Changes to the Securities and Futures (Financial Resources) Rules
The proposed changes include applying the FRR’s liquid capital regime to LCs engaging in OTCD activities by subjecting them to a liquid capital requirement. In addition, they may also be subject to a fixed-dollar baseline capital requirement through the introduction of the tangible capital concept. For the proposed new Type 7 activity, which is the provision of automated trading services for the trading of OTCD products, the SFC proposed to raise the capital requirements commensurate to the risk related to the OTCD activities.
The consultation paper also introduces the Standard Market Risk Approach and Standardized OTCD Counterparty Credit Risk Approach into the FRR. These approaches require complex calculation. Hence, their application would be more relevant to LCs engaging in regulated OTCD dealing activities (Type 11), providing automated trading services for the trading of OTCD (the new Type 7 activity) or providing client clearing services for OTCD transactions (Type 12). For LCs not engaging in any of these activities, these approaches may be too complex and not cost-effective to implement.
Two simpler approaches known as the Basic Market Risk Approach and the Basic OTCD Counterparty Credit Risk Approach are therefore proposed for such LCs in relation to the risk arising from their OTCD proprietary transactions. Further, for LCs engaging in certain regulated OTCD activities and LCs opting into the standardized approaches, it is proposed to annually conduct and submit to the SFC a self-assessment of their internal controls and risk management in order to ensure they properly manage their risks.
There are also proposed additional notification requirements for LCs that engage in OTCD transactions. This includes notification of opening of positions in non-standard instruments, notification by a LC which is subject to the tangible capital requirements of its tangible capital falling below the minimum requirement and notification of any drawdown of emergency funding by an LC which is required under the proposed liquidity risk management measures to maintain an emergency funding plan.
As for the rest of the LCs, the following are the most notable changes affecting all LCs, whether they engage in OTCD activities or not:
- Increased frequency of submission of the analysis of proprietary derivative positions from quarterly to monthly
- Imposition of a cap on an LC’s aggregate uncollateralized receivables from its affiliated banks and brokers. It is considered that the cap should be set at 25% of the LC’s shareholders’ funds
- Reduced reliance on external credit ratings by supplementing it with due diligence or other analysis
- Updated list of specified exchanges to include the China Financial Futures Exchange in order to facilitate LCs’ participation in this market through the Qualified Foreign Institutional Investor programme
- Updated haircut percentages for certain types of securities and commodities
- Allowance for an LC to include in its liquid assets any amount receivable from a General Clearing Participant (GCP) of a recognized clearing house in respect of securities sales cleared by that GCP; and where the LC is a GCP of a recognized clearing house, any amount receivable from a clearing client on securities purchase cleared for the client