The Securities and Futures Commission (SFC) will introduce two new licences next year to regulate investment banks conducting over-the-counter (OTC) trading and clearing as part of a global effort to curb risk and bolster transparency.
The reform will require a change in the law submitted to Legislative Council by the end of this year.
If passed, the SFC and the Monetary Authority (HKMA) will then implement the new rules on the US$2 trillion worth of OTC derivatives trading denominated in Hong Kong dollars or yuan in the city.
The changes would mean investment banks would have to get a licence from the SFC to do these kinds of trades and then settle them through a new clearing house being set up by Hong Kong Exchanges and Clearing (HKEx) or one approved by the SFC. Penalties for non-compliance would range from fines to licence withdrawals.
OTC trading refers to the trading of derivative products between two parties directly without using an exchange. Up until now, such trades have generally not been regulated and lacked transparency. But various factors including the 2008 global financial crisis and the collapse of US lender Lehman Brothers pushed Group of 20 leaders to step up regulation of OTC markets to control risks posed by major market players.
A second consultation about the licensing details will be held until the end of August. One licence would apply to those trading in OTC markets and the second would apply to those acting as clearing agents, SFC senior director Rico Leung Chung-yin said.
Banks already regulated by the HKMA would not need to apply for such licences, he said.
'We expect it will be mainly the investment banks that are not currently regulated by the HKMA that will need to apply for the new OTC licences,' Leung said.
Leung said that once the SFC approved the HKEx new clearing house later this year, the regulator would encourage banks to voluntarily report and clear OTC trades through HKEx from the end of this year before the law change came into effect.
In the fourth quarter, the SFC and the HKMA would also consult the market about monitoring big positions held by large investors. This could take the form of greater disclosure of trades or imposing a cap.
HKMA executive director Edmond Lau Ying-pan said regulation of these big investors were designed to protect the market. 'If any one of these big investors failed to settle a trade, the whole market would suffer ... We believe Hong Kong does not have a big investor that it needs to worry about, but we have to prepare regulations to ensure the stability of the market,' Lau said.