.jpg)
13 April, 2018
On 27 March 2017, the Securities and Futures Commission (“SFC”) launched a one-month consultation1 on proposals to enhance the over-the-counter (OTC) derivatives regime in Hong Kong; in particular, (i) to mandate the use of Legal Entity Identifiers (“LEIs”) for the trade reporting obligation, (ii) to expand the product scope applicable to the clearing obligation and (iii) to adopt a trading determination process for introducing a platform trading obligation.
With respect to the trade reporting and the clearing obligations that have already been implemented in Hong Kong, the SFC’s proposed changes will fine-tune the existing obligations; no substantial changes are being introduced at this stage. The SFC’s proposals were made having regard to the data available from Phase 2 reporting. The gradual nature of the proposals demonstrates that the SFC has got the right balance in its implementation of the mandatory obligations in the previous phases.
Deadline for submitting comments to the SFC is 27 April 2018.
Mandating use of LEIs for the reporting obligation
Currently, a variety of identifiers2 may be reported to the Hong Kong Trade Repository (“HKTR”) to indicate the identity of entities in reportable data fields. The SFC proposes to mandate the use of LEIs in OTC derivatives trade reporting so that all reports to be submitted to the HKTR must include LEIs for the following entities if they are required to be reported in the mandatory data fields:
a) entities subject to the reporting obligation (i.e. the reporting entities);
b) transacting parties that reporting entities report or act for;
c) HKTR members;
d) central counterparties (“CCPs”);
e) providers of clearing services; and
f) other entities that are transacting parties to reportable trades but do not fall into any of the above categories.
Implementation dates: The mandatory use of LEIs for trade reporting in Hong Kong is proposed to be phased. An entity belonging to categories (a) to (e) above is required to be identified with an LEI six months after publication of the conclusions to the Consultation Paper. Entities in category (f) are expected to be small-sized entities that are transacting parties to reportable trades not subject to any reporting obligation; they are given a longer period to obtain LEIs and the proposed date for these entities to be identified by an LEI is January 2020.
The mandatory use of LEIs only applies in the reporting of new trades and life-cycle events that take place on or after the implementation dates. For valuation information in a transaction report, since only the reporting entity (but not the transacting parties) is required to be identified in the relevant HKTR template, the requirement to use LEIs will be applicable to identify the reporting entity for the reporting of daily valuation information on or after the implementation date.
The SFC noted that LEIs were used to identify the transacting parties in around 90% of the outstanding transactions reported to the HKTR. A number of overseas jurisdictions have also introduced LEI requirements. It is therefore not expected that the new proposals will cause major difficulty; parties who do not yet have an LEI are advised to apply for one as soon as possible.
Phase 2 Mandatory Clearing
Expansion of product scope to include Australian dollar-denominated interest rate swaps
Phase 1 clearing came into effect on 1 September 2016 and covered certain types of interest rate swaps (“IRS”), namely, fixed-to-floating swaps and basis swaps denominated in HKD and G4 currencies, as well as overnight index swaps (“OIS”) denominated in USD, EUR and GBP. Having regard to trade data reported to the HKTR in Phase 2 reporting, the SFC is proposing to mandate plain vanilla AUD IRS with the following features to be subject to the mandatory clearing obligation for Phase 2 clearing:
|
Type of IRS |
Currency |
Floating Rate Index |
Tenor |
Optionality |
Constant Notional |
|---|---|---|---|---|---|
|
Basis swaps |
AUD |
BBSW |
28 days to 10 years |
No |
Yes |
|
Fixed-to-floating swaps (except OIS) |
AUD |
BBSW |
28 days to 10 years |
No |
Yes |
|
Type of IRS |
Currency |
Floating Rate Index |
Tenor |
Optionality |
Constant Notional |
|---|---|---|---|---|---|
|
OIS |
AUD |
IBOC |
7 days to 2 years |
No |
Yes |
Prescribed persons, clearing thresholds
Phase 1 clearing was intended to cover inter-dealer trades. The SFC had therefore specified the following types of persons to be subject to the Phase 1 clearing obligation (the “prescribed persons”): authorized institutions (“AIs”), approved money brokers (“AMBs”) and licensed corporations (“LCs”). A prescribed person has an obligation to clear specified OTC derivative transactions through a designated CCP when it trades with another prescribed person or a financial services provider (“FSP”), subject to the crossing of certain clearing thresholds applicable to prescribed persons.
