Jurisdiction - Hong Kong
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Hong Kong – Issues Consultation Paper On Draft Rules For Mandatory Reporting And Related Record Keeping In Relation To OTC Derivatives

6 August, 2014


Legal News & Analysis – Asia Pacific – Hong Kong – Regulatory & Compliance


The Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission (“SFC”) have recently issued a joint consultation paper (“CP”) detailing their proposed requirements relating to the mandatory reporting and record keeping obligations for over-the-counter (“OTC”) derivative transactions in Hong Kong. The CP sets out the draft proposed Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping) Rules (“Draft Rules”) and is the first of a series of further consultations on the subsidiary legislation under the Securities and Futures (Amendment) Ordinance 2014 (“Amendment Ordinance”).


The Amendment Ordinance was enacted in response to the 2008 global financial crisis, which highlighted the importance of regulating the OTC derivatives market. The Amendment Ordinance was enacted by the Legislative Council (“LegCo”) in April 2014 after the conclusion of two prior consultations. It is anticipated that the Amendment Ordinance will come into effect in 2015. For further details relating to the history and development of OTC derivatives reform in Hong Kong, please refer to the chronology at the end of this bulletin.


A. New Proposals Following Earlier Consultations


We summarise below the key developments set out in the CP:


  • Instead of relying on the ‘Hong Kong nexus’ test, as suggested in previous consultations, the CP states that authorized institutions (“AIs”), approved money brokers (“AMBs”) and licensed corporations (“LCs”) will be under an obligation to report reportable transactions that they have conducted in Hong Kong on behalf of an affiliate, or have entered into on behalf of a counterparty in their capacity as a person licensed or registered to carry on Type 9 regulated activity (asset management) for that counterparty.
  • Central counterparties (“CCPs”) that operate in Hong Kong as recognised clearing houses (“RCHs”) or that are authorised to provide automated trading services (“ATS-CCPs”) will also be required to make mandatory reports.
  • ‘Exempt persons’ relief (which cannot be recovered once lost) is available for AIs, AMBs and LCs to ensure that intermittent participants in the OTC derivatives markets, or those who wish to enter into OTC derivative transactions for commercial hedging reasons, are not discouraged from doing so because of the introduction of mandatory reporting.
  • A Hong Kong person will not need to report a reportable transaction if the transaction is also subject to reporting by an AI, AMB or LC. The scope of this exemption differs from what was proposed in the earlier consultations as a result of: (i) the removal of the ‘Hong Kong nexus’ requirement; and (ii) the revised ‘conducted in Hong Kong’ test.
  • Related record keeping requirements are proposed in light of the introduction of similar requirements in other jurisdictions implementing OTC derivatives regulation.
  • An express exemption from making mandatory reports will not be granted to central banks, monetary authorities, public bodies and global institutions, on the basis that they are unlikely to fall within the types of entities that are subject to mandatory reporting obligations.
  • Following the implementation of the Draft Rules and at a subsequent phase in the future, AIs, AMBs, LCs, RCHs and ATS-CCPs will be required to provide a daily mark-to-market valuation of all transactions they have reported to the HKMA, for as long as the transactions remain outstanding.


B. Summary Of Proposals Under The CP


The current proposals focus on mandatory reporting and related record keeping, and cover the following six areas:


1) The types Of Transactions Which Will Have To Be Reported – The mandatory reporting obligation will initially cover certain types of OTC derivative transactions (“product types”) falling within two specified product classes (“product classes”), namely interest rate swaps (“IRS”) and non-deliverable forwards (“NDF”) (collectively, “reportable transactions”).


2) The Persons And Types Of Organisations Subject To Reporting  The reporting obligations will apply to AIs, AMBs, LCs and other persons prescribed in the Rules. According to the Draft Rules, ‘other persons’ will include:


  •  CCPs that are RCHs or ATS-CCPs;
  •  all Hong Kong residents and entities established under Hong Kong law; and
  •  all overseas companies registered or required to be registered under the Companies Ordinance (excluding non-corporate entities established overseas, even if they are registered or have a presence in Hong Kong).


