Friday, December 10, 2010

Hong Kong Will Require Central Clearing and Trade Repositories for OTC Derivatives

Hong Kong regulatory authorities announced that they will implement a trade repository and central counterparty regime for OTC derivatives in line with G-20 principles and harmonized with the Dodd-Frank Act derivatives regulatory provisions and the derivatives legislation that emerges from the European Union. The Securities and Futures Commission said that it would work with the Hong Kong Monetary Authority and Hong Kong Exchanges to establish a regulatory regime for OTC derivatives transactions in Hong Kong with the goal of enhancing the transparency of and reducing overall counterparty risk in the OTC derivatives markets.

Martin Wheatley, SFC Chief Executive Officer, said that establishing a regulatory regime for OTC derivatives markets is an important move for Hong Kong to keep pace with international initiatives on this front. He also pledged that the SFC will closely monitor overseas developments with a view to bringing the Hong Kong derivatives regulatory regime appropriately in line with those that are taking shape in other major markets.

The regulatory regime would cover the reporting of OTC derivatives transactions, particularly those which are relevant to the Hong Kong market, to the trade repository and the clearing of standardized OTC derivatives transactions through an authorized central clearing party.

Initially, the reporting and clearing requirement will be applied to interest rate swaps and non-deliverable forwards. Consideration will be given to extending the requirement to other appropriate OTC derivatives asset classes after the initial roll out, noted the SFC, having regard to local and overseas market developments including any further guidance from international regulatory bodies.

The Hong Kong regulators envision that the trade repository will be a centralized registry that maintains an electronic database of records of OTC derivatives transactions. By providing OTC derivatives transactions information to regulators, the trade repository plays a vital role in supporting authorities in carrying out their market surveillance responsibilities, which will help maintain stability of the financial systems in Hong Kong. It also helps increase transparency in the market, promotes standardization, and provides a level of consistency in the quality and availability of transaction data.

Central clearing of OTC derivatives trades helps reduce counterparty risk in a financial system and is conducive to effective regulatory oversight of the trades. With the background of Hong Kong’s extensive experience in the central clearing of exchange-traded securities and derivatives transactions, the regulators believe that the system is well equipped for the clearing of OTC derivatives trades in Hong Kong.

The SFC plans to consult the market on the regulatory regime by the third quarter of 2011, so that there is sufficient time to prepare for the roll out of the regime by the end of 2012. This scenario will comply with the September 2009 G-20 communiqué that called for all standardized OTC derivative contracts to be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012 at the latest. The G-20 also said that OTC derivative contracts should be reported to trade repositories.

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