July 2015 Mandatory Clearing in Singapore Noteworthy next step Introduction On 1 July 2015, the Monetary Authority of Singapore ( MAS ) issued a consultation paper entitled Draft Regulations for Mandatory Clearing of Derivatives Contracts, which sets out the MAS detailed proposals for the mandatory clearing of OTC derivatives. The mandatory clearing of OTC derivatives is one of the key objectives set by the G20 in response to the 2008 global financial crisis 1 and has been recommended by the Financial Stability Board for the purpose of reducing systemic risk in the financial markets. The MAS consultation comes in the wake of framework amendments already made to the Securities and Futures Act (Cap. 289) ( SFA ) in order to allow for the mandatory clearing of OTC derivatives. Mandatory clearing of OTC derivatives will form part of a broader set of reforms which also includes a requirement to report OTC derivative transactions and a regulatory regime for trade repositories (both of which have already been implemented by the MAS), as well as a regulatory framework for intermediaries dealing in OTC derivative contracts (on which the MAS recently consulted separately). Contents Introduction... 1 Summary of proposals... 1 Commentary... 4 Further information... 5 The consultation paper is accompanied by a draft legislative instrument, the Securities and Futures (Clearing of Derivatives Contracts) Regulations 2015 (the Regulations ), which defines an initial set of products and persons that will be subject to the mandatory clearing requirement. Summary of proposals Types of OTC derivative to be cleared OTC derivatives subject to mandatory clearing will need to be cleared through an approved clearing house ( ACH ) or a recognised clearing house 1 G20 Leaders Statement, the Pittsburgh Summit, 24-25 September 2009 1
( RCH ) 2. Taking account of the level of systemic risk posed by different types of OTC derivatives, the depth and liquidity of these product types and the availability of ACHs and RCHs that are able to clear different product types, the MAS proposes that the first asset class to be subject to mandatory clearing will be interest rate swaps ( IRS ). This determination is based on the fact that interest rate derivatives in general and IRS in particular account for a significant proportion of all derivatives booked in Singapore and that their high degree of standardisation facilitates their clearing. At a minimum, the MAS proposes to subject Singapore dollar fixed-to-floating IRS based on the Swap Offer Rate and US dollar fixed-to-floating IRS based on LIBOR to the clearing obligation, and is considering extending the obligation to IRS denominated in euro, pounds sterling and Japanese yen (which have been or are proposed to be mandated for clearing in major jurisdictions such as the US, Europe and Australia). The MAS is also seeking feedback on whether mandatory clearing should also apply for other types of interest rate derivatives denominated in the abovementioned currencies, such as basis swaps, forward rate agreements or overnight index swaps. Territorial scope of the clearing obligation The MAS proposes that, at first, the clearing obligation will apply where both counterparties to the relevant trade book the trade in Singapore (i.e. where each counterparty is either a Singapore-incorporated company or a Singapore branch of a foreign entity). This restriction of the territorial scope of the clearing obligation takes account of the fact that foreign counterparties may not yet be required to clear trades in their home jurisdictions and may not therefore have the capability to do so, and equally avoids potential conflicts with clearing requirements in jurisdictions whose mandatory clearing regimes have come into force. The MAS notes, however, that the Singapore Exchange Derivatives Clearing Limited ( SGX-DC ) is registered as a Derivatives Clearing Organization with the U.S. Commodity Futures Trading Commission ( CFTC ) and is also recognised as an equivalent third country CCP by the European Securities and Markets Authority ( ESMA ), and that as such, counterparties clearing through SGX-DC will be able to comply with the mandatory clearing requirement of the MAS as well as those of the CFTC and ESMA respectively. The consultation paper suggests that the MAS will keep the territorial scope of the clearing obligation under review and consider to what extent transactions that are traded in Singapore but booked elsewhere (such as foreign subsidiaries or foreign branches of local banks) should also be subject to the obligation. 2 Broadly speaking, ACHs are systemically important clearing houses subject to the most rigorous standards of regulation, while all other clearing houses regulated by the MAS will be RCHs. At present, there are four ACHs (ICE Clear Singapore Pte. Ltd., Singapore Exchange Derivatives Clearing Limited, The Central Depositary (Pte) Limited and Eurex Clearing Asia Pte. Ltd.), whereas no RCH has been recognised as yet. The MAS expects to approve more ACHs and/or recognise more RCHs before commencement of the clearing obligation. 2