AIs, AMBs and LCs should report reportable transactions that:


  •  they are a counterparty to;
  •  they have conducted in Hong Kong on behalf of an affiliate (in the case of an overseas AI, where its Hong Kong branch conducts a reportable transaction on behalf of its head office or other branch outside Hong Kong, it will have to report the transaction); or
  •  they have entered into on behalf of a counterparty in their capacity as a person licensed or registered to carry on Type 9 regulated activity (asset management) for that counterparty, and in respect of offshore funds, transactions will have to be reported by the fund manager (or sub-fund manager) if the fund manager enters into the transaction on behalf of the fund and is an AI or LC registered or licensed for Type 9 regulated activity.


For these purposes a transaction will be considered to have been ‘conducted in Hong Kong’ on behalf of an affiliate where the trader entering into the transaction:


(a) is the person making the trading decision (i.e. sales teams will generally not be caught);


(b) is employed or engaged by the AI, AMB or LC; and


(c) must be performing his/her functions substantially in Hong Kong.


The effect of limb (c) is notable, as this means that transactions executed by a trader meeting the above criteria will be caught even where that trader is outside Hong Kong at the time of execution.


The HKMA will charge a fee for reporting transactions through the Hong Kong Trade Repository (“HKTR”). At present the proposed rate is HKD 3 for each transaction that is still outstanding on the last business day of the month, with the reporting fees capped at HKD 1m per reporting entity per annum.


3) Exemptions And Reliefs – The Draft Rules provide for a number of exceptions to the general reporting obligation, namely:


(i) Exempt persons, being persons who meet all of the following criteria:


(a) they are not involved in conducting OTC derivative transactions or entering into transactions on behalf of another person whose assets they manage; and

(b) they can only have a maximum of five outstanding OTC derivative transactions at any time; and


(c) the aggregate gross notional value of their outstanding OTC derivative transactions is not more than US$30 million; and


(d) the counterparty to the transaction is not a Hong Kong person.


Please note that for a branch of an overseas incorporated AI, the criteria described in (a) to (d) will only apply to the Hong Kong branch.


This relief cannot be revived once lost. As such, licensed banks that have already made arrangements to report their transactions for a particular product class under the interim reporting regime will not be entitled to this relief in respect of that class.


(ii) Hong Kong persons where the transaction is reportable by an AI, AMB or LC.


However, this relief will not apply where:


(a) the Hong Kong person enters into the transaction directly via the overseas office of an AI incorporated outside Hong Kong; or


(b) the Hong Kong person clears the reportable transaction but does so using client clearing services provided by a person other than an AI, AMB or LC; or


(c) the transaction has been cleared by a CCP, as this relief is limited to transactions involving an AI, AMB or LC.


(iii) Hong Kong persons where a fund manager has reported – Where a transaction is reportable by both a fund manager and the legal owner of the assets under management, the latter will be exempted from reporting that transaction.


(iv) Relief for an AI, AMB or LC where an affiliate has reported.


(v) Relief for partners in a partnership where one partner or authorised person has reported on behalf of the partnership.


(vi) Relief for a reporting entity when it has an extended period to report a transaction, and the transaction expires or reaches maturity within the extended period.


4) Reporting Timeframes And Applicable Grace Periods For Reporting Outstanding Transactions (i.e. Backloading) – new transactions and subsequent events must be reported within two business days (T+2) unless they are entered into within three months of the product type specification day, in which case they may be reported at any time within six months from that day.


Backloading/historical transactions must be reported within six months in the case of Hong Kong persons, and within three to six months in the case of other reporting entities. These reporting periods can be shortened when an entity becomes an AI, AMB, LC, RCH or ATS-CCP, or when an entity becomes entitled to the exempt persons relief.


5) The Form, Manner And Contents Of Reports – Where a transaction is reportable, it must be reported to the HKMA via the HKTR. Alternatively, the market participants can report their transactions to the HKMA via an agent.


