Hong Kong reporting obligations for certain OTC derivative transactions will come into effect on 10 July 2015. For asset managers, the reporting obligations will apply where either they are a counterparty to certain OTC derivative transactions or they conduct certain OTC derivative transactions in Hong Kong on behalf of an affiliate, where the affiliate is a counterparty.
The regulatory background
The Securities and Futures (Amendment) Ordinance (Amendment Ordinance) was gazetted on 4 April 2014. The Securities and Futures (Amendment) Ordinance 2014 (Commencement) Notice 2015 (Commencement Notice) was gazetted on 15 May 2015 and the Legislative Council negative vetting process is expected to be completed on 8 July 2015. This briefing assumes no further changes will be made during the negative vetting process. The Commencement Notice sets 10 July 2015 as the day on which various provisions of the Amendment Ordinance come into effect, in particular in relation to the reporting obligations for OTC derivative transactions.
At the same time as the Commencement Notice was gazetted, the final version of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules (Reporting Rules) was gazetted. The Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) have also issued their Conclusions on Further Consultation on the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules (Consultation Conclusions) and draft Frequently Asked Questions relating to the Reporting Rules (Draft Reporting FAQs).
When the Reporting Rules apply
The entities subject to the reporting obligations are referred to in the Reporting Rules as prescribed persons. Prescribed persons are banks, approved money brokers, SFC-licensed corporations, recognised clearing houses (when acting in their capacity as central counterparty) (RCH) and persons authorised under section 95 of the Securities and Futures Ordinance to provide automated trading services (when acting in their capacity as central counterparty) (ATS-CCP).
An asset manager licensed with the SFC will have a reporting obligation if (i) it is a counterparty to certain OTC derivative transactions (referred to as specified OTC derivative transactions) or (ii) it conducts a specified OTC derivative transaction in Hong Kong on behalf of an affiliate, where the affiliate is a counterparty. The definition of “affiliate” in the Reporting Rules contains an exclusion for collective investment schemes with a corporate structure that may otherwise fall within the definition (e.g. because the asset manager or other companies within the same group own shares in the collective investment scheme). The Reporting FAQs also contain guidance on when a transaction will be considered to be “conducted in Hong Kong”.
Practically, a reporting obligation will arise where the asset manager is conducting proprietary trading, for itself or its affiliates, in specified OTC derivative transactions.
Currently, an asset manager will not be subject to a reporting obligation where it enters into specified OTC derivative transactions for funds or client accounts that it manages. It is anticipated that at some future time the Reporting Rules will be extended to require asset managers to report specified OTC derivative transactions that they enter into for funds or client accounts.
Limited exemption from Reporting Rules
The Reporting Rules contain an exemption from the reporting obligations in relation to specified OTC derivative transactions within a product class if the sum of the notional amounts of all outstanding OTC derivative transactions within that product class to which the prescribed person is a counterparty does not exceed US$30 million.
It is important to note that:
- the threshold of US$30 million is calculated on a product class basis (e.g. interest rate swaps) rather than a specified OTC derivative transaction basis, so in determining whether you fall within the exemption you need to include OTC derivative transactions that are within the product class but may not be reportable;
- once you exceed the threshold of US$30 million, you lose the benefit of the exemption and will need to report all future specified OTC derivative transactions even if you subsequently fall below the threshold again.
What types of OTC derivative transactions will need to be reported
The Reporting Rules apply in relation to certain interest rate swaps and non-deliverable forward foreign exchange contracts, as set out below:
- Interest rate swaps (as defined in Schedule 1 to the Reporting Rules) where the payments are to be calculated by reference to (a) a fixed interest rate applied to a notional amount that is denominated in a specified currency; and (b) a specified floating interest rate index applied to the same notional amount;
- Interest rate swaps (as defined in Schedule 1 to the Reporting Rules) where the payments are to be calculated by reference to (a) a specified floating interest rate index applied to a notional amount that is denominated in a specified currency; and (b) another specified floating interest rate index applied to the same notional amount;
- Non-deliverable forward contracts (as defined in Schedule 1 to the Reporting Rules) where the reference currency is a specified currency and the settlement currency is a specified currency.
The HKMA will publish a separate notice in the Gazette setting out what are specified floating interest rate indices and specified currencies for the purpose of the Reporting Rules.
The Reporting Rules will likely be extended to other types of OTC derivative transactions over time.
How specified OTC derivative transactions will need to be reported
Where a reporting obligation arises, specified OTC derivative transactions will need to be reported by electronic transmission to the Hong Kong Trade Repository set up by the HKMA. In order to report, an asset manager will first need to register with the Hong Kong Trade Repository and establish a connection to allow for reporting. Detailed requirements are set out on the HKTR Info Page of the HKMA website (https://hktr.hkma.gov.hk/index.aspx).
When specified OTC derivative transactions will need to be reported
Initial reporting obligation
Where a reporting obligation arises, the time when a transaction needs to be reported will depend on when the specified OTC derivative transaction was entered into. For existing asset managers licensed with the SFC:
- A specified OTC derivative transaction that:
- is outstanding on the date the Reporting Rules come into effect in relation to that type of transaction (10 July 2015 for the categories of interest rate swaps and non-deliverable forward contracts noted above) (Effective Date) or that is entered into within 6 months of that date, and
- has not matured or terminated within 9 months of the Effective Date,
must be reported not later than 9 months of the Effective Date.
- A specified OTC derivative transaction that is entered into more than 6 months after the Effective Date must be reported within 2 business days after the transaction is entered into.
Subsequent reporting obligation
Once a specified OTC derivative transaction has been reported, the reporting entity is also required to report “subsequent events” in relation to that transaction, within 2 business days after the event occurs. A “subsequent event” is an event that occurs after the transaction was entered into, and which affects the terms and conditions on which the transaction was entered into or the persons involved in entering into the transaction.
Changes made after latest consultation
A number of changes to the Reporting Rules were made as a result of the most recent consultation, as set out in the Consultation Conclusions:
- Deferral of daily valuation reporting: The requirement to submit daily valuation reports was removed from the Reporting Rules. The Consultation Conclusions indicate daily valuation reporting will only be implemented at a later stage, after additional consultation.
- Addition of prescribed markets and clearing houses: Products traded on and cleared through prescribed markets and clearing houses are not regarded as OTC derivatives for the purpose of the Reporting Rules. A further 15 operations were added to the list of markets and clearing houses to be prescribed under the Securities and Futures (Stock Markets, Futures Markets and Clearing Houses) Notice.
- Exclusion of collective investment schemes from definition of “affiliate”: The definition of “affiliate” in the Reporting Rules was amended to exclude collective investment schemes with a corporate structure that may otherwise fall within the definition (e.g. because the asset manager or other companies within the same group own shares in the collective investment scheme).
- Relaxation of manner in which records to be kept: Records must be kept in a manner that enables them to be readily accessible. The requirement that records be readily searchable and identifiable by reference to a particular transaction and counterparty was removed, as was the requirement to keep records which evidence communications and instructions that result in the transaction being executed.
Helpful information on when and how the reporting obligations under the Reporting Rules apply, and the views of the HKMA and the SFC on the interpretation of various provisions of the Reporting Rules, are set out in the draft Reporting FAQs.