Persons subject to the clearing obligation Although the enabling provision in the SFA envisages that the clearing obligation would apply to all specified persons i.e. banks and other financial institutions such as insurers and capital markets services licence holders, the MAS proposes that, at first, only banks that have booked over S$20 billion in gross notional outstanding derivative contracts in Singapore for each of the last four calendar quarters should be subject to the clearing obligation. Banks which do not exceed such S$20 billion threshold, and all other specified persons that are not banks, will be granted an exemption from the clearing obligation. This approach takes account of the fact that the trading activities of large banks give rise to the largest counterparty credit risks in the Singapore OTC derivative markets, that few members of OTC derivatives clearing houses currently offer client clearing, and that smaller financial institutions may not find it commercially feasible to take up direct clearing membership. Any bank that fulfils the abovementioned criteria for triggering the clearing obligation as of a date falling after the commencement date of the clearing mandate but that did not fulfil those criteria on such commencement date will benefit from a transitional period of six months from the first-mentioned date prior to becoming subject to the obligation. Coordination of execution and clearing The MAS proposes that a derivative contract subject to the clearing obligation will need to be cleared within the same day it is executed, or where it is executed on a day other than a business day, within the next business day. For these purposes, a business day is any day on which the clearing house through which the derivative contract is to be cleared is open for business. Exemptions In line with other jurisdictions such as the US, EU, and Japan, the MAS proposes that the clearing obligation will not apply to intra-group transactions or to public bodies (including all central banks and governments, as well as international multilateral organisations such as the Bank for International Settlements, the International Monetary Fund and the World Bank). Record-keeping obligation It is further proposed that banks subject to the clearing obligation will be required to keep all relevant books, and all transaction information and other information as may be required by the MAS, for at least five years after the last date of the expiry or termination of a contract, an agreement or a transaction to which the book or information relates. Contravention of this record-keeping obligation will be an offence. Timeframe for implementation and further extension of scope The MAS intends to issue the Regulations by the end of 2015, and will provide at least six months notice before they take effect. The consultation suggests that once the Regulations have taken effect, the MAS will consider 3
whether a further extension of the scope of the clearing obligation may be appropriate, taking account of industry readiness and international developments. More specifically, the MAS will consider extending the clearing obligation to further product types (potentially so that it covers the most liquid products in the next largest asset class, foreign exchange OTC derivatives), lowering the maximum threshold for exemption from the clearing obligation and/or including the more active non-bank financial institutions that trade OTC derivatives, and extending the applicability of the clearing obligation to cross-border transactions with counterparties that do not book their trades in Singapore. The consultation closes on 31 July 2015. Commentary A key industry concern with respect to OTC derivatives reform globally, including in Singapore, remains how, and to what extent, rules in various jurisdictions on cross-border transactions might interact and, in turn, how best to introduce an appropriately calibrated mechanism for substituted compliance, mutual recognition or equivalence. The proposed approach to mandatory clearing contained in the MAS consultation and accompanying Regulations is noteworthy for the relative narrowness of its scope (in terms of product coverage, affected market participants and territorial reach) compared with the proposed or existing mandatory clearing frameworks in the EU and US and with the enabling provisions in the SFA on which the Regulations will be based. However, the consultation paper makes it clear that its proposals will, if implemented, only be a first step in what the MAS anticipates to be an ongoing development of the clearing obligation. The likely benefit of this incremental phase-in of the clearing obligation in Singapore is that it will facilitate coordination with mandatory clearing in other jurisdictions and allow for the obligation to be aligned with industry readiness. A few areas in the consultation paper might require clarification from the MAS, for example, the treatment under the clearing obligation of certain complex structures, and whether the concept of booked in Singapore for the purpose of the clearing obligation is intended to be identical to that under Singapore s current OTC derivatives reporting regulations. Overall, the MAS approach is indeed welcomed. For a comparison between the proposed mandatory clearing regime in Singapore and the EU and US frameworks, please see the annex to this alert, immediately below. 4
Further information If you would like to discuss the above, its implications for your existing business model, and/or any steps which ought to be taken as a result, feel free to contact Victor Wan, Peiying Chua, Henry Lobb or Hagen Rooke or any of your other Linklaters contacts. Contacts For further information please contact: Victor Wan Partner Capital Markets (+852) 29015338 victor.wan@linklaters.com Peiying Chua Managing Associate Financial Regulation (+65) 66925869 peiying.chua@linklaters.com Henry Lobb Managing Associate Capital Markets (+65) 66925850 henry.lobb@linklaters.com Hagen Rooke Managing Associate Authors: Hagen Rooke, Henry Lobb, Peiying Chua This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters Singapore Pte. Ltd.. All Rights reserved 2014 Linklaters Singapore Pte. Ltd. (Company Registration No. 200007472C) is a qualifying foreign law practice, incorporated with limited liability in Singapore. Linklaters Singapore Pte. Ltd. is affiliated with Linklaters LLP, a limited liability partnership registered in England and Wales with registered number OC326345. Linklaters LLP is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on www.linklaters.com. Please refer to www.linklaters.com/regulation for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. Financial Regulation (+65) 66925878 hagen.rooke@linklaters.com One George Street #17-01 Singapore 049145 Telephone (+65) 6692 5700 Facsimile (+65) 6692 5708 Linklaters.com 5
