MAS CONSULTS ON REGULATORY FRAMEWORK FOR INTERMEDIARIES DEALING IN OTC DERIVATIVE CONTRACTS

Transcription

1 JUNE MAS CONSULTS ON REGULATORY FRAMEWORK FOR INTERMEDIARIES DEALING IN OTC DERIVATIVE CONTRACTS The Monetary Authority of Singapore ( MAS ) has issued a Policy Consultation on Regulatory Framework for Intermediaries Dealing in OTC Derivative Contracts, Execution- Related Advice, and Marketing of Collective Investment Scheme ( Consultation ). The Consultation proposes the detailed licensing and regulatory framework for intermediaries dealing in OTC derivative contracts ( OTC Intermediaries ). Most of the framework proposed in this Consultation essentially brings OTC Intermediaries within the fold of the existing framework for holders of Capital Market Services ( CMS ) licences. For OTC Intermediaries dealing in non-centrally cleared OTC derivatives, the MAS is proposing an additional set of risk mitigating requirements. These are based on standards recommended by IOSCO and cover trading relationship documentation, trade confirmation, and portfolio reconciliation and compression. Finally, the Consultation also deals with proposals in relation to the provision of execution-related advice in respect of listed Excluded Investment Products and the regulation of the marketing of collective investment schemes under the Financial Advisers Act ( FAA ). This Update takes a look at this Consultation. We would be pleased to assist with any feedback that our clients would like to make to the MAS on the Consultation. Admission and Licensing Whom the proposed licensing framework will most likely impact The proposed licensing framework will likely have the most impact on OTC Intermediaries that deal in derivative contracts other than securities-based derivatives or futures contracts, as the latter group would already require a CMS licence for dealing in securities or trading in futures contracts under the current regulatory regime. In this regard, the MAS has also proposed that, given the futurisation of OTC derivative contracts, the admission criteria proposed for OTC Intermediaries that deal in OTC derivative contracts should also apply to intermediaries that deal in exchange-traded derivative contracts such as futures contracts. It was explained that this will allow OTC Intermediaries to apply for the necessary licence to continue to deal in these contracts should they be converted to exchange-traded or futures contracts.

2 JUNE For OTC Intermediaries Admission criteria The MAS proposes to apply the admission criteria set out in MAS Guidelines on Criteria for the Grant of a Capital Markets Services Licence other than for Fund Management to OTC Intermediaries. However, OTC Intermediaries will not be required to meet the minimum five-year track record requirement if they do not serve retail investors (i.e., only accredited, institutional, and / or expert investors are targeted). If they do, the five-year track record requirement will apply. Base capital requirements With respect to base capital requirements, the following have been proposed: An OTC Intermediary that is a member of a designated clearing house must have a minimum base capital of S$5 million; and An OTC Intermediary that is not a member of a designated clearing house must have a minimum base capital of S$1 million. CMS licensees dealing with retail / non-retail investors The MAS also proposes to require CMS licensees dealing in OTC derivative contracts (other than those dealing only with non-retail investors) to comply with the risk-based capital requirements under the Securities and Futures (Financial and Margin Requirements) Regulations. As for CMS licensees dealing in OTC derivative contracts only with non-retail investors, the MAS has stated that it will continue to monitor international developments before finalising the risk-based capital requirements for such licensees. For Representatives Requirements for representatives The MAS proposes to extend the existing representative notification requirement in respect of regulated activities under the Securities and Futures Act ( SFA ) and FAA to persons who act as representatives in respect of dealing in or advising on OTC derivative contracts. Transitional Arrangements One-year transitional period The table below sets out the actions that will need to be taken by the relevant persons referred to based on the proposals set out in the Consultation. There will be a one-year transitional period from the date that the new regime is effected to submit the relevant applications or notifications. Entities which submit the requisite applications or notifications within the transitional period will be allowed to continue with their OTC derivative activities until such

3 JUNE time that the MAS decides on the application or notification. Relevant Person / Entity Existing holders of a CMS / Financial Adviser ( FA ) licence for other activities Exempt persons under s.99(1)(a), (b), and (c) of the SFA or s.23(1)(a), (b), (c), (d) and (e) of the FAA Holders of a commodity broker s licence Other entities who are already dealing in / advising on OTC derivatives Entities who commence dealing in / advising on OTC derivatives after new regime comes into effect Action to Take Apply for variation of CMS licences to cover OTC derivative contracts. Submit notifications for representatives. Representatives currently dealing in or advising on OTC derivative contracts and intend to continue doing so will be grandfathered in relation to the minimum academic qualifications and CMFAS examination requirements. Notify the MAS that they and their representatives will be dealing in or advising on OTC derivative contracts. Apply for a CMS licence in respect of OTC derivative contracts. Submit notifications for appointment of their representatives. Submit CMS / FA licence application and notification for appointment of their representatives. Transitional period of one year does not apply. Submit CMS / FA licence application and notification for appointment of their representatives. Can only commence activities after the application or notification has been approved or published by the MAS. Business Conduct Requirements As noted above, the Consultation proposes bringing OTC Intermediaries within the fold of the existing framework for holders of CMS licences. As regards business conduct rules, the rules that the MAS proposes to apply to OTC Intermediaries and how they should be adapted to OTC Intermediaries are set out below: Requirement Regulation to Be Applied Differences in Application (if any) Risk management and controls Reg 13, Securities and Futures (Licensing and Conduct of Business) Regulations ( SFLCB Regulations ): Requirements to have in place proper risk management systems and controls to manage its operations and activities. None proposed.

