Jurisdiction - Singapore
Reports and Analysis
Singapore – Consultation on Proposed Regulation of Over-The-Counter-Derivatives.

22 February, 2012

 

 

INTRODUCTION
 
On 13 February 2012, the Monetary Authority of Singapore (“MAS”) issued a consultation paper on a significant new proposal: to regulate the trading of over-the-counter (“OTC”) derivatives. The consultation takes into consideration the recommendations made by the Group of Twenty Finance Ministers and Central Bank Governors (“G20”), the Financial Stability Board (“FSB”) and other financial watchdog organisations on improving the regulation and supervision of the derivatives market. The closing date for feedback is 26 March 2012.
 
The consultation paper sets out the main policy positions to be taken in respect of OTC derivatives regulation. Mandatory central clearing will be required for certain categories of OTC derivatives. Reporting of OTC derivatives to trade repositories will also be mandated. Additionally, new regulatory frameworks for OTC market operators, clearing facilities, trade repositories and capital markets intermediaries will be set up.
 
In a related move, MAS has concurrently issued another consultation paper in which it proposes to take over the regulatory oversight for commodity derivatives from International Enterprise Singapore. This will consolidate and align the regulatory approaches for different types of derivative products.
 
DEFINITION OF “DERIVATIVE CONTRACTS”
 
In line with the proposed changes, MAS will expand the scope of the Securities and Futures Act (“SFA”) to apply to “derivative contracts” as a new class of instruments. “Derivative contracts” will be defined to encompass the five major underlying asset classes for which OTC derivatives are currently traded: commodities, credit, equities, foreign exchange and interest rates.
 
MANDATORY CLEARING AND TRADE REPORTING
 
MAS is proposing to mandate central clearing and reporting of derivative contracts. Interestingly, it has chosen not to mandate the use of centralised trading platforms at this stage, deviating from the position taken by the G20. MAS will continue to monitor developments in this area and is also seeking public feedback on alternatives to mandatory trading on an exchange or electronic platform.
 
The proposed mandatory clearing and reporting requirements will apply to financial institutions, as well as non-financial entities whose total assets and derivatives exposure exceed a certain threshold. The clearing or trade reporting may either be done locally with a domestic clearing house or trade repository (“TR”) or with foreign clearing houses or TRs recognised by MAS.
 
MAS is also considering imposing the clearing and trade reporting requirements on derivatives contracts which have a remaining maturity of more than one year.
 
Mandatory clearing
 
Applicable products From a preliminary review, MAS proposes to require Singapore Dollar and United States Dollar interest rate swaps and non-deliverable forwards denominated in selected Asian currencies to undergo mandatory central clearing.
 
Going forward, MAS will adopt two approaches in determining which new products should undergo mandatory clearing. The “bottom-up” approach relies on a central counterparty (clearing facility) to submit an application for MAS to consider a product for mandatory clearing. The “top-down” approach would be where MAS initiates a review to determine such products.
 
The criteria for determining whether a product should be subject to mandatory central clearing include: the level of systemic risk, the depth and liquidity of the market, and the international regulatory approaches taken towards such products.
 
Applicable derivative contracts
 
MAS proposes to require central clearing for all derivative contracts where at least one leg of the contract is booked in Singapore, and where either both parties are resident or have a presence in Singapore and are subject to the clearing mandate, or where one party is resident or has a presence in Singapore and is subject to the clearing mandate whereas the other would be subject to the clearing mandate if it was resident or has a presence in Singapore.
 
Exemptions
 
Foreign exchange forwards and swaps will be exempted from the clearing obligation. MAS explained that the main source of systemic risk for such contracts has already been addressed by having an established settlement risk mitigation system.
 
Intra-group trades of both financial and non-financial entities will be exempted, but these will be subject to appropriate collateralisation requirements.
 
Financial institutions with minimal exposure to derivative contracts, central governments, central banks and supranationals will not be required to carry out central clearing.
 
Mandatory trade reporting
 
Applicable products
 
MAS proposes that in due course, derivative contracts across all asset classes will be required to be reported. However, it will implement mandatory trade reporting in phases. The first batch of products which will be required to carry out trade reporting would be interest rate derivatives, foreign exchange derivatives; and oil derivatives.
 
The criteria for determining which products take priority for mandatory reporting include: the significance of such product in the Singapore market, the significance of Singapore’s trading in that product in the global OTC market, and international developments in OTC derivatives reporting.
 
Applicable derivative contracts
 
Mandatory trade reporting will apply to all contracts which are traded or booked in Singapore.
 
Exemptions
 
Financial institutions with minimal exposure to derivative contracts, central governments, central banks and supranationals will not be required to carry out mandatory reporting.
 
Mode of reporting
 
MAS has put forward a proposed protocol for single-sided reporting, where if there is a financial entity involved in the transaction, it will be mandatorily required to report. If the contracting parties are all non-financial entities, any one of the non-financial entities may make the report. Contracting parties may also rely on a third party to report on their behalf, but will retain responsibility for the timeliness and accuracy of the report.
 
Information to be reported
 
The proposed data to be reported follows the recommendations by the Committee on Payment Systems and Settlements and the International Organisation of Securities Commissions. An illustrative list of data fields is set out in the Annex to the Consultation Paper.
 