ANNEX Mandatory clearing of OTC derivatives Comparison of proposed Singapore regime with EU and US frameworks Singapore European Union United States of America Product coverage Proposed minimum: SGD denominated fixed to floating interest rates swaps linked to Swap Offer Rate USD denominated fixed to floating interest rates swaps linked to LIBOR Possibly extending to: EUR, GBP and JPY denominated interest rate swaps SGD, USD, EUR, GBP and JPY denominated basis swaps, forward rate agreements and overnight index swaps Due to become subject to mandatory clearing: EUR, GBP, USD and JPY denominated basis and fixed to floating interest rate swaps EUR, GBP and JPY denominated forwardrate agreements and overnight index swaps itraxx Europe Main and itraxx Europe Crossover credit default swaps with 5 year maturity Non-deliverable forwards cash-settled foreign exchange forward contracts with the settlement currency being USD and the other currency in the currency pair being any of the following currencies: BRL, CLP, CNY, COP, IDR, INR, KRW, MYR, PHP, RUB or TWD Currently subject to mandatory clearing: EUR, GBP, USD and JPY denominated basis swaps, fixed to floating interest rate swaps and forward rate agreements EUR, GBP and USD denominated overnight index swaps itraxx Europe Main credit defaults swaps with 5 year or 10 year maturity itraxx Europe Crossover and itraxx Europe HiVol credit default swaps with 5 year maturity Market participant coverage Mandatory clearing proposed to apply to all Singaporeincorporated banks and Singapore branches of foreign banks with S$20billion gross notional outstanding derivative contracts booked in Singapore in each of the last four calendar quarters. This may later be extended by lowering the S$20billion threshold and/or including the more active non-bank financial institutions that trade OTC derivatives. Parties to intergroup transactions and certain public Mandatory clearing applies if OTC derivative is between: a financial counterparty (i.e. a bank, insurer, investment firm, pension fund, certain types of fund and management company) or (ii) a systemically important non-financial counterparty above a clearing threshold, and another counterparty falling within (i) or (ii); a financial counterparty or a non-financial Mandatory clearing of swaps and security-based swaps is applicable to all market participants unless an exemption applies. Exemptions exist for end users who are not a financial entity use a swap to hedge commercial risks, majority-owned affiliates (provided that a number of conditions are satisfied), and foreign governments, central banks and international finance institutions. No rules or guidance yet published for security-based swaps. There are statutory exemptions for transactions // 6
Singapore European Union United States of America bodies to be exempt. counterparty above a clearing threshold and a non-eu entity that would be subject to clearing if established in the EU; or two non-eu entities if there is a direct, substantial, foreseeable effect within the EU or where necessary to prevent evasion of any provisions of EU OTC derivatives regulation. Non-systemically important non-financial counterparties, parties to intragroup transactions, pension funds (until 12 August 2017, subject to conditions) and certain public bodies are exempt. entered into by end-users that are not financial entities, small depository institutions and captive finance companies hedging commercial risk. Extraterritoriality and equivalency Currently, clearing obligations only apply to relevant transactions if booked in Singapore by both parties. This may later be extended to cover some cross-border transactions. SGX-DC is registered as a Derivatives Clearing Organization with CFTC and recognised as an equivalent third-country CCP by European Securities Markets Authority. Mandatory clearing applies to contracts entered into between third country entities that would be subject to the obligation were they established in the EU provided that: the contracts have a direct, substantial and foreseeable effect within the EU; or such obligation is necessary or appropriate to prevent the evasion of any provision of EMIR. European Commission has adopted equivalence decisions for regulatory regimes in Australia, Hong Kong, Japan and Singapore; CCPs in these jurisdictions can therefore be used by EU market participants to satisfy mandatory clearing obligations. In relation to swaps, CFTC has jurisdiction over activities outside the US: which have a direct and significant connection with activities in, or effect on, commerce of the United States;or where it is necessary or appropriate to prevent evasion. Non-US market participants may substitute compliance with the requirements of their home jurisdiction s law and regulations in lieu of compliance with CFTC if the CFTC finds that such requirements are comparable to requirements under the CFTC regulations. In relation to security-based swaps, SEC has jurisdiction over activities outside the US where it is necessary or appropriate to prevent evasion. // 7