The Securities and Futures Commission (SFC), a Hong Kong regulator, released a consultation paper this Tuesday that proposes Regulation over non-centrally cleared over-the-counter (OTC) derivative transactions.

If implemented, the proposed legislative changes will see the SFC implementing the OTC derivatives rules as set out by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS-IOSCO).

These rules were laid out in March of 2015 when BCBS-IOSCO released a report, Margin requirements for non-centrally cleared derivatives. Full of near-impenetrable legalistic language, the report’s name is perhaps the only thing that provides a clear idea of what its purpose actually is.

Copycat

The consultation paper issued by the SFC today follows the BCBS-IOSCO paper’s guidelines almost exactly. The Hong Kong regulator has given firms two months to respond to its suggestions, after which it will start formulating new regulation.

The rules that the consultation paper sets out, in essence, require firms to exchange margins when certain thresholds are met regarding the total value of a firm’s outstanding non-cleared OTC derivatives positions.

A firm must use ‘variation margin’ on a regular basis in order to reflect changes in the value of its outstanding contracts. Firms may also have to use ‘initial margin’ to cover exposure to a defaulting counterparty.

Unfortunately for the bulk of firms, there is not much wiggle room with the regulation as it applies to nearly all OTC non-centrally cleared derivatives.

There are some exceptions which many readers here at Finance Magnates will be pleased about. Physically settled FX futures and Swaps will be exempt as they are seen as less risky than other non-centrally cleared OTC derivatives.