Financial Services Regulatory Singapore Client Alert June 2015 Proposed Regulatory Framework for Intermediaries Dealing in OTC Derivatives On 3 June 2015, the Monetary Authority of Singapore ("MAS") released the Policy Consultation on Regulatory Framework For Intermediaries Dealing in OTC Derivative Contracts, Execution-related Advice, and Marketing of Collective Investment Scheme ("Consultation Paper"). The Consultation Paper sets out: (i) the proposed regulatory framework for intermediaries dealing in over-the-counter ("OTC") derivative contracts ("OTC Intermediaries") and (ii) other proposed amendments in relation to executionrelated advice and the marketing of collective investment schemes ("CIS") regulated under the Financial Advisers Act ("FAA"). Proposed Regulatory Framework For OTC Intermediaries This Consultation Paper quickly follows MAS' previous consultation paper in February 2015 which proposed regulating OTC Intermediaries under the Securities and Futures Act (the "SFA"), such that OTC Intermediaries will be required to hold a capital markets services ("CMS") licence unless exempted. Broadly, the current regulated activity of "dealing in securities" for which a CMS licence is required, will be redefined to differentiate between various capital markets products, including securities, OTC derivatives contracts and exchange-traded derivatives contracts. This present Consultation Paper fleshes out the specifics of the proposed regulatory requirements for OTC Intermediaries. In overview, requirements presently applicable to CMS licensees will generally be applicable to OTC Intermediaries as well, with certain modifications. For instance, a slightly "lighter touch" regulatory approach is adopted for OTC Intermediaries dealing with non-retail clients only whereas additional requirements are proposed for non-centrally cleared OTC derivatives contracts. Where additional compliance obligations are introduced, some of MAS' proposals refer to international standards which may already be commonly adopted by OTC derivative market participants. An outline of the proposed regulatory requirements is as follows: (a) Admission Criteria. MAS proposes that OTC Intermediaries and intermediaries dealing in exchange-traded derivative contracts will only need to satisfy the minimum five-year track record requirement if they serve retail (i.e. non-accredited, institutional or expert) investors. (b) Base Capital Requirements. OTC Intermediaries that are members of approved clearing houses will need to have a minimum base capital of S$5 million whilst non-member OTC Intermediaries will require a minimum base capital of S$1 million. Licensed OTC Intermediaries would also be subject to ongoing risk-based capital requirements where they serve retail investors. For further information please contact Stephanie Magnus +65 6434 2672 firstname.lastname@example.org Liew Ying Yi +65 6434 2531 YingYi.Liew@bakermckenzie.com Baker & McKenzie.Wong & Leow 8 Marina Boulevard #05-01 Marina Bay Financial Centre Tower 1 Singapore 018981 www.bakermckenzie.com 2 Client Alert June 2015 (c) Business Conduct Requirements. The following business conduct requirements would apply to OTC Intermediaries with additional risk mitigation requirements to be imposed for non-centrally cleared derivatives: i. Risk Management. Proper risk management systems and controls to manage its operations and activities are required. ii. Advertising. Advertising materials published or circulated must not contain any inaccurate or misleading statement or presentation, or any exaggerated statement or presentation that is calculated to exploit lack of experience or knowledge. iii. Risk Disclosures. Written risk disclosures, about the material risks of the product (i.e. the counterparty, liquidity, market and leverage risks) and whether they are acting as an agent or principal, will need to be provided to, and acknowledged by, the customer in writing prior to the opening of the customer's account. However, this will not apply if the OTC Intermediaries are dealing with related entities or licensed financial institutions. Where there are established industry standards (e.g. the ISDA DF Disclosure documents), these may be relied upon if the licensee has assessed that these meet the proposed disclosure requirements; and iv. Handling of Customer Moneys and Assets. Existing rules applicable to CMS licensees on the handling of customer monies and assets will apply to OTC Intermediaries that deal in centrally-cleared OTC derivative contracts. MAS will consult separately on the appropriate requirements for non-centrally cleared OTC derivative contracts. Notably, MAS proposes enhancements to rules on the segregation of client moneys and assets. MAS proposes to require CMS licensees, when offering the individual client segregation model to its customers (as opposed to omnibus segregation), to disclose the costs associated and level of protection of the same. Also, CMS licensees may not be required to deposit moneys and assets of customers who have opted for the individual client segregation into a trust account separate from the other customers who have not opted to do so. v. Record-keeping. Record-keeping requirements will apply and information such as customer identification information; documents relating to the establishment of business relations; information necessary to reconstruct the