23 May, 2019
On 26 April 2019, the Hong Kong Monetary Authority and the Securities and Futures Commission launched a joint consultation1 on proposals to enhance the over-the-counter (OTC) derivatives regime in Hong Kong; in particular, (i) to mandate the use of unique transaction identifiers (“UTIs”) for the reporting obligation, (ii) to revise the list of designated jurisdictions for the masking relief of the reporting obligation and (iii) to update the list of financial services providers (“FSPs”) under the clearing obligation.
The deadline for submitting comments to the regulators is 25 May 2019 for the proposal on updating the list of FSPs and 25 June 2019 for the other two proposals.
The proposals will require system enhancements and modifications for entities subject to the reporting or clearing obligations in Hong Kong. Market participants are advised to consider the proposals and their implementation plans within the timing proposed by the HKMA/SFC and respond to the regulators with any comments or concerns.
Mandating the use of UTIs for the reporting obligation
Entities subject to the OTC derivatives reporting obligation in Hong Kong are required to report transaction data to the Hong Kong Trade Repository (“HKTR”). Amongst such data, the identifying reference assigned to each transaction is required to be reported. Currently, the HKMA accepts the reporting of transaction identifiers generated based on the US and/or EU local standards and requirements (being (i) Unique Swap Identifiers (“USI”) reportable under the US mandatory reporting requirements and/or (ii) Unique Trade IDs (“TID”) reportable under the EU mandatory reporting requirements), if available. If no USI or TID is assigned to a transaction, the mandatory reporting of a bilaterally agreed UTI is currently deferred pending the finalisation of the international standard for UTIs.
With the publication of the international standards on UTIs2 by the Committee on Payments and Market Infrastructures (“CPMI”) and the International Organisation of Securities Commissions (“IOSCO”) in February 2017 and the recommendation by the Financial Stability Board (“FSB”) that regulators and authorities implement the Technical Guidance no later than end-2020, the HKMA and the SFC are now proposing to mandate the use of UTIs in OTC derivatives trade reporting in Hong Kong. The idea is that each reportable transaction should be identified by one (and only one) bilaterally agreed UTI which is unique and shared and paired between the two counterparties, so as to facilitate the global sharing and aggregation of data reported across different trade repositories.
The UTI for a particular transaction should be used throughout the lifetime of the transaction (except for certain life-cycle events and changes to the original transaction where a new UTI is needed)3 and consistently adopted when the transaction is reported more than once. To align with global standards, the HKMA/SFC propose that reporting entities should adopt the Technical Guidance for the structure and format of UTIs. The regulators also propose to allow counterparties to agree on the responsibility for generating UTIs; if there is no agreement, counterparties should refer to the list of factors recommended in the Technical Guidance for allocating responsibility.
Timing: In recognition of the system changes required and the different implementation timelines that the US and the EU may have in adopting the international standards for UTIs, the regulators are proposing the following timeline which includes an interim measure to ease the compliance burden of reporting entities:
The implementation date for the mandatory use of UTIs is expected to be April 2020. The HKMA/SFC said that there will be at least six months between the publication of the consultation conclusions and the proposed implementation date so as to allow sufficient time for market participants to carry out the necessary preparation work.
As an interim measure, a transition period is proposed during which USIs and TIDs may continue to be used. The transition period will end six months after both the UK and the EU have adopted the international standard on UTIs; the HKMA and the SFC will give notice of the exact end date of the transition period.
For new transactions which take place on or after the implementation date4 with no transaction identifier generated based on the US or the EU reporting requirements, a new UTI is required to be generated and reported.
After the transition period, all transactions submitted to the HKTR are required to be identified by a UTI.
Designated jurisdictions for the masking relief of the reporting obligation
Under the reporting rules5, a reporting entity can mask the identify of its counterparty when it reports its OTC derivative transactions to the HKTR if (i) there is a legal or regulatory prohibition in respect of the disclosure of such particulars and (ii) the counterparty is incorporated in or located in a jurisdiction designated by the SFC6.
