Securities and Futures (OTC Derivative Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules

Our Ref: B9/135C
B1/15C
1 September 2016
The Chief Executive
All Authorized Institutions
Dear Sir/Madam,
Securities and Futures (OTC Derivative Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules As you may be aware, the Securities and Futures (OTC Derivative Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules (the “Clearing Rules”) come into operation today. I am pleased to attach a set of frequently asked questions (“FAQs”) prepared by the Securities and Futures Commission and the Hong Kong Monetary Authority, which serves to provide clarifications with regard to how the Clearing Rules operate. For the purpose of facilitating our regulatory monitoring, Authorized Institutions are requested to notify the HKMA when they have reached the clearing threshold for the first time (and the first time again after an exit notice has been given). Such notification should be sent via email to “OTCDclearing@hkma.gov.hk” within 60 days after the end of the relevant calculation period for the clearing threshold. If you have any questions about this letter, please call our hotline on 2878-1279 or write to the e-mail address “bpd_otc@hkma.gov.hk”. Yours faithfully, Karen Kemp Executive Director (Banking Policy) Encl. c.c. Financial Services and the Treasury Bureau (Attention: Mr Jackie Liu)

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Enclosure - Frequently Asked Questions on the Implementation and Operation of the Mandatory Clearing Regime

Frequently Asked Questions on the Implementation and Operation of the Mandatory Clearing Regime (1 September 2016) These FAQs elaborate on how the mandatory clearing regime under the Securities and Futures (OTC Derivative Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules (Clearing Rules) will operate and are intended to help market participants better understand their obligations and responsibilities under the Clearing Rules so that they are better able to prepare for implementation of the new regime and ensure compliance going forward.

Table of Contents
Definitions and interpretation ........................................................................................ 3
Legislation and technical guidance................................................................................. 3
Commencement date.................................................................................................... 3
Transitional arrangement .............................................................................................. 3
Persons subject to clearing and record keeping obligations................................................ 4
Circumstances clearing obligation is triggered................................................................. 4
Calculation period, prescribed day and clearing threshold................................................. 5
Average total position and average local total position...................................................... 6
Financial services providers.......................................................................................... 7
Transactions subject to mandatory clearing ..................................................................... 8
Exemptions from clearing obligation............................................................................ 12
Exempt affiliate exemption ......................................................................................... 13
Exempt jurisdiction exemption .................................................................................... 14
Exemption for transactions resulting from multilateral portfolio compression cycle ........... 17
Substituted compliance............................................................................................... 17
Exit from clearing obligation....................................................................................... 19
How to comply with clearing obligation ....................................................................... 20
Time allowed to clear................................................................................................. 21
Record keeping requirements...................................................................................... 21
Consequences of contraventions.................................................................................. 22
Annex 1.................................................................................................................... 23
Annex 2.................................................................................................................... 26
Annex 3.................................................................................................................... 27

Definitions and interpretation
Unless the context otherwise requires, terms defined in Schedule 1 to the SFO or in the Clearing Rules bear the same meaning when used in the questions and answers below, and the following terms bear the following meanings:

• “HKMA” refers to the Hong Kong Monetary Authority;
• “Clearing Rules” means the Securities and Futures (OTC Derivative
  Transactions – Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules;
• “SFC” refers to the Securities and Futures Commission;
• “SFO” refers to the Securities and Futures Ordinance (Chapter 571, Laws of
  Hong Kong);
• “specified OTC derivative transaction” means an OTC derivative transaction
  that is specified in section 2 of Schedule 1 to the Clearing Rules, which will be subject to mandatory clearing if certain criteria are satisfied. Legislation and technical guidance Q1. Where are the clearing and record keeping requirements set out? The broad framework for clearing and record keeping obligations is contained in
  Part IIIA of the SFO, and the detailed requirements are set out in the Clearing
  Rules.
  These documents are accessible at the Department of Justice’s website:
  www.legislation.gov.hk.
  Commencement date
  Q2. When will the clearing and record keeping obligations start to operate? The requirements for clearing and record keeping obligations will come into operation on 1 September 2016. Transitional arrangement Q3. Is there any transitional arrangement for complying with the mandatory clearing requirements? No, there is no provision for transitional arrangement under the Clearing Rules. That said, the first date a person may be required to clear a specified OTC

