Nothing spooks regulators like the over-the-counter (OTC) markets. Controlling the vast private meeting place for professional investors poses one of the toughest challenges for watchdogs like the Securities and Futures Commission (SFC). Regulators periodically fire off stern warnings on the need for cross-border co-operation to ensure transparency and accountability among practitioners. The response from the trading floor is generally scathing scepticism. Earlier this week SFC chairman Anthony Neoh played OTC sheriff, announcing fresh capital adequacy guidelines for brokerages trading equity options in a rare attempt to regulate the private arena. Few would argue against basic risk management criteria being imposed on local securities houses. Indeed it is the regulator's job to protect investors from the kind of collapse that befell Wei Xin Securities trading options in March. But the SFC - or any other regulator - is unlikely to wrest control of the electronic ether in the near future. 'Over the counter' refers to any trading activity outside of a public exchange. Everything from the electronic Nasdaq to private option agreements between banks and companies' major shareholders fall under the poorly descriptive term. Most business is conducted between banks hedging, punting and managing their exposure to movements in equity values. Industry bodies such as the International Swaps Dealers Association provide a formal settlement and trading framework. Regulators have no chance of policing transactions since deals are struck between offshore entities outside of local jurisdiction. Since most are cash settled without stock transfers taking equity, market policemen like the SFC have no reason to ask questions. Banks have successfully allowed a self-regulation framework to evolve with issues of capital adequacy and risk management handled by banking supervisors. For traders a happy situation persists where oversight is limited to their boss. Efforts to clamp down on the trade have proven futile as Japanese regulators can amply testify. OTC equity option trading to this day falls under the country's gambling laws. After the Ministry of Finance sought to clamp down on activity, brokers simply shifted to Hong Kong and banks booked the transactions offshore. Banks avoid publicity about their OTC activity, claiming counter parties aware of the risk they are taking should be free to trade without public interest issues being raised. If only life was so neat and tidy. Very often the reason for violent share price movements is OTC trading activity, invisible to non-professional investors. In Hong Kong, the most blatant example is the huge option positions run by major shareholders on their own stocks. Major shareholders deal huge option positions directly with banks that have no disclosure requirements. Nothing in the regulatory armour of the SFC allows a clampdown on a practice that can be considered nothing more than legalised insider trading. Vast positions - with premiums exceeding $250 million - have been written by big Hong Kong names on their personal accounts. A preponderance of owner capitalists with shareholdings exceeding 60 per cent and a strong trading mentality makes the activity a structural feature of the local market. The lead-up to corporate announcements commonly produces much talk of this tycoon or that businessman heavily trading OTC options with impunity. Not only does the activity explain significant share price movements but forms a sizeable source of private income for major shareholders. Similarly the offshore issuance of Luxembourg covered warrants sold to a small group of investors is not required to be disclosed by either the exchange or SFC. All are highly price-sensitive transactions having a material impact on share performance that are likely to stay that way whatever the noble intentions of regulators like Mr Neoh.