This article discusses proposed amendments to clearing rules for over-the-counter derivative (OTC) transactions in Hong Kong, in alignment with global OTC market reforms. The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) introduced mandatory clearing for specific interest rate swaps (IRS) in 2016. Now, in response to changing benchmarks and international standards, the HKMA and SFC are proposing adjustments. These include removing clearing requirements for transactions tied to discontinued interbank offered rates (IBORs) and introducing clearing requirements for transactions referencing alternative reference rates (ARRs). The proposed changes aim to streamline Hong Kong's clearing regime, reduce compliance burdens, and ensure easy access to clearing services through designated central counterparties (CCPs). Pending approval, these changes are expected to come into effect on July 1, 2024. Market participants are advised to prepare for these revisions in OTC derivative clearing rules. For more information, please contact one of our OTC Derivatives Clearing Rules lawyers.
Proposed Amendments to the Clearing Rules for Over-the-Counter Derivative Transactions Pursuant to Global Interest Rate Benchmark Reform
Background
In line with global efforts to meet the G20 commitments to reform over-the-counter (“OTC”) derivatives markets, the Hong Kong Monetary Authority (“HKMA”) and Securities and Futures Commission (“SFC”) implemented a regulatory regime for OTC derivatives in Hong Kong, with rules already implemented for both mandatory reporting and mandatory clearing.
Mandatory clearing took effect on September 1, 2016 and captured specified standardised interest rate swaps (“IRS”) between major dealers when certain conditions under the Securities and Futures (OTC Derivatives Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules (“Clearing Rules”) are met. Currently three types of IRS denominated in HKD and G4 currencies (i.e. USD, EUR, GBP and JPY) are subject to mandatory clearing and these are set out in Schedule 1 to the Clearing Rules (“Product Tables”).
ARRs to replace IBORs
Separately, in 2014, the G20 commissioned the Financial Stability Board (“FSB”) to (a) undertake review of major interest rate benchmarks and plan for reform, and (b) ensure that interest rate benchmarks were robust and used appropriately by market participants. Various jurisdictions and regulators then worked to identify, develop and implement alternative reference rates (“ARRs”) which could be used instead of certain interbank offered rates (“IBORs”) that have either ceased (or will cease) to be published by their respective administrators, or which have ceased (or will cease) to be representative, so as to enable an orderly transition from the IBORs to the ARRs.
The HKMA and the SFC issued their joint consultation paper (“Consultation Paper”) on their proposed changes to the mandatory clearing regime in March 2023, in which they proposed to (i) remove the requirement to clear certain OTC derivative transactions referencing IBORs that have ceased or will cease to be published or considered representative by relevant regulators and administrators, and (ii) require the clearing of transactions that reference ARRs as identified by relevant regulators in the relevant jurisdictions.
In particular, it was noted that the following benchmarks have ceased or will cease to be representative or published from the dates below:
EUR EONIA (all tenors) (after 3 January 2022)
GBP LIBOR (all tenors) (after 31 December 2021)
JPY LIBOR (all tenors) (after 31 December 2021)
USD LIBOR (tenor of one week and two months) (after 31 December 2021)
USD LIBOR (tenors of overnight, one, three, six and 12 months) will cease to be representative or published immediately after 30 June 2023.
Separately, it was noted that in Hong Kong, whilst HONIA has been identified as an alternative to HIBOR, there is no plan to discontinue HIBOR as market participants still widely recognise it as a credible and reliable benchmark.
Aims and Policies of Consultation Paper
With a view to keeping Hong Kong's OTC derivatives clearing regime up to date and relevant as the market evolves, the HKMA and the SFC have indicated that they wish to support international efforts to transition from IBORs to ARRs. Specifically, in the Consultation Paper they proposed amendments to the Product Tables to (a) remove specified OTC derivatives transactions referencing certain IBORs that have ceased or will cease to be published, or are no longer representative; and (b) to replace those transactions with specified Overnight Index Swaps (“OIS”) referencing the relevant ARRs.