4 JUNE Requirement Regulation to Be Applied Differences in Application (if any) Requirements relating to advertisements Reg 46, SFLCB Regulations: Requirements as to the presentation and contents of advertising materials that are published or circulated by the intermediary None proposed. Risk disclosure Handling of customers moneys and assets Segregation of customers moneys and assets Reg 47E, SFLCB Regulations: Requirement to provide a risk disclosure document to customers before opening an account for them Parts III and IV, SFLCB Regulations: Requirements as to the handling and treatment of moneys and assets received from customers Reg 35, Securities and Futures (Clearing Facilities) Regulations 2013: Members of clearing facilities must offer the choice of an omnibus segregation model or an individual client segregation model to customers. Accordingly, OTC Intermediaries will, to the extent that they are members of clearing facilities, be required to offer this choice to their customers. The form of the disclosure document may be prescribed for retail customers. It will not be prescribed for certain products (e.g., swaps) which are transacted primarily with non-retail counterparties. The requirement will not apply when dealing with related entities or with licensed financial institutions. To be extended to OTC Intermediaries that deal in centrally-cleared OTC derivative contracts. For OTC Intermediaries that deal in non-centrally cleared OTC derivative contracts, the MAS will review the recommendations of the Basel Committee on Banking Supervision and IOSCO on margin requirements for noncentrally cleared derivatives. OTC Intermediaries offering clients individual client segregation should disclose the comparative difference in costs and level of protection accorded by individual client segregation and omnibus segregation. OTC Intermediaries will not be required to deposit the moneys or assets of customers who have opted for individual client segregation in a trust account separate from other customers who have not opted so.

5 JUNE Requirement Regulation to Be Applied Differences in Application (if any) Record keeping Section 102, Securities and Futures Act: Obligation to keep and retain proper records of transactions undertaken for OTC Intermediaries will be required to maintain the following information in respect of their OTC derivative transactions: customers. Customer identification information and other documents relating to the establishment of business relation; Information necessary to reconstruct the derivative transaction, including; o Pre-execution information (e.g. quotes, bids, offers, instructions, date and time of quotations provided to and received from counterparty); o Execution information (e.g. terms of swap, time and price of execution, name of counterparty, date of swap agreement, fees, commission and other expenses); and o Post-trade information (e.g. confirmation, time of confirmation, reconciliation, netting, compression, valuation, margining, collateralisation, central clearing); Payments and interest received on the derivative transaction; Daily value of each outstanding derivative transaction; Daily initial and variation margin payable or receivable; Daily value of all collateral held by or posted by the OTC Intermediary, including transfer of collateral; and All charges against and credits to each counterparty s account (e.g., funds deposited / withdrawn, unrealised gains / losses).

6 JUNE Risk Mitigating Requirements for Non-Centrally Cleared Derivatives The MAS has proposed requirements on trading relationship documentation, trade confirmation, portfolio reconciliation and dispute reporting, and portfolio compression on CMS licensees dealing in non-centrally cleared OTC derivatives. The table below summarises the requirements proposed. Requirement Summary of Proposal Comment Trading relationship documentation Trade confirmation OTC Intermediaries should have policies and procedures to execute written trading relationship documentation with their counterparties prior to or contemporaneously with executing a non-centrally cleared OTC derivative transaction. Such documentation should include all material terms governing the trading relationship between the counterparties, and should be executed in writing or through other equivalent non-rewritable, nonerasable electronic means. OTC Intermediaries should execute trade confirmation for non-centrally cleared OTC derivative transactions within a specific timeframe, taking into account the status of the counterparty. The trade confirmations should include the items listed in Annex 1. For counterparties that are licensed financial institutions, the OTC Intermediary should execute a two-way confirmation by T+1 for trades that are executed It should be noted that MAS did not expressly state in the Consultation that one-off transactions can be documented in the form of longform confirmations even though this appears to be permitted under paragraph 2.3 of IOSCO s report on Risk Mitigation Standards for Non- Centrally Cleared OTC Derivatives. In relation to the proposed list of terms that need to be included in a trade confirmation, market participants should consider whether this would be overly prescriptive. As non-centrally cleared derivatives transactions may contain rather bespoke terms, some of these mandatory terms prescribed by the MAS may not necessarily feature in such bespoke transactions.

