Currency Conversion Arrangement Involving Onshore RMB (CNY) under Northbound Swap Connect

55th Floor, Two International Finance Centre, 香 港 中 環 金 融 街 8 號 國 際 金 融 中 心 2 期 55 樓 8 Finance Street, Central, Hong Kong 網 址：www.hkma.gov.hk Website: www.hkma.gov.hk 28 April 2023 The Chief Executive All Hong Kong FX Settlement Banks Dear Sir/Madam, Currency Conversion Arrangement Involving Onshore RMB (CNY) under Northbound Swap Connect I am writing to advise you on certain issues relating to the currency conversion activities that your bank may undertake under Swap Connect. With reference to the Joint Announcement between the People’s Bank of China (PBoC), the Securities and Futures Commission of Hong Kong (SFC) and the Hong Kong Monetary Authority (HKMA) on 4 July 2022, Swap Connect is an arrangement that enables overseas and Mainland investors to participate in the financial derivatives markets in the Mainland and Hong Kong through a connection between the infrastructure institutions in both places. In the initial stage, Northbound Trading will commence first, allowing overseas investors to participate in the Mainland interbank financial derivatives market through mutual access between Hong Kong and Mainland infrastructure institutions in respect of trading, clearing and settlement. Pursuant to the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets1 , investors are allowed to use offshore RMB (CNH) or foreign currencies to invest under Swap Connect. Swap Connect investors using foreign currencies may conduct currency conversion (CNY/FX) with the designated settlement banks in Hong Kong for daily settlements2 arising from outstanding Northbound interest rate swap contracts (referred to as “daily settlements” hereafter). The said banks may square their positions arising from the aforementioned transactions in the onshore interbank foreign exchange market in accordance with the relevant rules and regulations. In order to maintain access to the onshore interbank foreign exchange market to conduct the permitted position squaring transactions, Hong Kong banks should have proper internal controls in place to ensure compliance with the requirements in this circular and other relevant requirements including those stipulated by Mainland authorities. 1 http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/4868907/index.html 2 Daily settlement types are defined under OTC Clearing Hong Kong Limited Clearing Procedures, available at https://www.hkex.com.hk/-/media/HKEX-Market/Services/Rules-and-Forms-and￾Fees/Rules/OTC-Clear/Clearing-Procedures/Whole_OTCP.pdf.

Scope
Banks that can offer the CNY conversion service under Swap Connect include the RMB Clearing Bank and overseas RMB participating banks in Hong Kong which have been approved by the Mainland authorities to take part in the onshore interbank foreign exchange market (collectively referred to as “Hong Kong FX Settlement Banks” hereafter). Hong Kong FX Settlement Banks shall only provide the CNY conversion service to investors who have completed the application3 for the Northbound Swap Connect (referred to as “Investors” hereafter). Hong Kong FX Settlement Banks may refer to Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets for the detailed investor eligibility requirements). Each Investor can appoint one Hong Kong FX Settlement Bank to undertake CNY conversion. The Hong Kong FX Settlement Bank must concurrently be the member of the RMB RTGS system that settles all Swap Connect payments for the Investor. Upon the appointment, the Investor should inform the HKMA of its appointment through its Hong Kong FX Settlement Bank. Principle In providing the CNY conversion service, the Hong Kong FX Settlement Banks should ensure that the CNY spot transactions arise from genuine and reasonable needs from Swap Connect investments. In order to ensure continued access to the onshore interbank foreign exchange market, the Hong Kong FX Settlement Banks should ensure compliance with the relevant Mainland regulations, and have proper internal controls in place to monitor the following:
(i) the eligibility of the Investors using the CNY conversion service; (ii) the genuineness and reasonableness of the CNY spot transactions by each Investor; and (iii) the CNY converted for the Investors is properly ring-fenced and is only used for settling daily settlements. Monitoring Responsibilities In monitoring the genuineness and reasonableness of the CNY spot transactions, Hong Kong FX Settlement Banks are expected to:
(i) Obtain confirmation from the Investors that their CNY spot transactions are underpinned by genuine and reasonable Swap Connect investment needs; (ii) Maintain ongoing and dynamic oversight of (1) the net amount of CNY conversion conducted by an Investor; and (2) the net remittance4 to the settlement bank(s) of OTC Clearing Hong Kong Limited (OTC Clear) for settlings daily settlements; and (iii) Notify the HKMA if the difference between (1) and (2) exceeds 15% for a period longer than 10 trading days5 . 3 Please refer to the Swap Connect Investors Business Application Form, administrated by Bond Connect Company Limited, for more details. 4 Including payments to/from OTC Clear resulting from direct debit/credit of investors’ relevant nostro accounts by OTC Clear. 5 Northbound Swap Connect will follow the Mainland calendar. Please refer to OTC Clearing Hong Kong Limited Clearing Procedures, available at https://www.hkex.com.hk/-/media/HKEX-

