives; and/or
- widening the nexus for OTC derivative contracts subject to clearing obligations, including cross-border transactions with counterparties that do not book their trades in Singapore-based operations.
7. Consultation period
The consultation period ends on 31 July 2015.
