On 28 June 2013, the Securities and Futures (Amendment) Bill 2013 ("Bill") was published in the Gazette, unveiling the proposed regulatory regime for over-the-counter ("OTC") derivatives in Hong Kong. This follows the public consultation that ended in 2011 and subsequent publication of the joint consultation conclusions of the Securities and Futures Commission ("SFC") and Hong Kong and Monetary Authority ("HKMA") in July 2012.
The global financial crisis exposed the risks of unregulated OTC derivatives trading and paved the way for major financial centres to introduce reforms. Unlike exchange-traded derivatives, the OTC market was largely unregulated before 2008. The absence of regulation and bilateral nature of OTC derivatives transactions resulted in a market that was essentially opaque. This lack of transparency meant regulators did not have information on OTC derivatives positions held by market players, and therefore could not be alerted to the build-up of exposures that might threaten the market or wider economy.
In September 2009, the G20 group of countries agreed to rein in the "wild west" OTC derivatives market, endorsing a global transition of standardised OTC contracts trading towards recognised exchanges or trading platforms, and where appropriate cleared from central counterparties, as well as reporting of OTC contracts to trade respositories. Principally, the Bill delivers on these G20 commitments by introducing mandatory reporting, clearing and trading obligations with respect to OTC derivative transactions.
Whilst the primary role of the HKMA is to supervise authorised institutions ("AIs"), the SFC is the lead regulator for the securities industry. As such, in order to enable the SFC to fulfil its regulatory role, the Securities and Futures Ordinance ("SFO") has traditionally encapsulated investigatory powers of the SFC in Part VIII of the SFO and the disciplinary powers of the SFC in Part IX of the SFO. Under the regulatory regime envisaged in the Bill, AIs who serve as intermediaries in the OTC derivative market will continue to be regulated by the HKMA, and the HKMA will be given new investigatory and disciplinary powers to regulate activities in the OTC market. The new powers proposed under the Bill will see the HKMA's role shift from consultative and co-operative supervision to a more active regulatory role in the area of OTC derivatives. Specifically, these new powers include:
- New investigation powers in Part VIII of the SFO concerning supervision and investigations – Under new section 184A, if the HKMA has reasonable cause to believe that an AI may have contravened a reporting, clearing or trading obligation, the HKMA may investigate the matter. New section 184B provides that a person under investigation must give the HKMA investigator all assistance in connection with the investigation that the person is reasonably able to give, including producing a record or document relevant to the investigation in the person's possession, or attending before the HKMA investigator to answer questions.
- New disciplinary powers in Part IX of the SFO concerning discipline – Under new section 203A, if an AI contravenes an obligation, the HKMA may exercise disciplinary powers, including (a) public or private reprimand; (b) prohibiting the person from carrying on the business of OTC derivative transactions; (c) ordering pecuniary penalty of HK$10 million or 3 times the amount of profit gained or loss avoided as a result of the contravention, whichever greater.
Just as existing section 378 of the SFO imposes a duty of secrecy in relation to information obtained by the SFC in the course of exercising its investigatory powers, new section 381A proposes to impose a similar duty with respect to the HKMA carrying out its new statutory function under the SFO.
New section 388A empowers the HKMA to prosecute certain offences relating to the HKMA's new functions, including offences committed under new section 184D such as failure to produce records or attend before an HKMA investigator in an HKMA investigation, and providing false and misleading information to the HKMA.