HK OTC derivatives reform too fast: HKIFA

The Hong Kong Investment Funds Association says the territory’s regulators should take their cue from Europe and the US before proceeding with new proposals.
HK OTC derivatives reform too fast: HKIFA

Hong Kong regulators this week gave more clarity on how portfolio managers, fund trustees and managers of funds domiciled in the territory will be affected by mandatory reporting and clearing requirements with regard to over-the-counter derivatives.

But some in the asset-management industry feel the Hong Kong Monetary Authority (HKMA) and Securities & Futures Commission (SFC) should slow down and take their cue from regulators in Europe and the US.

Concluding its consultation launched in October on the proposed regulatory regime for OTC derivatives, the HKMA and SFC said in a document released on Wednesday (July 11) that they would likely exempt central banks, monetary authorities and supranational agencies such as the International Monetary Fund.

Exemption from the rules also appears likely for sovereign wealth funds, but this will depend on whether Hong Kong entities enjoy reciprocal exemptions in the respective jurisdictions of these monetary authorities or public bodies.  

However, requests from industry players to exempt pension funds have not been entertained.

Sally Wong, executive director of the Hong Kong Investment Funds Association, says the association generally welcomes the overall direction of the proposed OTC regime. But she warns against the city implementing its own requirements ahead of those being finalised under US and European OTC regimes, the US Dodd Frank Act and European market infrastructure regulations.

“We still urge Hong Kong regulators to await more clarity from the OTC reforms being led by regulators in the US and Europe before implementing their own,” adds Wong. “Given that Hong Kong’s share of the world’s OTC market remains insignificant, there is no reason why Hong Kong should implement them ahead of [the other major jurisdictions].”

Industry players have long been concerned that the lack of global regulatory alignment could create the possibility of regulatory arbitrage that would defeat the aim of all these global OTC reforms which is to reduce systemic risk.

The near-two-month consultation has drawn keen interest from the asset-management industry. The 34 submissions received included submissions from pension fund managers such as Dutch institution APG; hedge funds like Vicktor Capital (Asia); custodians including State Street Bank and Trust; and industry associations such as the HKIFA and Alternative Investment Management Association.

Investment funds would be caught by the reporting and clearing requirement under the definition of them being “Hong Kong persons”, once domiciled in the territory. Fund managers licensed by the SFC will also have to report and clear, but they will be defined as “licensed corporations”, so will be regulated differently.    

For investment funds, the HKMA and SFC say the reporting obligation will rest with the legal owner of the fund assets – for example, a fund trustee if the fund is structured as a trust.

“Hong Kong persons” will need to report and clear OTC transactions when they exceed a certain threshold, which will be decided in a separate round of consultation slated for the fourth quarter.

In a departure from how banks are treated, OTC transactions not related to or denominated in Hong Kong dollars, Hong Kong dollar interest rates or referencing entities listed or incorporated in Hong Kong are still subject to mandatory reporting by funds as “Hong Kong persons”. A local trade repository set up by the HKMA will start receiving OTC transaction information starting in the fourth quarter.

On clearing, asset managers will have to clear their OTC trades at a recognised clearing house if the gross position of an eligible trade held by both the asset manager and its counterparty exceeds a certain threshold, to be decided in the next consultation slated for the fourth quarter.

Both local and overseas central counterparties (CCPs) can apply to become recognised clearing houses; currently the only one expected to be recognised is the CCP being set up by Hong Kong Exchanges & Clearing.

Initially, clearing will only be required for certain types of interest-rate swaps (IRSs) and non-deliverable forwards (NDFs); but will be extended in phases to cover other interest-rate and foreign-exchange derivatives and other asset classes such as credit and equity derivatives. The HKEx’s CCP is due to go live by the fourth quarter.

Singapore Exchange was the first bourse in Asia to offer OTC clearing of IRSs and NDFs, in 2010, ahead of clearing being made mandatory by the authorities.

Demand began to gain momentum earlier this year among global asset managers with a presence in Asia to send OTC trades for clearing voluntarily, says Thomas Treadwell, Asia-Pacific head of OTC clearing at Citi in Singapore.

“We have seen a significant increase in client clearing in Asia over the past few months from a group of our key clients putting their OTC trades on our clearing platform,” says Treadwell.

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