In light of public comment, the Hong Kong Monetary
Authority and Securities and Futures Commission have revised a joint legislative
proposal for a regulatory regime for Hong Kong ’s
over-the-counter (OTC) derivatives market. Significantly, the revision narrowed
the cross-border reach of the derivatives regulatory regime. The regulators
reacted to widespread concern about the extraterritorially reach of the
proposed mandatory reporting and clearing obligations. In particular, there was concern about extending these
obligations in respect of transactions that are only originated or executed in
Hong Kong or that have a tenuous Hong Kong nexus.
The regulators originally proposed that an
overseas-incorporated financial institution should report a transaction if it
has become a counterparty to the transaction through its Hong Kong branch, it has originated or executed the transaction
through its Hong Kong branch, or the transaction has a Hong Kong nexus and the financial
institution has become a counterparty to it, albeit not through its Hong Kong
branch.
The revised proposal narrows the reporting obligation
of overseas-incorporated financial institutions so that it only applies where
the firm has become a counterparty to a reportable transaction through its Hong
Kong branch, or the firm has originated or executed a reportable transaction
through its Hong Kong branch and the transaction has a Hong
Kong nexus. Thus, the
original proposal to require reporting where the Hong Kong
branch has become a counterparty to the transaction will remain. However, the
original proposal to require reporting where the Hong Kong branch has
originated or executed the transaction will be tightened by adding a
requirement for the transaction to have a Hong Kong
nexus. The concept of originated or executed itself will also be tightened. The
original proposal to require reporting where the Hong Kong
branch is not involved at all was removed
The important concept of Hong Kong
nexus was introduced in the proposed legislation to define the reporting
obligation of an overseas-incorporated financial institution. The definition of
Hong Kong nexus was fine-tuned in the revised proposal to mean, in the case of equity derivatives and credit
derivatives, that the underlying entity or the reference entity is listed in
Hong Kong, and where there is more than one underlying entity or reference
entity, a specified percentage of the entities are listed in Hong Kong, or that
the underlying is an index and a specified percentage of the underlying
companies are listed in Hong Kong, or that the reference entity is, or is
wholly owned by, the Government of the Hong Kong Special Administrative Region.
In the case of other derivatives, there will be a Hong Kong nexus if the
underlying asset, currency or rate is denominated in or related to (or includes
an asset, currency or rate that is denominated in or related to) Hong Kong
dollars or Renminbi.
With regard to the specified
percentages used in the revised proposal, the regulators said that they are
considering several options and promised to provide more details in the fourth
quarter of 2012.
Further, the regulators explained that it was important
to include Renminbi within the scope of the Hong King nexus because Hong Kong is a major offshore Renminbi business center
and many financial institutions are active in conducting Renminbi deliverable
and non-deliverable derivatives transactions. Thus, there is a need for the SFC
and the Monetary Authority to monitor the exposure of financial institutions to
these transactions as well as any systemic risk that such transactions in
aggregate might pose.