derivative transaction is 1 July 2017, i.e. there is a gap of 10 months from the date the Clearing Rules come into operation on 1 September 2016. This is explained in Q6 below. Persons subject to clearing and record keeping obligations Q4. Who would be subject to the mandatory clearing and related record keeping requirements? The Clearing Rules at present are intended to cover specified OTC derivative transactions entered into between major dealers (phase 1 clearing). The clearing and record-keeping obligations apply to the following persons:
(a) an authorized institution (AI);
(b) an approved money broker (AMB); or
(c) a licensed corporation (LC).
In respect of an AI and AMB that is incorporated overseas, the obligations apply only to the transactions that are recorded in the Hong Kong books of that AI and AMB, and transactions that are not recorded in the Hong Kong books are not subject to the obligations. AIs, AMBs and LCs will need to ensure that their specified OTC derivative transactions are cleared in accordance with the Clearing Rules if circumstances for triggering mandatory clearing are met. Circumstances clearing obligation is triggered Q5. Under what circumstances are specified OTC derivative transactions subject to clearing obligation? An AI, AMB or LC must centrally clear a specified OTC derivative transaction if the following circumstances are all met – (a) The AI, AMB or LC has reached the clearing threshold. (Please see Q6 to Q10 on clearing threshold, calculation of average total position and average local total position, and types of transactions to be included in the calculation.) (b) The transaction is entered into on or after the prescribed day for the calculation period in respect of which the AI, AMB or LC reached the clearing threshold for the first time (or for the first time again after giving

an exit notice). (Please see Q6 on calculation period and prescribed day and Q35 and Q36 on exit notice.) (c) The counterparty is an AI/AMB/LC and is also required to clear the transaction concerned (i.e. circumstances (a) and (b) above are applicable to that counterparty), or the counterparty is a financial services provider. (Please see Q11 below for the definition of a financial services provider.). Calculation period, prescribed day and clearing threshold Q6. What is a calculation period and what is a prescribed day in relation to a calculation period? A calculation period is the period in which a person’s applicable position in OTC derivatives is calculated to determine whether it has reached the clearing threshold. Please see Q8 to Q10 for further information. There are multiple calculation periods. Each calculation period is three months in duration and there is a six-month interval between the start of one calculation period and the start of the next one. We may extend this six-month gap in future as appropriate. A prescribed day in relation to a calculation period is the day which is seven months after the end of the calculation period. For a person who has reached the clearing threshold for the first time in a calculation period, the clearing obligation will only apply to future transactions entered into on or after the prescribed day for that calculation period. This is to allow one month for the calculation of the applicable position and six months for setting up the infrastructure and completing the documentation and on-boarding exercise for central clearing. Currently, there are four calculation periods specified in Schedule 2 to the Clearing Rules, each with its corresponding prescribed day. The first calculation period runs from 1 September 2016 to 30 November 2016. The first prescribed day is 1 July 2017, seven months after 30 November 2016. This explains the 10-month gap between the commencement of the Clearing Rules and the first date a person may be required to clear a specified OTC derivative transaction. A simplified table of the four calculation periods and their corresponding prescribed days is set out below for easy reference - Calculation period Prescribed day

1. 1 September 2016 to 30 November 2016 1 July 2017

2. 1 March 2017 to 31 May 2017 1 January 2018

3. 1 September 2017 to 30 November 2017 1 July 2018

4. 1 March 2018 to 31 May 2018 1 January 2019
   Q7. What is the clearing threshold for an AI/AMB/LC?
   The clearing threshold for phase 1 clearing is set out in Schedule 2 to the Clearing Rules. It is currently set at US$ 20 billion for all four calculation periods specified in the rules. We may lower the threshold in future as appropriate. Q8. When is a person regarded as having reached the clearing threshold? A person has reached the clearing threshold if its applicable position for a calculation period equals or exceeds the clearing threshold for that calculation period. (Please see Q9 below for the calculation of the applicable position) The person is regarded as having reached the clearing threshold at all times thereafter, even if the person’s applicable position falls below the threshold for a subsequent calculation period, until an exit notice is given. (Please see Q35 and Q36 in relation to exit notice.) Average total position and average local total position Q9. How should a person calculate its applicable position in relation to its clearing threshold? For a person that is a local AI/AMB/LC, its applicable position is its average total position which is calculated by taking a simple arithmetic average of the three month-end snapshots of the total position of the person over the 3-month calculation period. For a person that is an overseas AI/AMB/LC, its applicable positon is its average local total position which is calculated by taking a simple arithmetic average of the three month-end snapshots of the person’s local total position over the 3-month calculation period. In other words, this calculation only takes into account the position that is booked in the person’s Hong Kong branch.

