The following updates are examinable from 23 November 2020
TOPIC 1 – REGULATORY FRAMEWORK
- Terminology updates
TOPIC 2 – LICENSING AND REGISTRATION
- No updates
TOPIC 3 – CLIENT SECURITIES AND MONEY
- No updates
TOPIC 4 – CONDUCT OF BUSINESS
- No updates
TOPIC 5 – RECORD KEEPING AND CONTRACTS LIMITS AND REPORTING
- No updates
TOPIC 6 –FUTURES TRADING AND SETTLEMENT
- No updates
TOPIC 7 –OVER-THE-COUNTER (OTC) DERIVATIVES TRADING, REPORTING AND CLEARING
Material added relating to margin requirements for non-centrally cleared OTCD transactions:
Introduction
- As part of the post-2008 financial crisis reforms to the OTC derivative market, minimum standards for margin requirements for NCC OTCDs have been established jointly by the Bank of International Settlements and IOSCO
- Objectives of the requirements are to reduce systemic risk and promote central clearing
- The Code of Conduct provides for the collection of initial margin (IM) and variation margin (VM)
- IM and VM refer to collateral that has to be posted by one party to the other to protect the receiving party from the giving party defaulting
- IM reflects the potential future exposure at the time of entering into the OTCD transaction, whereas VM reflects the current exposure incurred as the mark-to-market value changes over time
- IM and VM are normally posted and collected by both parties, protecting each party from the possibility of default
Scope of Application
Persons subject to the requirements
- The requirements apply to any licensed person who is a contracting party to an NCC OTCD transaction with a “covered entity”. They do NOT apply to registered institutions
- “Covered entity” refers to entities that, during the 12-month period from 1 September to 31 August the following year, is either:
- A financial counterparty (itself or with its group companies) with an average aggregate notional amount of NCC OTCD exceeding HK$15 billion; or
- A significant non-financial counterparty (itself or with its group companies) with an average aggregate notional amount of NCC OTCD exceeding HK$60 billion
- The following are specifically excluded from the definition of covered entity:
- Governments
- Central banks
- Non-commercial government agencies
- Multilateral development banks specified by the HKMA
- Bank of International Settlements
Instruments subject to the requirements
- IM/VM requirements apply to all NCC OTCD transactions, however they do not apply for certain physically settled FX transactions, certain commodity forward transactions and certain currency contracts
Exceptions to the margin requirements
- The margin requirements may not apply in three circumstances:
- Where there is reasonable doubt about the enforceability of a netting agreement in respect of IM or VM or collateral protection arrangements
- Intragroup transactions where risk is managed on a consolidated basis
- The licensed person has notified the SFC that it will perform substituted compliance – licensed person will adhere to margin requirements of another jurisdiction
Initial Margin Requirements
- IM must be exchanged where both the licensed person and the counterparty have an average aggregate notional amount of NCC OTCDs in excess of HK$375 billion (this will go down to HK$60 billion from 1 September 2022)
- IM does not need to be exchanged where the licensed person has no counterparty risk or where the counterparty is a significant non-financial counterparty using NCC OTCDs for hedging purposes
- IM does not need to be collected where the amount due is HK$375 million or less
- IM received by a licensed person should be protected by using a third-party custodian and should be treated as client assets
- IM requirements will start from 1 September 2021; VM requirements took effect from 1 September 2020
Variation Margin Requirements
- Where the licensed person has an average aggregate notional amount of NCC OTCDs in excess of HK$15 billion, VM must be exchanged for a 12-month period commencing 1 September
- For certain FX contracts, the threshold is HK$60 billion
- The calculation of VM should be subject to a single, legally enforceable netting arrangement
- The licensed person may elect not to exchange VM with a significant non-financial counterparty using NCC OTCDs for hedging purposes
- VM does not need to be collected where the amount due since the last exchange is equal to or less than HK$3.75m. Where the amount is more than HK$3.75m, the full amount needs to be exchangedVM should be calculated at least on a daily basis
Assets Eligible as IM and VM
-
- Assets accepted as collateral: cash, marketable debt securities, gold and listed share
- Assets not acceptable as collateral:
- Securities issued by a company in the same consolidated group as the licensed person
- Securities significantly correlated with the counterparty’s creditworthiness or the OTCD’s value
- Securities that are not of investment grade
TOPIC 8 –OVERVIEW OF MAJOR OVERSEAS FUTURES EXCHANGES AND CLEARING HOUSES
- No updates