These proposed amendments are in line with the proposed/implemented IBOR-related changes in the mandatory clearing regimes of other major jurisdictions, including the United States, the United Kingdom, the European Union, Australia, and Japan and reflect a policy to keep the scope of the current mandatory clearing obligation in Hong Kong relatively unchanged. The proposals also took into account the fact that:
The experiences of other jurisdictions over the past two years could help reduce the implementation, compliance and monitoring burden on prescribed persons and market participants;
There are at least two CCPs designated under the Clearing Rules that currently provide clearing services for each of the proposed new types of OIS such that specified persons are not expected to encounter significant difficulties in accessing the necessary clearing services for these types of OIS; and
As other aspects of the Clearing Rules remain unchanged, including the clearing threshold, the frequency of the calculation periods and prescribed day, and the availability of designated CCPs, there should be minimal impact to market participants in terms of their substantive compliance burden, with relevant data from the HKMA’s Trade Repository showing that participants in the Hong Kong OTC derivatives market were already voluntarily submitting the bulk of some of the proposed types of OIS for central clearing.
Specific Changes to the Product Tables
In line with the IBOR to ARR changes in other major jurisdictions, the Consultation Paper proposed:
Transactions referencing GBP LIBOR - (i) to remove the requirement to clear transactions referencing GBP LIBOR for basis swaps and fixed-to-floating swaps; and (ii) to revise the requirement to clear transactions referencing GBP SONIA for OIS with tenors ranging from the current “seven days to two years” to “seven days to 50 years”
Transactions referencing JPY LIBOR - (i) to remove the requirement to clear transactions referencing JPY LIBOR for basis swaps and fixed-to-floating swaps; and (ii) to add a requirement to clear transactions referencing JPY TONA for OIS with tenors ranging from “seven days to 30 years”
Transactions referencing EUR EONIA - (i) to remove the requirement to clear transactions referencing EUR EONIA for OIS; and (ii) to add a requirement to clear transactions referencing EUR €STR for OIS with tenors ranging from “seven days to three years”
Transactions referencing HKD HONIA - to add a requirement to clear transactions referencing HONIA for OIS with tenors ranging from “seven days to 10 years”, noting that the proposed addition of OIS in HKD referencing HONIA for mandatory clearing along with the retention of the current transaction types referencing HIBOR was consistent with the HKMA’s “multi-rate approach” to maintaining both HIBOR and HONIA
Transactions referencing USD LIBOR - (i) to remove the requirement to clear transactions referencing USD LIBOR in basis swaps and fixed-to-floating swaps; and (ii) to add the requirement to clear transactions referencing USD SOFR in OIS with tenors ranging from “seven days to 50 years”
Consultation Submissions
The HKMA and the SFC received 10 submissions in response to the proposed changes set out in the Consultation Paper and subsequently published their consultation conclusions on August 29, 2023, which included the revised version of the Product Tables.
Consultation Conclusions
In addition to revising the Product Tables in line with the specific changes described above (with such changes, subject to negative vetting by the Legislative Council, coming into operation on July 1, 2024), the Consultation Conclusions noted the following matters:
Availability of designated CCPs - The HKMA and the SFC noted that there are at least two designated CCPs available for each of the new or amended IRS types referencing ARRs, covering all tenors as set out in the revised Product Tables. As a result, it is not expected that there should be significant difficulties for prescribed persons to access the necessary clearing services in respect of the revised Product Tables.
Non-Standard Conventions - The HKMA and the SFC also noted that whilst there are multiple overnight rate conventions to support ARR OIS, the designated CCPs generally support both the standard overnight rate conventions commonly used by market participants together with selected non-standard conventions. Thus, even where a designated CCP does not support all the non-standard conventions, that should not by itself present an obstacle to clearing and the designated CCPs should be able to adequately support the clearing of the prescribed products.
Based on the submissions received, market participants appeared to not be overly concerned with this issue, however, if a designated CCP usually engaged by a prescribed person is unable to clear a prescribed product on the basis that it does not support a particular non-standard overnight rate convention for OIS, then the prescribed person is expected to make reasonable efforts to ensure that the IRS is cleared if and as required by the Clearing Rules (for example, by way of seeking to clear the IRS with another designated CCP).
Whilst the Clearing Rules do not stipulate what happens if a trade is not cleared (as that is fact dependant and all such situations cannot be accounted for under the Clearing Rules), if a prescribed person fails to clear an in-scope OIS as required by the Clearing Rules after taking reasonable steps, because the convention is not supported by any of the designated CCPs, then proper records of such reasonable steps taken by the prescribed person to comply with its clearing obligation should constitute a reasonable excuse.
Notwithstanding the foregoing, if there is subsequently market concern that designated CCP support may not be available for certain non-standard overnight rate conventions for OIS, the HKMA and the SFC have stated that they will take such concerns into account when next reviewing the Clearing Rules.