Reporting Requirements
The Hong Kong FX Settlement Banks are required to submit to the HKMA the net amount of CNY spot transactions conducted with each Investor on a monthly basis using a reporting template to be distributed to the banks’ contact persons for Swap Connect (please refer to “Way Forward” below). The HKMA will make use of the data collected from the monthly report as well as the settlement data available from OTC Clear to conduct ex post spot checking of the CNY conversion service obtained by Investors via Hong Kong FX Settlement Banks. If any irregularities are found, the HKMA may ask investors to provide supporting documents, through their Hong Kong FX Settlement Banks, to clarify that their CNY spot transactions are conducted based on genuine and reasonable Swap Connect investment needs. Way Forward The Hong Kong FX Settlement Banks may start to provide the CNY conversion service after the issuance of this circular and after they have the necessary control and system in place to discharge the abovementioned requirements. Please nominate a staff member as the contact person in your bank for further communication with the HKMA on matters relating to Swap Connect currency conversion. Please submit relevant details by email to swapconnect@hkma.gov.hk. The Frequented Asked Questions are provided in Annex. Should you have any question, please contact Ms Tiffany Tang at +852 2878 1909 or Ms Andrea Chen at +852 2597 0605. Yours faithfully, Daniel Leong Division Head (External) Encl.

Market/Services/Rules-and-Forms-and-Fees/Rules/OTC-Clear/Clearing-Procedures/Whole_OTCP.pdf for more details.

---

Annex
Frequently Asked Questions in Relation to the Currency Conversion Arrangement under Swap Connect
I. Appointment and change of the Hong Kong FX Settlement Banks
Q1 How should a Hong Kong FX Settlement Bank inform the HKMA that it is appointed by an Investor? A1 Upon the appointment by an Investor, the Hong Kong FX Settlement Bank should provide the following information to the HKMA (via email: swapconnect@hkma.gov.hk) on behalf of the Investor no later than five trading days before the service commencement date: (1) the name of the Investor; (2) the CFETS ID of the Investor; (3) the name of the Hong Kong FX Settlement Bank; and (4) service commencement date. The HKMA will issue a “no objection” notification upon completion of the review. For the avoidance of doubt, in the event that an Investor is concurrently a Hong Kong FX Settlement Bank, it should also observe the aforementioned appointment procedures to obtain CNY conversion service under Swap Connect. Q2 Can Investors change the appointment of Hong Kong FX Settlement Bank? A2 Investors may change the appointment of Hong Kong FX Settlement Bank, provided that the appointed bank at any given time is concurrently the member of the RMB RTGS system that settles all Swap Connect payments for the Investor. To change the appointment, Investors should submit a Request Form 1 to swapconnect@hkma.gov.hk no later than five trading days before the effective date. Investors may submit the request directly or via a relevant Hong Kong FX Settlement Bank, provided that both the incumbent and the new Hong Kong FX Settlement Banks are copied in the submission. The Request Form will include, among other items, the Investor’s (1) net amount of CNY conversion conducted with the incumbent Hong Kong FX Settlement Bank; and (2) net remittance 2 to the settlement bank(s) of OTC Clear for daily settlements under Swap Connect. The HKMA will issue a “no objection” notification upon completion of the review. Investors should transfer all RMB funds maintained at the incumbent Hong Kong FX Settlement Bank under Swap Connect to the new Hong Kong FX Settlement Bank before the effective date. The new Hong Kong FX Settlement Bank should take into account the relevant data of CNY conversion and net remittance in the Request Form when carrying out monitoring responsibilities going forward. Q3 If an Investor has engaged more than one member of the RMB RTGS system to settle payments with the settlement bank(s) of OTC Clear, and the said members are all Hong Kong FX Settlement Banks, can the Investor appoint all the said members to undertake CNY conversion under Swap Connect? A3 No. An Investor, at any given time, can only appoint one Hong Kong FX Settlement Bank to undertake CNY conversion under Swap Connect. The bank must concurrently be the member of the RMB RTGS system that settles all Swap Connect payments for the Investor.

1 The Request Form can be obtained by emailing swapconnect@hkma.gov.hk. 2 Including payments to/from OTC Clear resulting from direct debit/credit of investors’ relevant nostro accounts by OTC Clear.