In view of the report published by the FSB in November 2018 which re-categorised a number of jurisdictions as having no legal or regulatory prohibitions to the disclosure of counterparty identifying particulars or having prohibitions which are curable by standing consent, the HKMA/SFC propose to remove 17 jurisdictions from the current list of 18 designated jurisdictions for the masking relief, leaving only one jurisdiction (the PRC) on the list.
It should be noted that under the reporting rules7, once the SFC removes a jurisdiction from the designated list, reporting entities are required to unmask the relevant transactions (other than those which will have matured or been terminated before the end of the unmasking periods) within three months after the SFC gazettes a revised designated list, unless counterparty consent is required for the disclosure of the counterparty particulars in which case reporting entities have to unmask one month after obtaining counterparty consent. The regulators also propose that when unmasking counterparty particulars, reporting entities will only be required to submit counterparty information for the latest position (so called “snapshot approach”) and not for past life-cycle events.
Timing: In order to give market participants sufficient lead time to prepare for any unmasking of transactions before revocation of the 17 designated jurisdictions, the HKMA/SFC proposed that they will not publish the revised designated list in the Gazette on a date earlier than 1 October 2019.
Market participants are advised to plan ahead and get their systems in place to comply with the unmasking deadlines and obtain any counterparty consent required for the unmasking.
Update of the list of Financial Service Providers
By way of background, the Hong Kong clearing obligation applies, subject to the satisfaction of certain conditions, to a “prescribed person” (i.e. an authorized institution, a licensed corporation or an approved money broker) when it enters into a specified OTC derivative transaction with another prescribed person or a FSP. FSPs are major dealers outside Hong Kong.
The HKMA/SFC are now proposing to update the list of FSPs in line with its process of annual updates. Market participants with OTC derivatives trading relationships with the proposed new entities should note that the regulators will align the effective date of the updated list to the prescribed day of the calculation period nearest to when the consultation conclusion is published.
The regulators are targeting Q2 2019 for conclusion of the FSP proposal; assuming that the consultation conclusion is published in June 2019, prescribed persons subject to the clearing obligation in Hong Kong may have to start clearing specified products traded with the new FSP entities from 1 January 2020. Such prescribed persons are advised to allow sufficient time to negotiate and put in place the relevant clearing documentation.
Next steps
The proposals in the Consultation Paper will require system enhancements and modifications. Market participants likely to be affected by the changes should study the proposals and assess if they are able to implement the relevant system changes within the timeline proposed by the HKMA/SFC.
Linklaters has extensive experience in assisting clients with regulatory changes in the OTC derivatives space and would be delighted to assist you with working through the new proposals.
For further information, please contact:
Chong Liew, Partner, Linklaters
chin-chong.liew@linklaters.com
2 “CPMI IOSCO Technical Guidance – Harmonisation of Unique Transaction Identifier” issued by the CPMI and IOSCO in February 2017 (the “Technical Guidance”).
3 See Paragraph 26 (c) and (d) of the Consultation Paper for the situations where a new UTI is required.
4 The mandatory requirement to use UTIs only applies to the reporting of new trades (including their life-cycle events) which take place on or after the implementation date. For trades already reported to the HKTR without a transaction identifier (i.e. USI, TID or a bilaterally agreed unique identifier) before the implementation date, a new UTI is not required to be added to the HKTR report. Reporting entities are also not required to use a UTI when reporting life-cycle events (which take place on or after the implementation date) of previously submitted trades, unless a new UTI is required as described in Paragraph 26(c) and (d) of the Consultation Paper (see footnote 3)
5 Rule 26(1) of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules (Cap. 571AL of the Laws of Hong Kong) (the “Reporting Rules”)
6 The current designated jurisdictions are: Algeria, Argentina, Austria, Bahrain, Belgium, France, Hungary, India, Indonesia, Israel, Luxembourg, Pakistan, People’s Republic of China, Samoa, Singapore, South Korea, Switzerland and Taiwan.
7 Rule 26(2) of the Reporting Rules.
