The Securities and Futures (OTC Derivative Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules (the Clearing Rules) impose mandatory clearing obligations for certain over-the-counter (OTC) derivative transactions. A key part of the regulatory framework for mandatory clearing of OTC derivative transactions is the designation by the Securities and Futures Commission (SFC) of central counterparties through which such transactions can be cleared.
On 31 August 2016, the SFC issued notices designating four central counterparties (CCPs). The four designated CCPs include one Hong Kong CCP and three overseas CCPs:
- Chicago Mercantile Exchange Inc
- Japan Securities Clearing Corporation
- LCH.Clearnet Limited
- OTC Clearing Hong Kong Limited
Each designated CCP is subject to conditions that are set out on the SFC website (available here). The conditions for each are substantially the same, except for the following:
- The types of OTC derivative transactions for which each is a designated CCP are different. As examples, only LCH.Clearnet Limited is a designated CCP in respect of HKD basis swaps and only Chicago Mercantile Exchange Inc and LCH.Clearnet Limited are designated CCPs in respect of overnight index swaps.
- OTC Clearing Hong Kong Limited is subject to an obligation to report certain specified information on its clearing members to the SFC, regardless of the location of the clearing members. The other designated CCPs only need to report such information to the SFC to the extent that it relates to their Hong Kong clearing members that are incorporated in Hong Kong.
The mandatory clearing obligation under the Clearing Rules will apply where all the following elements are present:
- the OTC derivative transaction is a “specified OTC derivative transaction” for the purposes of the Clearing Rules; at present, certain “plain vanilla” interest rate swaps are “specified OTC derivative transactions”,
- one of the counterparties is an authorised institution, approved money broker or licensed corporation (and, where the authorised institution or approved money broker is incorporated outside Hong Kong, the transaction is recorded in the Hong Kong books of that authorised institution or approved money broker),
- this counterparty exceeds a specified clearing threshold, currently US$20 billion,
- the other counterparty is either (i) an authorised institution, approved money broker or licensed corporation that exceeds the specified clearing threshold or (ii) a “financial services provider”, being an entity named in the notice issued by the SFC on 22 August 2016 (available here, the named entities are large international banks and securities dealers).
The first date on which specified OTC derivative transactions will need to be cleared through a designated CCP is 1 July 2017. If you are subject to the mandatory clearing obligation under the Clearing Rules, you must ensure that any relevant OTC derivative transaction is cleared through one of the four designated CCPs and that the relevant central counterparty is a designated CCP for the particular type of OTC derivative transaction.
For asset managers, the specified clearing thresholds under the Clearing Rules have been set at a high level so, even if an asset manager is a counterparty to a “plain vanilla” interest rate swap, it is unlikely the asset manager’s proprietary OTC derivative positions will exceed the clearing threshold. The Clearing Rules do not currently apply to OTC derivative transactions where the counterparty is a collective investment scheme managed by an asset manager.