The proposed content of the reports is set out in Schedule 2 to the Draft Rules and include matters such as identifying the product class and product type to which the transaction belongs.


Non-disclosure of the particulars of a counterparty in reports will only be permitted where:


 (i) the laws of an overseas jurisdiction (which is designated by the SFC with the HKMA’s consent) prohibit the disclosure of such information; or


 (ii) in respect of historical transactions, the disclosure of the particulars requires the consent of the counterparty, and despite reasonable efforts, such consent cannot be obtained.


If either of the above limitations on disclosure is removed, the Draft Rules state that the particulars of the counterparty should then be reported.


6) Related Record Keeping Obligations – Relevant persons are required to keep records that, amongst other things, demonstrate compliance with the reporting obligations set out under the Draft Rules, or otherwise records evidencing that the requirements for exemptions are met.


Where reporting is done via an agent or an affiliate, records relating to the agent’s appointment and its compliance with the reporting requirements for a transaction, or the affiliate’s confirmation of compliance with those requirements should be monitored. Such records must be kept for at least 7 years after the relevant transaction has reached maturity or has been terminated. These records must also be stored in such a way so that they can be made available to the HKMA and/or the SFC upon request.


The Draft Rules on mandatory reporting and related record keeping obligations are the first in a series of regulatory reforms and resulting new rules that will impact on the Hong Kong OTC derivatives markets. Any LCs, banks and unlicensed entities dealing in or advising on OTC derivative transactions are advised to consider the scope and effect of these obligations on their businesses, and stay tuned for further developments in the licensing regime, in particular on mandatory clearing and trading.


C. History Of The Regulatory Reform And Future Developments For The OTC Derivatives Markets


Date Event 
December 2010 Announcement by the HKMA to develop the HKTR and to link it to the CCP for OTC derivatives, which was launched by the Hong Kong Exchanges and Clearing Limited (“HKEx”) 
17 October 2011 – 30 November 2011  Joint consultation by the HKMA and the SFC on the proposed regulatory regime for Hong Kong’s OTC derivatives market (“first consultation”)
11 July 2012  Publication of the conclusions from the first consultation 
11 July 2012 – 31 August 2012  Joint supplemental consultation by the HKMA and the SFC on the proposed scope of the new regulated activities (Type 11 and Type 12) to be introduced under the proposed OTC derivatives regulatory regime, and the proposed oversight of systemically important players (“second consultation”) 
December 2012  Launching of the link with the CCP of the HKEx by the HKTR to prepare for commencement of central clearing of OTC derivative transactions 
28 June 2013  Gazetting of the Securities and Futures (Amendment) Bill 2013 (“Amendment Bill”) 
10 July 2013  Introduction of the Amendment Bill into the LegCo 
July 2013  Activation of HKTR’s reporting function to support the commencement of reporting under the interim reporting requirements 
August 2013  Introduction of a set of interim reporting requirements by the HKMA on licensed banks, requiring them to report specified OTC derivative transactions carried out amongst themselves to the HKTR, which will remain in effect until the OTC regulatory regime comes into force 
6 September 2013  Publication of the conclusions from the second consultation
25 October 2013  Launch of OTC Clearing Hong Kong Limited as a recognised clearing house to provide clearing services for OTC derivatives 
March 2014  Passage of the Amendment Bill by the LegCo
April 2014  Enactment of the Amendment Ordinance by the LegCo (anticipated to come into effect in 2015) 
18 July – 18 August 2014  The current (third) consultation
Sometime in  2015  Commencement of the Amendment Ordinance, publication of the conclusions from the third consultation and further consultations on other aspects of the OTC regulatory regime, including mandatory trading and clearing


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For further information, please contact:


Mark Johnson, Partner, Herbert Smith Freehills

[email protected]


Will Hallatt, Partner, Herbert Smith Freehills

[email protected]


Jojo Fan, Herbert Smith Freehill

[email protected]


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