II. Account Structure and Fund Flow
Q4 Should Hong Kong FX Settlement Banks open a new and designated CNY account for each Investor? A4 The HKMA does not intend to prescribe the operational arrangement, so long as the Hong Kong FX Settlement Banks can (i) properly ring-fence the CNY converted by each Investor and ensure that it is only used for settling daily settlements under Swap Connect; (ii) put in place proper book-keeping arrangements to monitor and track fund flows by each Investor in connection with Swap Connect activities; and (iii) fulfil the reporting obligations at the investor-level as set out in this circular. Q5 Do Hong Kong FX Settlement Banks need to ring-fence CNH funds? A5 No. Q6 Is pre-funding allowed? Can Investors keep idle cash in the account for future daily settlements? A6 Hong Kong FX Settlement Banks are expected to maintain ongoing and dynamic oversight of the CNY conversion services provided to each Investor and notify the HKMA if the currency conversion exceeds the 15% threshold prescribed in the circular for a period longer than 10 trading days.
III. Monitoring Responsibilities
Q7 How often should the Hong Kong FX Settlement Banks obtain confirmation from the Investors that the CNY spot transactions are underpinned by genuine and reasonable Swap Connect investment needs? Do banks have to obtain such confirmation on a deal-by-deal basis? A7 It is up to the Hong Kong FX Settlement Banks to decide the format and frequency of such confirmation. Depending on the relationship with the Investors, the Hong Kong FX Settlement Banks may choose to accept periodic confirmation rather than deal-by-deal confirmation. Q8 Could the HKMA illustrate with some examples how the Hong Kong FX Settlement Banks should calculate whether an Investor’s currency conversion exceeds the threshold prescribed in the circular? A8 An Investor’s ① net CNY conversion with the Hong Kong FX Settlement Bank should reasonably match ② the net remittance via the said bank to the settlement bank(s) of OTC Clear for settling daily settlements under Swap Connect over a period of time. Their ③ difference should not exceed 15% for a period long than 10 trading days. Consider the following scenarios:
On Day 1, Investor A buys CNY 200 from the Hong Kong FX Settlement Bank. It has not conducted any remittance to or from OTCC. ① = 200 ② = 0 ③ = | (200 – 0) / 0 | (exceeds 15%) On Day 2, Investor A sells CNY 90 to the Hong Kong FX Settlement Bank. It remits a net amount of RMB 100 to OTCC.

① = 200 – 90 =110
② = 100
③ = | (110 – 100) / 100 | (does not exceed 15%) On Day 3, Investor A sells CNY 150 to the Hong Kong FX Settlement Bank. ① = 200 – 90 – 150 = – 40 ② = 100 ③ = | (– 40 – 100) / 100 | (exceeds 15%) On Day 4, Investor A receives a net remittance of RMB 145 from OTCC. ① = 200 – 90 – 150 = – 40 ② = 100 – 145 = –45 ③ = | (– 40 – (–45)) /(–45) | (does not exceed 15%) Q9 How should the Hong Kong FX Settlement Banks inform the HKMA if Investors’ currency conversion exceeds the 15% threshold prescribed in the circular for a period longer than 10 trading days? A9 The Hong Kong FX Settlement Banks should inform the HKMA by emailing swapconnect@hkma.gov.hk. We may require supporting documents to review the actual circumstances of the case and assess whether the CNY conversion arises from genuine and reasonable Swap Connect investment needs. The banks may continue to provide CNY conversion service to the Investor, unless otherwise instructed by the HKMA. Q10 It is mentioned in the circular that the HKMA may ask for supporting documents. Can the HKMA provide examples of the acceptable supporting documents? A11 The type of clarifications and supporting documents will vary depending on the circumstances of the case. Generally speaking, records of CNY spot transactions, fund remittance, Swap Connect transactions, coupon/variation margin/price alignment interest payments are supporting documents that we may ask for.
IV. Reporting Requirements
Q12 How should Hong Kong FX Settlement Banks submit their monthly report to the HKMA? A12 The report should be submitted to swapconnect@hkma.gov.hk by the fifth trading day of every month. Q13 For the Hong Kong FX Settlement Banks that employ a centralised settlement model pursuant to the PBoC’s Notice 159 (i.e. all offshore banks under the same banking group square their CNY positions in the onshore Interbank FX Market through its Hong Kong affiliates), what would be the reporting requirements? A13 The reporting requirements set out in this circular apply to all CNY conversion activities provided by the Hong Kong FX Settlement Banks under Swap Connect. So for the Hong Kong FX Settlement Banks that centrally square the Swap Connect-related CNY spot transactions on behalf of their banking groups, Hong Kong FX Settlement Banks should include the CNY spot transactions conducted by their offshore affiliates in the reporting.

For example, if Investor A buys CNY 100 from an overseas branch of Bank A and the overseas branch buys CNY 100 from Bank A back-to-back, Bank A’s monthly report to the HKMA should reflect a net CNY conversion of 100 by Investor A. Q14 Are self-trades reportable? If buy and sell CNY trades are netted out among different Investors engaging the same Hong Kong FX Settlement Bank at the end of a trading day (i.e. not subsequently squared in the onshore FX market), does the bank still need to report the relevant trades in their monthly report to the HKMA? A14 Under Swap Connect, all client-facing CNY spot transactions 3 are reportable, irrespective of whether the Hong Kong FX Settlement Bank is concurrently the Investor, and whether the relevant positions are ultimately squared in the onshore FX market. For example, if Investor A buys CNY 100 from Bank A and Bank A (as an Investor) sells CNY 100 to itself (as a Hong Kong FX Settlement Bank), the monthly report of Bank A (as a Hong Kong FX Settlement Bank) to the HKMA should reflect a net CNY conversion of 100 by Investor A and a net CNY conversion of -100 by Bank A (as an Investor).

3 Except the scenario specified in Q&A 13.