Total position and total local position are the aggregate of notional amounts of applicable trades, calculated on a gross basis, i.e. without netting. Please see further elaboration in Q10. Q10. What transactions are included in the calculation of the total position? Whilst only certain types of plain vanilla Interest Rate Swap (IRS) transactions are subject to mandatory clearing, for the purposes of calculation of the total positon, all outstanding OTC derivative transactions are to be counted, except for transactions in deliverable FX forwards and deliverable FX swaps which the Clearing Rules have specifically excluded. Outstanding OTC derivative transactions refer to transaction which have not been matured or early terminated and to which the person is a counterparty. Accordingly, this means that outstanding transactions – (a) that are entered into before and during the calculation period; (b) that are exempted; or (c) that are outside the scope of the first phase of clearing mandate must also be included in the calculation of total position or local total position, as applicable. For avoidance of doubt, any OTC derivative transactions not required to be cleared (whether by reason that the person has not yet reached the clearing threshold, the transactions are not specified OTC derivative transactions, or by any other reason) will still have to be included in the calculation. However, intra-company transactions between (i) two trading desks or (ii) branches/offices of the same entity do not have to be included in the calculation. Financial services providers Q11. Who are financial services providers? A financial services provider refers to a person that is designated by the SFC with the HKMA’s consent pursuant to Rule 3(1) of the Clearing Rules. The list of designated financial services providers has been published in the Government gazette and is reproduced in Annex 1 to this FAQ for ease of reference.

As we intend to cover only dealer-to-dealer transactions in phase 1 clearing, only persons that meet the following criteria are included in the gazette list of financial services providers – (a) persons that are clearing members of the largest IRS central counterparties (CCPs) in the US, Europe, Japan and Hong Kong as at 5 February 2016; and (b) persons that belong to a group of companies appearing on the list of global systemically important banks published by the Financial Stability Board in November 2015, and/or on the list of dealer groups which undertook to the OTC Derivatives Supervisors Group to work collaboratively with CCPs, infrastructure providers and global supervisors to continue to make structural improvement to the global OTC derivatives markets. The factors that are relevant to determining the list of financial services providers may also change when we expand our clearing obligation in the future to cover a wider range of entities. We will review the list of financial services providers from this perspective. Point to note:
If the clearing obligation is applicable to a transaction between an AI/AMB/LC and a financial services provider, the responsibility for ensuring compliance with clearing obligation rests with the AI/AMB/LC and not with the financial services provider. Transactions subject to mandatory clearing Q12. What OTC derivative transactions are subject to the clearing obligation? Only specified OTC derivative transactions which are set out in Schedule 1 to the Clearing Rules are subject to clearing obligation under the Clearing Rules (reproduced below for ease of reference) – (a) a basis swap that has all of the features specified for an item in a row of the table below – Item Currency Floating rate index Tenor Optionality Constant notional

1. USD LIBOR 28 days to 10 years No Yes

Item Currency
Floating rate index Tenor Optionality
Constant notional
2. EUR EURIBOR 28 days to 10 years No Yes
3. GBP LIBOR 28 days to 10 years No Yes
4. JPY LIBOR 28 days to 10 years No Yes
5. HKD HIBOR 28 days to 10 years No Yes
(b) a fixed-to-floating swap (except an overnight index swap) that has all of the features specified for an item in a row of the table below – Item Currency Floating rate index Tenor Optionality Constant notional

1. USD LIBOR 28 days to 10 years No Yes
2. EUR EURIBOR 28 days to 10 years No Yes
3. GBP LIBOR 28 days to 10 years No Yes
4. JPY LIBOR 28 days to 10 years No Yes
5. HKD HIBOR 28 days to 10 years No Yes
   (c) an overnight index swap that has all of the features specified for an item in a row of the table below - Item Currency Floating rate index Tenor Optionality Constant notional
6. USD Fed Funds 7 days to 2 years No Yes
7. EUR EONIA 7 days to 2 years No Yes
8. GBP SONIA 7 days to 2 years No Yes
   Q13. Are historical transactions subject to clearing obligation? No, historical transactions are not subject to clearing obligation under the Clearing Rules. Only specified OTC derivative transactions which the person entered into on or after the prescribed day that corresponds to the calculation period with respect to which the person reached the clearing threshold for the first time (or for the first time again after giving an exit notice) will be subject to the clearing obligation when other criteria are satisfied (see Q5 above). Please

