CONSULTATIONS ON OTC DERIVATIVES AND CONDUCT RISK

On 20 December 2017 the Securities and Futures Commission (‘SFC’) issued a consultation paper to refine the over-the-counter (‘OTC’) derivatives regime in Hong Kong and to propose conduct requirements to address risks posed by group affiliates (the ‘Consultation Paper’).

As a result of the consultation conclusion released by SFC on the primary legislation for the regulation of OTC derivatives in 2013 and the enactment of the Securities and Futures (Amendment) Ordinance in April 2014, Schedule 5 to the Securities and Futures Ordinance (Cap. 21) (‘SFO’) was amended to introduce (i) the dealing in or advising on OTC derivatives (Type 11); and (ii) the providing of client clearing services for OTC (Type 12) as regulated activities (‘RAs’) under the SFO. Market participants engaging in these activities should obtain a license(s) from the SFC.

After the introduction of Type 11 and Type 12 RAs, SFC noted some comments from the market on the scope of these RAs and proposed to refine their scope to provide clarity on the OTC derivatives licensing regime, for example, to narrow the scope of certain RAs so that they do not capture corporate treasury activities of non-financial groups, certain portfolio compression services and overseas clearing members and their agents.

The Consultation Paper also includes proposals on risk mitigation, client clearing, record keeping and other conduct requirements for OTC derivatives transactions, as well as licensing fees, insurance, competence and training requirements under the new OTC derivatives licensing regime. It further proposes to require licensed corporation to properly manage their financial exposures to group affiliates and other connected persons according to the same risk management standards they would apply in respect of exposures to independent third parties undertaken by the licensed corporations on an arm’s length basis in order to minimise interconnectedness risk.

The Law Society considers the proposals to be broadly appropriate and proportional in nature, bearing in mind the International Organization of Securities Commissions context and the novel issues created under the incoming regime. It will be important to monitor the new regime for unintended consequences and to remediate issues arising. Elements of the flexible approach intended and stated by the SFC are to be welcomed.

The full submission of the above is at:

http://www.hklawsoc.org.hk/pub_e/news/submissions/20180227a.pdf

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