The Hong Kong Monetary Authority (HKMA) adopted a mandatory clearing obligation, in which a ‘prescribed person’ (authorised financial institution, approved money broker, licensed corporation) must clear specified Over-The-Counter (OTC) derivative transactions through a ‘designated Central Counterparty Clearing House’ (CCP).
A ‘prescribed person’
The clearing obligation applies to prescribed persons when they trade an in-scope product with another prescribed person or a financial services providers designated by Securities and Futures Commission (SFC). If the prescribed person is incorporated outside of Hong Kong, the obligation arises if the trade is recorded in its Hong Kong books.
A ‘designated Central Counterparty Clearing House’
A ‘designated CCP’ is a CCP approved by the SFC as a recognised clearing house. There is no location requirement for a designated CCP.
The prescribed person may clear a transaction with a designated CCP either directly or through a third party (‘clearing agent’). Mandatory clearing applies to basis swaps and fixed to floating swaps referencing EUR EURIBOR and HKD HIBOR (28 days to 10 years), and overnight index swaps referencing USD Fed Funds (7 days to 2 years), EUR €STR (7 days to 3 years), HKD HONIA (7 days to 10 years), JPY TONA (7 days to 30 years), GBP SONIA and USD SOFR (7 days to 50 years).
Supervision of Clearing Agents in OTC derivatives
The HKMA proposes to regulate and supervise the activities of persons who serve as clearing agents in OTC derivatives under the new ‘Type 12 RA (Regulated Activity)’.
What does ‘Type 12 RA’ cover?
- Type 12 RA covers the provision of clearing and settlement services on behalf of another person in respect of that other person’s OTC derivatives transactions (i.e. client clearing services).
- Type 12 RA does not cover clearing and settlement activities in relation to a person’s own proprietary positions in OTC derivatives transactions.
About the new ‘Type 12 RA’ and OTC Derivatives Clearing
In order to manage counterparty risk arising from bilateral OTC derivatives transactions, market participants have started clearing their OTC derivatives transactions through a Central Counterparty Clearing House. They can do so directly (i.e. by becoming a member of the CCP) or indirectly (i.e. by clearing with a CCP through a third party). Due to the stringent admission criteria of CCPs, not every market participant may become member of a CCP and clear directly. They may instead engage third parties who provide clearing agency services so that they can clear indirectly through a CCP. As mandatory clearing obligations are introduced to cover more market participants, the demand for indirect clearing is likely to increase.
The HKMA’s Joint Supplemental Consultation Conclusions, released in September 2013, proposes scope for the new Type 12 RA, which is intended to capture the activities of those who serve as clearing agents for OTC derivatives.
Submitting OTC derivatives transactions to central clearing is a relatively new practice around the world, and entirely new in Hong Kong, and there are few established providers of such services. Therefore, persons who provide such services are likely to be newcomers. Consequently, the HKMA extended the two-year experience requirements for Type 12 RA to also recognise overseas experience, experience of an affiliate company in the same group of companies and experience in clearing proprietary trades in OTC derivatives.
Timeline and impact to market participants
To regulate these activities, the HKMA and SFC are expected to issue rule amendments and further guidance to address the proposed licensing regime for dealing in, and advising on, OTC derivatives and for providing clearing services for OTC derivatives.
For more information on the HKMA’s OTC regulation, please visit HKMA’s website.