see Q6 above for the different calculation periods and their corresponding prescribed days. Q14. Is a swaption subject to clearing obligation? A swaption is an option to enter into a swap transaction, and is not itself a swap transaction. As it does not fall within the definition of IRS in the Clearing Rules, it is not subject to phase 1 clearing. Q15. Is an IRS entered into pursuant to the physical exercise of a swaption subject to clearing obligation? An IRS entered into pursuant to the physical exercise of a swaption may be subject to phase 1 clearing if:
(a) it falls within the definition of IRS under the Clearing Rules and its features meet the specified criteria set out in Schedule 1 to the Clearing Rules, and (b) the IRS and the corresponding swaption are entered into on or after 1 September 2016, the commencement date of phase 1 clearing. Q16. Will an IRS become subject to mandatory clearing as a result of an amendment to its original terms or the occurrence of certain life cycle events? Amendments to an IRS transaction may or may not make the transaction become subject to mandatory clearing, and this depends on whether a new transaction is created because of the amendment. Much will depend on the nature and scope of the amendment. A simple amendment normally does not constitute a new transaction. However, an amendment that substantially changes the terms and conditions of the transaction would result in a new transaction and hence may be subject to clearing obligation. A pragmatic approach should be adopted when assessing if an amendment results in a new transaction that is subject to clearing obligation.

Q17. Is an IRS that forms part of a larger, complex or packaged structure subject to clearing obligation? When an IRS that falls within Schedule 1 to the Clearing Rules is a transaction on its own, and is combined with other separate transactions to make up a larger, complex or packaged structure, that particular IRS transaction will be caught by our clearing requirements. However, if the larger, complex or packaged structure is a single transaction with different components and one of the components is similar to an IRS, we do not intend to require the single transaction to be broken down into its individual components and subject the component which is similar to an IRS to clearing obligation. Also, if the larger, complex or packaged structure is in fact an embedded derivative, i.e. a simple instrument (e.g. shares, bonds, notes) with the IRS being merely an embedded feature that makes the structure a “structured product” (as defined in the SFO), the structure itself falls outside the scope of “OTC derivative product” (as defined in the SFO). The IRS, being only an embedded feature of the structure, will not be subject to mandatory clearing. Q18. Is an IRS created as a result of novation subject to clearing obligation? An IRS transaction that results from a novation will be subject to clearing if its features meet the specified criteria set out in Schedule 1 to the Clearing Rules. As these features are likely to be the same for both the original transaction and the new transaction resulting from the novation, it follows that if the original transaction was subject to clearing, the new transaction will be subject to clearing also. Additionally, the new IRS transaction may be subject to clearing even if the old transaction was not. This can happen when the old transaction is a historical transaction executed prior to the prescribed day for a calculation period and the novation may happen after the relevant prescribed day. Q19. Is a zero coupon swap subject to mandatory clearing? A zero coupon swap is an exchange of income streams in which the stream of floating rate interest payments is made periodically, but the stream of fixed rate payments is made as one lump-sum payment at maturity instead of periodically

over the life of the swap. It falls within the definition of fixed-to-floating swap in Schedule 1 to the Clearing Rules. It will be subject to mandatory clearing if it has the features specified in Schedule 1 to the Clearing Rules. Q20. What are the applicable floating rate indexes for IRS? The applicable floating rate indexes are set out in Schedule 1 to the Clearing Rules. References to floating rate indexes include all valid quoting sources.. However, certain indexes may not be relevant if they are no longer maintained. For example, we do not expect HIBOR-ISDC will be used as it is no longer maintained by the International Swap and Derivatives Association. The list of indexes may evolve over time but changes will be subject to consultation and the industry will be given time to make necessary arrangements before changes are implemented. Q21. Are intra-company transactions subject to mandatory clearing? Intra-company transactions between (i) two trading desks or (ii) branches/offices of the same entity are not subject to mandatory clearing. Exemptions from clearing obligation Q22. Are there any exemptions from the clearing obligation? Yes. There are three exemptions available and they are - (a) transactions with an exempt affiliate – Rule 8 of the Clearing Rules (see Q23 to Q25 below); (b) transactions recorded in the books of an exempt jurisdiction – Rule 9 of the Clearing Rules (see Q26 to Q29 below); and (c) transactions resulting from multilateral portfolio compression cycle – Rule 10 of the Clearing Rules (see Q30 below). The three exemptions are subject to certain requirements being fulfilled as set out in the Clearing Rules.

