By Simon Hawkins and Kenneth Hui

The SFC’s consultation conclusions carve out non-financial groups and multilateral portfolio compression services.

On 12 June 2020, the Securities and Futures Commission (SFC) published its conclusions (Consultation Conclusions) on its December 2017 consultation paper that proposed modifications to the scope of regulated activities (i.e., activities for which a licence from the SFC is required) that will apply to dealing in, advising on, and providing clearing services for over-the-counter (OTC) derivatives.

The Consultation Conclusions set out the SFC’s final proposals to refine the scope of regulated activities in relation to the OTC derivatives licensing regime by implementing various amendments, clarifications, and carve-outs to the scope of applicable regulated activities.

Importantly, the SFC has confirmed that non-financial groups using OTC derivatives as part of their the corporate treasury activities will not need to be licensed.

Similarly, the SFC licensing regime will not cover providers of multilateral portfolio compression services  (i.e., services facilitating the modification, early termination or replacement of OTC derivative transactions among multiple participants to reduce the notional amount of outstanding OTC derivative transactions and/or the number of OTC derivative transactions, and therefore decrease risk).

The Consultation Conclusions also confirm that the framework for assessing whether an individual is competent to be licensed under the expanded licensing regime, and the ongoing continuous professional training (CPT) requirements that apply to individuals once they are licensed, will be consistent with the competence and CPT frameworks that currently apply to individuals licensed to conduct other regulated activities.

The SFC intends to “future-proof” the regime by including provisions that empower the SFC to prescribe future modifications to the regime by way of subsidiary legislation.

Licensing Recap

Since the Consultation Conclusions relate to the specific refinements of various regulated activities under Hong Kong’s principal securities and futures law, the Securities and Futures Ordinance (SFO), recapping the current status of the law with respect to OTC derivatives is beneficial here.

As it stands, the SFO has already been amended to introduce two new regulated activities that will apply to OTC derivatives transactions, being:

  • Dealing in OTC derivative products or advising on OTC derivative products: Type 11 regulated activity (Type 11 RA)
  • Providing client clearing services for OTC derivative transactions: Type 12 regulated activity (Type 12 RA)

In addition, the scope of certain existing regulated activities in the SFO has been expanded, namely to both:

  • Asset management: Type 9 regulated activity (Type 9 RA), which currently applies to the management of portfolios of securities and futures contracts, has been broadened to also cover the management of portfolios of OTC derivative transactions
  • Providing automated trading services: Type 7 regulated activity (Type 7 RA), which currently applies to electronic facilities that are used for trading securities and futures contracts, will be expanded to cover electronic facilities that are used for trading OTC derivative transactions

While these provisions have already been incorporated into the SFO, they have not yet been brought into effect, pending further work by the SFC to determine the precise scope of this licensing framework involving OTC derivatives.

The Consultation Conclusions mark another step forward on the road to implementing the OTC derivatives licensing regime.

Summary of changes proposed in the Consultation Conclusions

The following table summarizes a number of the SFC’s final proposals, as set out in the Consultation Conclusions.

Competence and CPT requirements

  • The core requirements under the SFC’s Guidelines on Competence and the CPT requirements that currently apply to Type 1-10 RAs will apply equally to Type 11 and 12 RAs.
  • The SFC will be developing new regulatory licensing examination papers and modifying existing examination papers to cover the industry and regulatory knowledge requirement under the Guidelines on Competence in relation to the new and expanded RAs.
  • When the licensing regime is brought into effect, there will be a transitional period during which time some individuals may be exempted from taking the new exams, provided that those
    individuals complete a post-licensing refresher course. The details of these grandfathering arrangements will be announced at a later stage.

Next Steps

The SFC has stated in its Consultation Conclusions that the OTC derivatives licensing regime will not be brought into effect until all applicable legislation has been amended to reflect the refinements set out in the Consultation Conclusions. The SFC is currently working with the Department of Justice to make the relevant amendments.

Although the OTC derivatives licensing regime will not come into effect immediately, market participants are recommended to review their existing businesses to identify if and how the licensing regime will impact their businesses and plan ahead accordingly.