derivative transaction, including preexecution, execution and post-trade information (e.g. quotes, bids, terms of the swap, confirmation); daily values of each outstanding derivative transaction; margin payable or receivable; collateral held by or posted by the OTC Intermediaries, among others, would need to be retained for prescribed retention periods. vi. Risk Mitigation Requirements For Non-centrally Cleared Derivatives. The following additional requirements will be imposed for non-centrally cleared derivatives: Trading Relationship Documentation. CMS licensees dealing with non-centrally cleared derivatives will need policies for the execution of written trading relationship documentation with their counterparties. This should be done prior to or contemporaneously with executing a non-centrally cleared OTC derivative transaction. Such documentation should include all material terms governing the trading relationship between the counterparties. 3 Client Alert June 2015 Trade Confirmations. A trade confirmation for non-centrally cleared OTC derivative transactions must be executed within certain prescribed timeframes. A prescribed list of terms (broadly in line with the data fields of MAS and US CFTC trade reporting requirements) must be included in each trade confirmation. These requirements will be effected in phases starting with interest rates and credit derivative contracts. MAS also proposes a phase-in timeline which will begin with transactions where the counterparty is a licensed financial institution. Portfolio Reconciliation. CMS licensees will be required to undertake portfolio reconciliation of non-centrally cleared OTC derivative contracts with their counterparties. Where the counterparty is a licensed financial institution, parties are to agree in writing on the terms of the portfolio reconciliation. For all other counterparties, the CMS licensees will be required to have in place policies and procedures that facilitate the portfolio reconciliation on a best effort basis. The Consultation Paper also sets out the proposed frequencies for the portfolio reconciliation (e.g. where there are more than 500 outstanding contracts with a licensed financial institution counterparty, portfolio reconciliation should be conducted on a daily basis). Portfolio reconciliation should minimally cover terms which are generally based on the 2013 EMIR Portfolio Reconciliation Operational Guidance Note by ISDA. Material disputes (i.e. disputes exceeding S$25 million that remain unresolved beyond 15 business days) are to be reported to MAS promptly. Portfolio Compression. Where appropriate, CMS licensees dealing in non-centrally-cleared OTC derivative contracts must undertake portfolio compression (i.e. terminating and replacing economicallyequivalent non-centrally cleared OTC derivative transactions). These conduct of business requirements will apply equally to exempt persons, e.g. banks, merchant banks and finance companies licensed in Singapore when dealing with OTC derivatives contracts. (d) Representative Notification Requirements The existing representative notification requirements in respect of regulated activities will be extended to persons who act as representatives in respect of dealing in or advising on OTC derivative contracts. Existing representatives, who already deal in or advise on OTC derivative contracts (e.g. notified as a representative for a CMS licensee dealing in securities under the current regime) would be grandfathered. (e) Paragraph 9 and Paragraph 11 Arrangements Arrangements approved by MAS under Paragraph 9 and Paragraph 11 generally allow foreign companies to conduct regulated activities under the SFA or FAA through an arrangement with its related corporation which is a CMS licensee / prescribed exempt CMS licensee or a licensed financial adviser ("FA") / prescribed exempt FA, as applicable. This will extend to dealing in and advising on OTC derivative contracts. Existing approvals granted under Paragraph 9 and Paragraph 11 in respect of current regulated activities will not be affected by the proposed redefinition of regulated activities. 4 Client Alert June 2015 (f) Transitional Arrangements MAS has proposed a one-year transitional period from the date that this new proposed regulatory framework is effected, for affected parties to submit the relevant applications or notifications to MAS. OTC Intermediaries and their representatives who are presently regulated as CMS licence holders, financial advisers or exempt persons would need to make the relevant applications or notifications to MAS. Other Proposed Amendments In addition to the above, MAS has also proposed the following: Execution-related Advice. Persons who provide execution-related advice in relation to listed Excluded Investment Products (e.g. listed CIS or ETFs that meet certain requirements) may be exempted from the existing business conduct requirements, e.g. having a reasonable basis for the recommendation made, taking into consideration the customer's investment objectives, financial situation and particular needs. Marketing of Collective Investment Schemes. The current regulated activity of marketing CIS under the FAA is to be removed as it is already regulated as "dealing in securities" under the SFA. MAS is inviting feedback and comments to the Consultation Paper by July 3, 2015. 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