7 JUNE Requirement Summary of Proposal Comment Portfolio reconciliation and dispute reporting before 4pm Singapore time. In the event that the counterparty resides in a different time zone which does not allow for confirmation by the stipulated deadline, the deadline can be extended by one business day. For other counterparties, the OTC Intermediary should provide a one-way confirmation to counterparties by T+1 and have in place written policies and procedures that would facilitate, on a best effort basis, the execution of a two-way confirmation by T+2. Where the counterparty is a licensed financial institution, the OTC Intermediary should agree in writing with the counterparty on the terms of the portfolio reconciliation. Where the counterparty is not a licensed financial institution, the OTC Intermediary should have in place policies and procedures that facilitate, on a best effort basis, portfolio reconciliation between the OTC Intermediary and the counterparty. The Consultation also sets out proposed frequencies for portfolio reconciliation. OTC Intermediaries should report promptly material disputes (i.e. those exceeding In relation to the proposed list of terms that need to be included in a trade confirmation, market participants should consider whether this would be overly prescriptive. As non-centrally cleared derivatives transactions may contain rather bespoke terms, some of these mandatory terms prescribed by the MAS may not necessarily feature in such bespoke transactions. --

8 JUNE Requirement Summary of Proposal Comment S$25 million that remain unresolved beyond 15 business days) to the MAS. -- Portfolio compression OTC Intermediaries dealing in non-centrally cleared OTC derivative contracts should undertake portfolio compression, where appropriate. The MAS did not elaborate when it would be considered appropriate to undertake portfolio compression. In this regard, it should be noted that paragraph 6.4 of IOSCO s report on Risk Mitigation Standards for Non- Centrally Cleared OTC Derivatives states that portfolio compression may carry some disadvantages specific to a party s legal, tax, accounting and/or operational status and may therefore not be appropriate in all circumstances. Para 9 and Para 11 Arrangements Proposed extension to application of exemptions The Consultation proposes to extend the application of the exemptions under Paragraph 9 of the Third Schedule to the SFA ( Para 9 ) and Paragraph 11 of the First Schedule to the FAA ( Para 11 ) to dealing in and advising on OTC derivative contracts respectively. Under Para 9 and Para 11, a foreign company is exempted from the requirement to hold a CMS licence or a financial adviser licence (as the case may be), if it is doing so under an arrangement between it and its related corporation which is licensed or belongs to certain categories of exempt persons under the SFA or FAA, where such arrangement is approved by the MAS. No change to existing approvals by the MAS The MAS has stated that existing approvals granted by it under Para 9 and Para 11 in respect of current regulated activities will not be affected by the new proposals. As no grandfathering has been proposed for Para 9 and Para 11 arrangements, it would appear that an application for the MAS approval under Para 9 and/or Para 11 will be required for any such arrangements in respect of dealing in or advising on OTC derivative contracts, whether or not such arrangements are already in place before the new regime comes into effect. Other Miscellaneous Proposals The MAS has included two additional proposals in this Consultation which are not related to the licensing and regulatory

9 JUNE Provision of execution related advice Marketing of collective investment schemes framework for OTC Intermediaries: It proposes to exempt the provision of execution-related advice in respect of listed Excluded Investment Products from the FAA, subject to the following safeguards: o The dealer must provide the customer with a written warning at account opening that the advice does not take into account the customer s investment objectives, financial situation, and particular needs, and highlight to the customer that it is his responsibility to ensure the suitability of the product recommended; and o The dealer must state the rationale for the advice provided to the customer so that the customer can make an informed assessment on whether to act on the dealer s advice. The regulated activity of marketing of collective investment schemes will be removed from the FAA and be regulated only under the SFA. The exemptions in the SFA will be expanded to allow financial advisers to help customers transact in both listed and unlisted collective investment schemes if such dealing in incidental to their advisory activities. The amendment is intended to be cosmetic and not substantive, and the necessary drafting changes are proposed to be made to ensure that this is the case. While this has not been expressly raised in the Consultation, presumably existing exemptions currently relied upon by financial institutions under the FAA will be similarly ported over as well. If you would like information on this or any other area of law, you may wish to contact the partner at WongPartnership that you normally deal with or any of the following partners: Elaine Chan Joint Head Financial Services Regulatory Practice DID: Click here to see Elaine s CV. Rosabel Ng Head Derivatives & Structured Products Practice DID: Click here to see Rosabel s CV. Low Kah Keong Head Asset Management & Funds Practice DID: kahkeong.low@ wongpartnership.com Click here to see Kah Keong s CV

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