18 October, 2018
On 28 September 2018 and 1 October 2018, the Monetary Authority of Singapore ("MAS") published its Response to Feedback Received on the Consultation Papers on Draft Regulations pursuant to the Securities and Futures Act ("SFA").
In our update last week, we looked at certain aspects of the first MAS Response and in this update, we will consider a few aspects of the second MAS Response. As the second MAS Response is fairly wide ranging, this update will focus on certain sections relating to the Securities and Futures (Licensing and Conduct of Business) Regulations ("SFLCBR"), and we will discuss the new Securities and Futures (Offers of Investments) (Securities and Securities-based Derivatives Contracts) Regulations 2018 in a separate update.
Licensing Requirements for Dealing in OTC Derivatives
Market participants which currently or plan to deal in OTC derivatives will undoubtedly be aware that the new regulations in Singapore will require such activity to be licensed (unless an exemption applies).
Until recently, dealing in OTC derivatives was not explicitly regulated under Singapore regulations. Certain types of OTC derivatives are caught by the licensing regime because they fall within the definition of "securities" (e.g. equity or bond derivatives) or constitute leveraged foreign exchange trading but otherwise, dealing in other types of OTC derivatives would not have required a licence. This has now changed because the new regulations contemplate licensing for dealing in "capital markets products" which will include OTC derivatives generally.
There is therefore a question as to what action (if any) needs to be taken by existing holders of a capital markets services licence ("CMSL holders") and exempt persons (e.g. licensed banks) in relation to the expansion of the licensing regime. Equally, what do market participants which have been unregulated to date have to do now, recognising that applying for a licence takes time?
In this regard, the MAS Response has provided useful flowcharts to guide market participants on what action (if any) needs to be taken (and by when).
Banks. For banks, assuming that you are currently dealing in regulated OTC derivatives (e.g. equity or bond derivatives), and that you are also currently dealing in unregulated OTC derivatives (e.g. interest rate swaps), then no further action is required. However, if you are not currently dealing in regulated OTC derivatives but are currently dealing in unregulated OTC derivatives, then you are required to notify MAS within two yearsfrom the commencement of the new SFA.
Existing CMSL holders. For existing CMSL holders, the situation is similar.
If you are already dealing in regulated OTC derivatives and are also currently dealing in unregulated OTC derivatives (or are planning to do so), no further action is required.
However, if you are not currently dealing in any OTC derivatives (e.g. if you hold a licence for dealing in futures contracts only) but intend to deal in regulated OTC derivatives or unregulated OTC derivatives, you will need to apply for a variation in your licence. This is similar to any other expansion in the scope of regulated activities conducted by a CMSL holder and a CMSL holder may not deal in the relevant OTC derivatives until the variation is approved.
But if you are already dealing in unregulated OTC derivatives, the situation is different. You would not have required a licence for that so your licence may be for dealing in futures contracts only (while you enter into interest rate swaps on the side). In such cases, there is a transition period of two years for you to apply for a variation in your licence to add dealing in OTC derivatives.
Unregulated entities. For entities that do not hold any licence with MAS, for example, an entity that currently deals in only unregulated OTC derivatives, then, assuming status quo, it will be required to apply for a licence within two years from the commencement of the new SFA. However, if you intend to deal in unregulated OTC derivatives only after the commencement of the new SFA, there is no such transition period – you may only commence dealing in such OTC derivatives after your application for a licence is approved.
Risk Mitigation Requirements
The amended SFLCBR contains a new Regulation 54B which requires certain exempt persons to implement policies and procedures in relation to certain risk mitigation techniques when dealing in uncleared OTC derivatives with counterparties who are accredited investors, expert investors or institutional investors("Professional Investors").
Broadly speaking, this will affect banks, merchant banks and finance companies which deal in OTC derivatives because it is expected that not all of their OTC derivatives will be cleared and the bulk of the counterparties will be Professional Investors.
Regulation 54B requires the bank, merchant bank or finance company to implement policies and procedures in relation to :
- execution of trading relationship documentation prior to or contemporaneously with entry into trade;
- timely provision of trade confirmations;
- portfolio reconciliation at regular intervals;
- assessing necessity of portfolio compression at regular intervals; and
- dispute resolution.
These requirements are framed at a very high level and are intended to be non-prescriptive so that a bank, merchant bank or finance company may assess the manner in which its policies and procedures ought to be implemented. That said, the high level nature of the rules mean that there may be many questions surrounding interpretation.
For example, does timely provision of trade confirmation require a T+1 timeline and how does it affect your current operational set-up? How would you assess the frequency of portfolio reconciliation and what are the material terms and valuations that are required to be reconciled?
How would you undertake portfolio reconciliation with Professional Investors? How would you assess the frequency of portfolio compression? Does the requirement in relation to dispute resolution necessitate a repapering of some of your relationships?
Although the MAS Response does not shed light on all of the questions above, it has helpfully clarified that the risk mitigation requirements ("RMRs"):
- apply to only uncleared OTC derivatives that are booked in Singapore. This is consistent with the margin requirements; and
- apply to all Professional Investors, including private banking clients, but the form in which the RMRs take may differ. For instance, the trading relationship documentation may be a trading account agreement and a portfolio reconciliation may take the form of a statement of account.
- This recognises the fact that for private banking clients, there may not be an ISDA Master Agreement but rather a "mini-master" agreement that has to be read together with the other account documentation.
- In terms of whether statements of account can be used for the purposes of portfolio reconciliation, this may depend on the frequency at which they are produced and also the content – do they contain the "material terms" and "valuations" that are required to be reconciled? Furthermore, is there an existing process for a customer to raise discrepancies?
As such, an assessment of the internal processes would have to be undertaken to determine how compatible they are with the RMRs. For global institutions that are already subject to RMRs of one or more other jurisdictions, there is also a question as to whether compliance with the rules of your home jurisdiction (or another relevant jurisdiction) is sufficient for the purposes of, and is otherwise compatible with, compliance with Regulation 54B.
Record Keeping Requirements
Regulation 39 of the SFLCBR requires a CMSL holder to keep books containing the particulars of every customer and every transaction. In relation to OTC derivatives, a new limb has been added and the particulars include:
- price, fees, commissions and other expenses; and
- the terms and conditions including margin requirements.
In this regard, MAS has clarified that the record keeping requirements apply to OTC derivatives that are either traded or booked in Singapore.
This is consistent with the reporting rules which require every specified person to ensure that all relevant books and all transaction information be kept for at least 5 years.
For further information, please contact:
Kai Loon Loh, Ashurst
kailoon.loh@ashurst-adtlaw.com
