Types of transactionClearing transactions
What categories of equity derivatives transactions must be centrally cleared and what rules govern clearing?
Listed equity options are cleared through SEOCH.
For OTC derivatives transactions, mandatory clearing of certain standardised interest rate swaps (in Hong Kong dollar, euro, pound sterling, Japanese yen or US dollar) through a central counterparty designated by the SFC has been implemented since 1 September 2016 pursuant to the Securities and Futures (Amendment) Ordinance 2014, which came into effect on 26 March 2014 (the Amendment Ordinance). The Amendment Ordinance is being implemented in stages, and at present only transactions between major dealers (eg, authorised institutions, licensed corporations or approved money brokers) with an OTC threshold of US$20 billion are mandated for clearing. As yet, there are no details on whether OTC equity derivatives will be subject to mandatory clearing.Exchange-trading
What categories of equity derivatives must be exchange-traded and what rules govern trading?
Listed equity options in Hong Kong are traded on the SEHK and cleared through SEOCH. There are currently no requirements for OTC derivatives transactions to be exchange traded.Collateral arrangements
Describe common collateral arrangements for listed, cleared and uncleared equity derivatives transactions.
Common collateral arrangement
Listed equity options
Short positions: SEOCH requires margin for all short positions. Marked-to-market daily following market close and margin is collected on the transaction date plus one day basis.
Long positions: no margin required.
Assigned or exercised positions: subject to margin requirement pending stock settlement but short call positions that are covered by a corresponding amount of the underlying stock deposited with the SEOCH as collateral are not.
Dealers carrying customer option accounts: may impose higher margin standards than SEOCH.
Uncleared OTC equity derivatives transactions
Counterparties typically document collateral arrangements using ISDA credit support documentation (eg, Credit Support Annex to the ISDA Master Agreement).
Typically, bespoke security arrangements are used (eg mortgage over shares).
OTC equity derivatives transactions are not centrally cleared, although it remains to be seen whether this will change in the future.Exchanging collateral
Must counterparties exchange collateral for some categories of equity derivatives transactions?
The requirements for counterparties to non-centrally cleared OTC derivatives to exchange collateral (ie, margin rules for uncleared derivatives) have recently been finalised. These reflect the BCBS-IOSCO margin framework and IOSCO’s standards for risk-mitigation techniques for non-centrally cleared OTC derivatives and set out the minimum standards to be adopted. The regulations cover matters such as:
- the exchange of initial margin (IM);
- variation margin (VM);
- substituted compliance; and
We have seen the following go-live dates most recently:
- 1 March 2017 for margin requirements with a six-month transition period for IM in the first phase and VM. For OTC equity derivatives transactions, early in 2017 HKMA stated that margin provisions applicable to non-centrally cleared derivatives transactions will not apply to, inter alia, transactions, such as reps and securities lending transactions, which are not themselves derivatives but share some attributes with derivatives; and
- 1 March 2017 to 29 February 2020 for non-centrally cleared single-stock options, equity basket options and equity index options.
The following collateral instruments are eligible as margin (both VM and IM):
- cash funds (money credited to an account or similar claims for the repayment of money) in any currency;
- marketable debt securities issued or fully guaranteed by a sovereign;
- marketable debt securities issued or fully guaranteed by a multilateral development bank;
- marketable debt securities issued or fully guaranteed by a public-sector entity;
- other marketable debt securities;
- gold; and
- publicly traded equities included in the Hang Seng Index or any other main index.
Securities issued by authorised institutions or foreign banks and securities whose value exhibits a significant correlation with the creditworthiness of the counterparty or the value of the underlying non-centrally cleared derivatives portfolio in such a way that would undermine the effectiveness of the protection offered by the margin (wrong-way risk) are not eligible for VM or IM.
In June 2018, the SFC launched a consultation on proposals to impose margin requirements on non-centrally cleared over-the-counter derivatives applicable to all licensed corporations.
For information on listed equity options and margin loans, see question 24.