Exempt affiliate exemption
Q23. How does an exempt affiliate exemption under Rule 8 operate and what are the requirements? Transactions with an exempt affiliate do not have to be subject to mandatory clearing if - (a) the accounts of the person and the exempt affiliate are consolidated in full by the holding company; and (b) the risk evaluation, measurement and control procedures applicable to the person and the exempt affiliate are centrally overseen and managed within the group. In respect of (a), the consolidated accounts of the holding company must be prepared in compliance with the accounting standards issued by the Hong Kong Institute of Certified Public Accountants or the International Accounting Standards Board, or the standards of accounting practices applicable to the holding company in its place of incorporation. In respect of (b), we would expect that, for instance, there is a centralised evaluation, measurement and control function to oversee the risks relating to OTC derivative transactions of the person and its exempt affiliates for which the exemption is being sought. Q24. What does a person have to do in order for an affiliate to become an exempt affiliate under Rule 8 of the Clearing Rules? The person must send an exemption notice to either the HKMA or the SFC. The exemption notice should specify – (a) the identity of the affiliate(s) to be regarded as an exempt affiliate and more than one affiliate may be included in the exemption notice; and (b) the date from which the exemption is to take effect and that date must not be backdated, i.e. it must not be earlier than the day the notice is received by the HKMA or SFC. The exemption will only apply to transactions that are entered into by the person with the relevant exempt affiliate(s) on or after the effective date(s) as specified in the exemption notice.

Point to note:
An affiliate of a person is a corporation that is in the same group of companies as the person, except a corporation that is a collective investment scheme. Q25. What should a person do if it becomes aware that an affiliate will no longer meet the requirements set out in Rule 8(2) of the Clearing Rules after an exemption notice has been sent in respect of that affiliate to the HKMA or the SFC? When a person becomes aware that an affiliate will no longer meet the requirements, it should give a cessation notice to the HKMA or the SFC. A cessation notice must specify the following – (a) the identity of the affiliate(s) that will no longer be regarded as an exempt affiliate; and (b) the date from which the affiliate is no longer an exempt affiliate and the date must not be backdated, i.e. it must not be earlier than the day the notice is received by the HKMA or the SFC. It is the responsibility of the person (that otherwise has the clearing obligation) to ensure that it is entitled to benefit from the exemption. As and when an exempt affiliate ceases to meet the requirements under Rule 8(2) of the Clearing Rules, even if a cessation notice has not been sent to the relevant regulator, any new transaction between the person and that affiliate cannot benefit from the exempt affiliate exemption. Point to note:
Only transactions after the affiliate stops meeting the requirements under Rules 8(2) of the Clearing Rules are not exempted from clearing. Historical transactions prior to that date are not affected. Exempt jurisdiction exemption Q26. How does an exempt jurisdiction exemption under Rule 9 operate, and what are the procedures to follow if a person wishes to benefit from the exemption?

An exempt jurisdiction exemption is available to an LC or a local AI/AMB. This exemption applies to the transactions of such an institution that are booked in its branch in certain overseas jurisdictions provided that the conditions in Rule 9(2) are met. (Please see Q28 below.) To benefit from the exemption, a person must send an exemption notice to the relevant regulator (if it is an LC, to the SFC, and if it is a locally incorporated AI or AMB, to the HKMA). The exemption notice should specify – (a) the jurisdiction(s) that is to be regarded as exempt jurisdiction(s) and more than one jurisdiction may be included in the exempt jurisdiction list; and (b) the date from which the exemption is to take effect and the date must not be backdated, i.e. it must not be earlier than the day the notice is received by the HKMA or the SFC. Point to note:
There is no need to provide a similar exemption for overseas incorporated AI/AMB because OTC derivative transactions that are booked overseas for an overseas incorporated AI/AMB are not subject to the Clearing Rules. The exemption will only apply to transactions that are entered into on or after the effective date(s) specified in the exemption notice. Q27. Can a person change the list of exempt jurisdictions in its previously submitted exemption notice? A person may change its list of exempt jurisdictions from time to time. However, when an exempt jurisdiction is removed from the list, it may only be reinstated into the exempt jurisdiction list one more time. In other words, if an exempt jurisdiction is removed from the list the second time, it can never be added back to the list and new transactions booked in that jurisdiction after the second removal will not be able to benefit from the exemption under Rule 9. This is set out in Rule 9(5) of the Clearing Rules. Q28. What are the conditions under Rule 9(2) of the Clearing Rules that must be satisfied in respect of the exempt jurisdiction exemption? Rule 9(2) requires that the total position of the person for each exemption jurisdiction does not exceed 5% of the total position of the person and the total

