28 January, 2016
The Securities and Futures Commission (SFC) has proposed amendments to the Guidelines for the Regulation of Automated Trading Services (ATS Guidelines). The proposed revised ATS Guidelines, which are attached to the SFC’s consultation paper of 20 November 2015, aim to take into account the following:
- the implementation of the regulation of over-the-counter (OTC) derivative transactions, which is currently in progress;
- international standards and best practices since the publication of the current ATS Guidelines in 2003; and
- the SFC’s experience in regulating ATS since 2003.
The SFC intends to implement the revised ATS Guidelines at the same time as the implementation of the subsidiary legislation for mandatory clearing of OTC derivative transactions, which is targeted for mid-2016.
A. BACKGROUND
The current ATS Guidelines were published in 2003 upon the introduction of the regulatory regime for automated trading services (ATS) under the Securities and Futures Ordinance (SFO).
The SFO provides two regimes for regulating ATS providers:
- A Part III authorisation is appropriate for entities which provide ATS as a core function, typically those which offer facilities that are similar to those of a traditional exchange or a clearing house / central counterparty (CCP). They are a key focus of the present consultation. Examples of Part III authorised ATS providers include the Australian Securities Exchange Ltd, the Shanghai Stock Exchange, Tokyo Stock Exchange, Inc. and Bloomberg Tradebook Hong Kong Limited. A large number of them are based overseas.
- A Part V licence or registration is appropriate where the provision of ATS is incidental to the performance of a dealing function. It is typically obtained by intermediaries which provide dealing services and offer ATS as an additional service to their clients. The provision of ATS constitutes a regulated activity under Part V of the SFO (Type 7).
The ATS Guidelines set out principles and procedures in relation to the authorisation and licensing/registration of ATS providers, as well as the standards of practice expected of them by the SFC.
B. HIGHLIGHTS OF THE PROPOSED CHANGES
1. Amendments in light of the new OTC derivatives regulatory regime
A key objective of the proposed amendments to the ATS Guidelines is to provide further guidance in light of the new OTC derivatives regulatory regime which is being introduced under the Securities and Futures (Amendment) Ordinance 2014 (SFAO 2014), where ATS providers are impacted. Under the SFAO 2014, amongst other things:
- the definition of ATS will be expanded to include services for the trading or clearing of OTC derivatives (in addition to securities and futures contracts);
- a mandatory clearing obligation will be introduced where specified OTC derivative transactions have to be cleared through designated CCPs that are either recognised clearing houses (RCHs) or Part III ATS providers;
- a mandatory trading obligation will be introduced where specified OTC derivatives transactions may only be traded on designated trading platforms that are either recognised exchange companies (RECs) or Part III ATS providers; and
- the licensing regime will be amended such that Type 7 regulated activity (providing ATS) and Type 9 regulated activity (asset management) will be expanded to take into account OTC derivative transactions and two new OTC derivatives-specific regulated activities will be introduced.
The above will be implemented in phases. The next phase will involve the implementation of the mandatory clearing obligation (initially for limited persons and products) and the clearing leg of the expanded ATS definition, targeted for mid-2016. This will mean that:
- CCPs (including those based overseas) which currently provide or market ATS for clearing OTC derivative transactions to persons in Hong Kong will be required to seek SFC authorisation as Part III ATS providers if they wish to continue providing such services; and
- overseas CCPs which intend to provide services as designated CCPs for the purposes of the mandatory clearing obligation will also need to seek authorisation as Part III ATS providers.
The proposed revised ATS Guidelines provide more specific guidance on the application requirements and procedures for entities seeking Part III authorisation to provide OTC derivatives clearing services, as well as those that are also seeking CCP designation for the purposes of mandatory clearing. The SFC has indicated in the proposed revisions that where an entity intends to seek both a Part III authorisation and a CCP designation, it may submit the applications simultaneously.
2. Amendments to improve alignment with international standards and best practices
The SFC has proposed various amendments to the ATS Guidelines to better align ATS regulation in Hong Kong with international standards and best practices. They include (among others):
- making it clear that the SFC will take into account the Principles for Financial Market Infrastructures (PFMI) (published by the Committee on Payment and Settlement Systems and the International Organisation of Securities Commissions in April 2012) in regulating ATS, and that an ATS provider whose facilities are similar to those of a CCP will be expected to demonstrate that it complies with the PFMI;
- expanding and reorganising the 7 standards of practice into 9 core standards of practice to better align them with relevant PFMI requirements for CCPs, for example:
- separating the existing standard for “financial resources” and “risk management” into two core standards to stress the significance of each;
- introducing a new core standard on “governance” (incorporating the previous standard on “fitness”) which highlight the importance of management and decision-making processes, such as clear lines of reporting, internal control procedures, and arrangements to handle conflicts of interest; and
- introducing a new core standard on “access and participation”, which require that ATS providers have objective, risk-based and transparent criteria for participation which permit fair and open access (this is particularly important in light of the upcoming mandatory clearing obligation).
3. Amendments to codify SFC practices in regulating Part III ATS providers
The proposed revised ATS Guidelines include amendments which take into account the SFC’s experience in regulating Part III ATS providers since 2003. They are set out in part D of the draft guidelines headed “Additional considerations applicable to Part III ATS”:
- Further clarification and guidance have been proposed regarding the matters to bear in mind where the provision of ATS might constitute the operation of a “stock market”, “futures market” or “clearing house” as defined under the SFO. Such activities are subject to restrictions in relation to RECs and RCHs.
- A new section has been proposed to clarify the key regulatory differences between a REC and a Part III ATS provider, so that persons wishing to operate exchange-like platforms can better decide which of the two regimes are more appropriate for them.
- The SFC’s pragmatic approach in regulating domestic ATS providers (including adopting a level of regulation which is akin to that of a REC in appropriate cases) has been reiterated.
- A new section has been proposed to highlight the need for an ATS provider to ensure that it (and its members) comply with the offers of investments regime under Part IV of the SFO.
4. Housekeeping amendments
Lastly, the proposed revised ATS Guidelines include some housekeeping amendments. The illustrative examples on how the guidelines would apply in practice have been updated and expanded, with examples in relation to the trading or clearing of OTC derivatives, interests in collective investment schemes and structured products.
In addition, procedures for applying for a licence/registration to provide ATS under Part V of the SFO have been removed, given that detailed information is included in the SFC’s Licensing Information Booklet.
C. COMMENT
The proposed amendments to the ATS Guidelines are timely given the planned implementation of the initial phase of the OTC derivatives clearing obligation in mid-2016. The SFC aims to review the comments received during the consultation and finalise the guidelines within the first quarter of the year. It will then work towards implementing the revised guidelines at the same time as the implementation of the subsidiary legislation for mandatory clearing, currently targeted for mid-2016.
The proposed updates to the core standards of practice reflect the need to align local regulation with current international standards. In particular, the addition of the new “governance” core standard highlights the importance of corporate governance and internal control in the current global regulatory landscape.
Finally, the proposed additional guidance incorporating the SFC’s experience gained since 2003 is helpful, and will no doubt provide more transparency and clarity to market practitioners.
For further information, please contact:
William Hallat, Herbert Smith Freehills
william.hallatt@hsf.com
Rachel Yu, Herbert Smith Freehills
rachel.yu@hsf.com
Valerie Tao, Herbert Smith Freehills
valerie.tao@hsf.com