The SFC noted in the Consultation Paper that, based on data reported under Phase 2 reporting, the OTC derivatives market in Hong Kong continues to be dominated by inter-dealer trades. The SFC therefore proposes to maintain the current scope of prescribed persons.
The current clearing thresholds (US$20 billion) also seems to be effective in capturing the major dealers in Hong Kong for clearing: the SFC noted that the current threshold captures institutions that, in aggregate, account for approximately 96% of all AIs’ OTC derivatives positions. The current clearing threshold and the calculation method for measuring outstanding positions against the threshold are also proposed to be unchanged. In addition, the frequency and length of calculation periods will remain unchanged, with eight new calculation periods being added till November 2022.
Financial Service Providers
The concept of FSP was introduced in Phase 1 to identify the major dealers outside Hong Kong. The SFC proposes to maintain the current criteria for identifying major overseas dealers as FSPs. Under the current criteria, an entity will be designed as an FSP if it:
(i) is a member of the largest IRS CCPs in the US, Europe, Japan and Hong Kong; and
(ii) belongs to a group appearing on the list of global systemically important banks (GSIBs) published by the Financial Stability Board (“FSB”), and/or on the list of dealer groups (G15-dealers) which undertook to the OTC Derivatives Supervisors Group to work collaboratively with central counterparties, infrastructure providers and global supervisors to continue to make structural improvements to the global OTC derivatives markets.
The SFC noted in the Consultation Paper that it has considered whether to extend limb (i) above to cover affiliates of clearing members of major IRS CCPs. The SFC concluded that the additional compliance costs do not justify such a proposal. The SFC noted that over 93% of the IRS transactions between group entities of GSIBs or G15-dealers and prescribed persons were transacted through entities in the current FSP list.
Updating the FSP list
The list of FSPs is proposed to be revised to reflect (i) the changes in the list of GSIBs issued by the FSB in November 2017 and (ii) the new entities that are part of a GSIB group or G15-dealers group that have become members of major IRS CCPs since the list was last drawn up by the SFC.
Note that FSP entities in the current list which (1) belonged to GSIB groups that have since been removed from the GSIB list and (2) are no longer members of IRS CCPs are proposed to be kept in the list to minimise changes. The SFC’s rationale is that these entities will still have access to clearing services (which in the second case will be via their clearing member affiliates).
Trading determination process for introducing a platform trading obligation
Provisions for the introduction of a trading obligation (where standardised derivatives contracts are traded on exchanges or electronic trading platforms) were included in the Securities and Futures Ordinance although the SFC has yet to implement such obligation. The SFC is still studying the feasibility, scope and timing for implementing the mandatory trading obligation in Hong Kong.
However, it has taken a first step towards the possible introduction of a platform trading obligation by proposing to formally adopt a trading determination process for considering which products are appropriate to be subject to a platform trading obligation in Hong Kong. The SFC proposes that the following factors should be taken into account in such process:
a) whether the product is sufficiently standardised for platform trading;
b) the nature, depth and liquidity of the market for the product;
c) the availability of trading venues that may be designated for trading that product;
d) whether the product is already subject to the central clearing obligation in Hong Kong;
e) whether regulators in other jurisdictions consider such a product to be suitable for platform trading; and
f) the impact on the market and market participants of imposing a platform trading obligation for the product.
Timing
As mentioned above, the mandatory use of LEIs for trade reporting in Hong Kong for “Phase 1” entities will commence six months after publication of the conclusions to the Consultation Paper – such commencement date expected to be end of 2018.
For Phase 2 clearing, the SFC aims to publish the revised FSP list in the Government Gazette in the second half of 2018. The expanded product scope and addition of further calculation periods will require legislative amendments – the SFC is aiming to table the amendments before the Legislative Council in the next legislative session that commences in September 2018.
The SFC aims to adopt the trading determination process by June 2018.
2 For example, TR Member Codes issued by the HKTR, LEIs issued under the Global LEI System, BICs issued by SWIFT, certificate of incorporation numbers or certificate of registration of non-Hong Kong company numbers issued by the Company Registry in Hong Kong and business registration numbers issued by the Inland Revenue Department.
For further information, please contact:
Andrew Malcolm, Partner, Linklaters
andrew.malcolm@linklaters.com
