Hong Kong's securities and banking regulators have issued a joint consultation proposing certain carve-outs from requirements under the over-the-counter ("OTC") derivatives regulatory regime. The consultation proposals reflect concerns raised by market participants through the International Swaps and Derivatives Association ("ISDA") in the lead-up to the introduction of mandatory reporting for OTC derivatives transactions on 1 July.
While the Hong Kong Monetary Authority ("HKMA") and the Securities and Futures Commission ("SFC") supported the proposals, they warned that the earliest the necessary legislative amendments could come into force would be in October this year.
"It … will not in any event be possible for the changes discussed in this paper to take effect before the scheduled commencement of phase 2 reporting on 1 July 2017. In view of this, market participants who envisage difficulty in complying with their phase 2 reporting obligations prior to any such changes taking effect, should contact their respective regulator as soon as possible," the regulators said.
The two regulators said they wanted to expand the list of markets and clearing houses prescribed under s. 392A of the Securities and Futures Ordinance ("SFO"). This would have the effect of excluding them from the OTC derivatives regulatory regime, as the regime is not intended to encompass products that are traded on an exchange and cleared through a clearing house.
The markets and clearing houses involved are:
- Hanoi Stock Exchange
- HoChiMinh Stock Exchange
- Miami International Securities Exchange, LLC
- Pakistan Stock Exchange
- Taipei Exchange
- Taiwan Stock Exchange
- The Irish Stock Exchange Plc Main Securities Market
- Clearstream Banking, S.A.
- Euroclear Bank S.A./N.V.
- National Clearing Company of Pakistan Limited
- Taiwan Stock Exchange Corporation
- Vietnam Securities Depository
The consultation also proposed excluding a certain type of warrant from the OTC regime. Delta One warrants, the regulators said, were different from other OTC derivative products in that they did not contain features commonly associated with OTC derivatives.
In particular, a Delta One warrant is fully funded and therefore the counterparty risk involved is simpler than most OTC derivatives, they said. Furthermore, the strike price of a Delta One warrant is zero or close to zero, and as such the holder of the warrant has effectively paid for the underlying assets in full upfront, and is not providing any leverage to the holder. In contrast, most OTC derivatives typically involve some leverage exposure, they said.
"We consider that Delta One warrants do not pose systemic risk in the way that other OTC derivative products might," the regulators said. "We note also that retaining these products within the ambit of 'OTC derivative product' may unnecessarily hinder market development and create compliance burdens."