On 17 July 2015, the Securities and Futures Commission (SFC) released a consultation paper on proposed changes to the Securities and Futures (Financial Resources) Rules (FRR) relating to capital and other prudential requirements for licensed corporations engaged in over-the-counter (OTC) derivatives activity (Proposals). The purpose of the Proposals is to enhance the SFC’s prudential regulatory regime in line with recent international developments in the US, UK, Australia and Singapore with regards to capital standards for investment intermediaries.

The Proposals, largely based on the existing standards for market risk capital requirements and OTC derivatives related counterparty credit risk capital requirements set by the Basel Committee on Banking Supervision[1] (Basel Committee), aim to ensure that licensed corporations (regardless of license held) maintain capital and liquidity levels proportionate to the risks from their derivatives businesses and to encourage the adoption of advanced risk management standards. Key areas of the Proposals include:

  • minimum capital requirements for licensed corporations engaging in OTC derivatives activity;
  • capital treatments for OTC derivatives, other proprietary trading position market risk and counterparty credit risk arising from OTC derivatives transactions;
  • an internal models approach to calculate the capital requirements for proprietary investment market risk and OTC derivatives transactions counterparty credit risk;
  • measures to address operational risks encountered by licensed corporations when engaging in certain types of regulated OTC derivatives activity; and
  • notification and reporting requirements related to OTC derivatives activity.

The consultation ends on 16 October 2015. The SFC plans to further consult the public on subsidiary legislation which will incorporate the Proposals.

We note that the Basel Committee is currently reviewing the market risk framework and has recently issued a new non-model based approach for measuring counterparty credit risk exposure of OTC derivatives transactions, which will take effect from 1 January 2017. However, as no final conclusions have been issued, the Proposals have not incorporated this proposed new approach.

In addition to the proposed capital requirements for OTC derivatives related activities, a consultation was carried out last year on reporting and record keeping rules for OTC derivatives transactions. The Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules came into force on 10 July 2015. For more information, please refer to our previous blog entry.

The SFC press release is available here.

[1] In Basel II market risk framework (updated as of 31 December 2010) (February 2011), Basel III: A global regulatory framework for more resilient banks and banking systems (December 2010 (rev June 2011)), Basel III: International framework for liquidity risk measurement, standards and monitoring (December 2010) and Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools (January 2013)published by the Basel Committee on Banking Supervision.