Market split over HK OTC derivatives proposals
The regulatory proposals for
OTC derivatives from the Hong Kong Monetary Authority (HKMA) and Securities and
Futures Commission (SFC) are garnering a mixed response from market
participants, with some broadly welcoming them and others doubting the
practicality of crucial elements of the new regime.
Following a consultation at
the end of last year, the HKMA and SFC published its conclusions earlier this
month and announced a supplementary consultation on the changes would be held
until the end of August.
“In general, the effect of
current regulatory regime proposals in Asia is that Hong Kong, Singapore and
Australia will come into line with most regulatory aspects of the G20 – which
can be summarised as ‘Stage One’ swap execution facilities and clearing as per
the Dodd-Frank regime [in the US] – with a second stage of detailed rule-making
to follow,” said Michael Go, executive director of the Money Market and Debt
Hong Kong’s regulators are
“liaising with the market comprehensively,” suggested Go, who stressed the
importance of taking into account the practicalities of the proposed changes
for participants and new electronic trading platforms.
Dr Alex Frino, professor of
finance at the University of Sydney Business School and CEO at Capital Markets
Cooperative Research Centre, said: “There are similar consultations going on in
major markets around the world and they are centred on three points:
centralised clearing, centralised reporting and the issue of trading OTC
derivatives on exchanges.”
The HKMA/SFC consultation
documents “lack specifics, and the devil will be in the details,” said Frino,
who believed the proposals for shifting OTC derivatives on to electronic
platforms will be the biggest stumbling block.
“There are good reasons why they
don’t trade on exchanges. If there were good economic reasons for them to do
so, they would be traded and the liquidity would be absorbed. I don’t think
forcing them onto exchanges is going to work, it will diminish their value,” said
Frino, who added the point of OTC instruments is that the specific terms and
dates can be tailored to suit the parties involved and to defer the risk from
those who are willing to pay for that. “They are so non-homogenous; how can you
fit that onto exchange trading?”
Trading on exchanges would
bring more transparency and create an audit trail, conceded Frino, but he
believed the practicalities involved made it close to “impossible”.
“The trading technology will
also struggle to handle the complexity of them; it already struggles with some
of the more exotic instruments that are traded electronically now,” Frino said.
Similar considerations exist
for centralised clearing and reporting, says Frino, “They are so heterogeneous
that working out the risks for each one individually will be so difficult that
the economies of scale for clearing houses won’t work, it will be very
expensive. That would impose costs on OTC derivatives.”
He said reporting made
perfect sense in a broad-brush sense. But OTC instruments are so specifically
tailored and exotic that reporting is almost meaningless.
“What do you gain? OTC
derivatives exist because two parties hammer out the details between them,”
However, MMADX’s Go sees the
shift towards automated trading and processing as unstoppable.
“With the SFC’s proposed
regulations, G20 directives and Dodd-Frank all pushing, there is a lot of
momentum behind OTC derivatives moving onto an electronic trading platform.
There are also benefits for the market in pooling liquidity onto an exchange,
efficiencies from straight-through processing and improvements to pre- and post-trade
risk management,” said Go. “Therefore, it is MMADX’s view that this movement is
inevitable, noting that virtually every other financial instrument trades
MMADX is currently looking
at the feasibility of launching its platform in Asia after it becomes
operational in Australia.