REGULATORY FRAMEWORK FOR MARKET OPERATORS
 
Currently, MAS already has in place a two-tier regulatory regime under the SFA covering approved exchanges and recognised market operators (“RMOs”) for the trading of securities and futures contracts. It intends to enhance and extend these regulations to cover operators of derivative markets as well.
 
For RMOs, MAS intends to accord differential regulation depending on whether the RMO is locally-incorporated or not. Locally-incorporated RMOs are directly supervised by MAS and therefore subject to a higher standard of scrutiny and closer oversight. For overseas RMOs, MAS will rely upon the supervision of their home country regulators and will also require such RMOs to regularly submit self-assessment reports to MAS.
 
REGULATORY FRAMEWORK FOR CLEARING HOUSES
 
Currently, clearing facilities regulated by MAS under the SFA are known as “designated clearing facilities”. MAS intends to move from the designation approach to a two-tier regulatory regime similar to that for market operators. Systematically-important clearing facilities will be regulated as approved clearing houses, whereas all other clearing facilities will be recognised clearing houses (“RCH”). As in the case of the RMOs’ regulatory regime, local and overseas RCHs will also be subject to differential regulation.
 
REGULATORY FRAMEWORK FOR TRADE REPOSITORIES
 
MAS only intends to regulate trade repositories (“TRs”) which facilitate market participants’ compliance with MAS’ trade reporting mandate. Such TRs will be required to seek authorisation by MAS. MAS contemplates that it may be possible for an existing trading platform or clearing facility which is already regulated by MAS to apply to be authorised as a TR.
 
A single-tier regulatory regime under the SFA will apply to approved TRs (locally-incorporated) and recognised overseas TRs. Similar to the proposed regimes for market operators and clearing houses, MAS will rely on the home regulators’ supervision of overseas TRs and require self-assessment reports.
 
REGULATORY FRAMEWORK FOR CAPITAL MARKETS INTERMEDIARIES
 
Currently, both licensed banks and non-bank entities engage in capital markets intermediary functions in the derivatives market. Licensed banks’ derivatives activities are already supervised by MAS as part of their banking supervisory role. On the other hand, non-bank intermediaries are currently not regulated by MAS.
 
MAS proposes to licence non-bank intermediaries which deal in derivative contracts where the underlying asset classes are any of the five major asset classes (see the paragraph titled “Definition of “derivative contracts” above). Such non-bank intermediaries will be issued a capital markets services (“CMS”) licence to carry out dealing in derivative contracts. MAS has indicated that it will only issue licences to entities which have an established track record and parentage, and which are reputable and financially strong.
 
“Dealing in derivative contracts” will include the following activities:
 
  • making or offering to make with any person, or inducing or attempting to induce any person to enter into, or to offer to enter into any agreement in respect of a derivative contract; and
  • soliciting or accepting any order for, or otherwise dealing in, a derivative contract.

 

Intermediaries which function as brokers in derivatives transactions will be exempted from licensing, provided they comply with certain requirements. End-users (parties who participate in derivatives transactions as price-takers, not price-makers) will not be regulated as CMS licensees.

 

COMMENTS

 

As this is a consultation on policy issues only, there will be many details which may have to be fine-tuned at a later stage. The following are some observations on the proposals.

 

One implication which arises from imposing a central clearing requirement is increased costs to market participants. For example, they will need to furnish the central clearing house with margins or collateral. Another concern which may arise is if insufficient clearing houses are approved. If MAS only approves one clearing house, there may be concerns about monopolistic business practices.

 

Another issue which arises and which may need to be thought through is the proposal that existing derivative contracts with remaining maturity of one year be subject to central clearing. This is likely to raise implementation challenges, which may in turn increase compliance costs.

 

In relation to mandatory reporting, it is unclear at this juncture who will have the right to access or use the information which has been disclosed to the trade repositories. It is likely that the home regulators of the reporting parties would wish to access this information. The consultation paper also makes it clear that MAS will seek to obtain information on contracts transacted between entities that neither have a presence nor are resident in Singapore but in which MAS has an interest. It is not clear at this juncture how MAS will determine what contracts it has an interest in. In addition, parties who access or handle the information would need to balance the reporting obligation with the relevant banking confidentiality requirements. It is unclear whether this reporting obligation will be made an exception to existing banking confidentiality requirements.

 

With new definitions come problems of what falls within the definitions. There will be uncertainty as to whether something falls within the definition of “derivative contract” or “dealing in derivatives contracts”. This may cause delay and add cost, for example, if legal advice has to be obtained or regulators have to be consulted for clarification. 

 
REFERENCES
 
Please click on the links below to access the relevant documents.
 
1. Consultation Paper on Proposed Regulation of OTC Derivatives
 
2. Consultation Paper on Transfer of Regulatory Oversight of Commodity Derivatives from IE to MAS
 
 
For further information, please contact:
 
Farhana Siddiqui, Partner, Drew & Napier
farhana.siddiqui@drewnapier.com
 
Eric Chan, Partner, Drew & Napier
eric.chan@drewnapier.com
 

 

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