position for all exemption jurisdictions added together does not exceed 10% of the total position of the person. If the total position of the person for any one exempt jurisdiction on the list specified in the exemption notice exceeds the 5% threshold, then the requirement under Rule 9(2)(a) is not met, and consequently, the exemption for not only that exempt jurisdiction but also all other exempt jurisdictions on the list will cease. Therefore, a person should remove any exempt jurisdiction that will not be able to comply with the 5% threshold in advance, so that the exemption in respect of the other exempt jurisdictions on the list will not be affected. Similarly, if any increase of the total position of one exempt jurisdiction on the list is going to bring the total position of all exempt jurisdictions above the 10% threshold, the person should take action (e.g. remove that particular exempt jurisdiction) in advance to bring the total position down, so that the person can continue to utilise the exemption. It is therefore critical that the list of exempt jurisdictions is kept up-to-date at all times and the person that is relying on the exemption closely monitors the level of activity in each exempt jurisdiction. Q29. How can a person remove an exempt jurisdiction from the list? When a person becomes aware that total position of an exempt jurisdiction will not be able to meet the requirements in the near future, it should give a cessation notice in respect of that jurisdiction as soon as possible to the HKMA or the SFC, as applicable. The cessation notice must specify the following – (a) the jurisdiction(s) that will no longer be regarded as exempt jurisdiction(s); and (b) the date from which the jurisdiction is no longer regarded as an exempt jurisdiction and the date must not be backdated, i.e. it must not be earlier than the day the notice is received by the HKMA or the SFC, as applicable. It is the responsibility of the person (that otherwise has the clearing obligation) to ensure that it is entitled to benefit from the exemption. As and when the total position of an exempt jurisdiction or the total position of all exempt jurisdictions (as the case may be) ceases to meet the requirements under Rule 9(2) of the Clearing Rules, even if a cessation notice has not been sent to the relevant

regulator, any new transaction in respect of all exempt jurisdictions on the list cannot benefit from the exempt jurisdiction exemption. Point to note:
Only new transactions after the total position of an exempt jurisdiction stops meeting the requirements under Rules 9(2) of the Clearing Rules are not exempted from clearing. Historical transactions prior to that date are not affected. Exemption for transactions resulting from multilateral portfolio compression cycle Q30. What are the requirements in order for transactions resulting from multilateral portfolio compression cycle to benefit from the exemption? The transaction must satisfy the criteria set out in Rule 10(2) of the Clearing Rules, i.e. – (a) the transaction is entered into as a result of a multilateral portfolio compression cycle between two participants of the compression cycle; and (b) the multilateral portfolio compression cycle (i) is conducted in accordance with the rules of the operator of the multilateral portfolio compression cycle; (ii) involves more than 2 participants and the operator cannot be a participant (i.e. a bilateral compression will not be able to benefit from the exemption); and (iii) is conducted in compliance with the risk tolerance levels set by the participants in the cycle. Substituted compliance Q31. Relief in the form of substituted compliance is available. What does this mean and how does it provide relief to a person subject to clearing obligation? When a cross-border transaction is entered into by a person, the transaction may be subject to more than one set of clearing requirements (from Hong Kong or the jurisdiction in which one of the counterparties to the transaction is based or

incorporated) and the different sets of requirements may be duplicative or conflicting. Substituted compliance addresses such potential duplication or conflict by confirming that compliance with the overseas clearing requirements will suffice. Rule 11 of the Clearing Rules essentially provides that clearing obligation is taken to have been complied with if the transaction has been cleared under the laws of a comparable jurisdiction through a designated CCP. Specifically, a transaction is taken to have complied with the Clearing Rules if – (a) under the laws of the comparable jurisdiction, that transaction is required to be cleared with a CCP; (b) the transaction has been cleared with a CCP in accordance with the laws of the comparable jurisdiction; and (c) that CCP is a CCP that has been designated by the SFC under section 101J of the SFO. Q32. What does the “stricter rule” approach under the substituted compliance framework mean and how does it work? The substituted compliance framework operates on a stricter rule approach. By that, it means if a transaction is exempted from clearing in a comparable jurisdiction, substituted compliance is not applicable. That transaction will have to be cleared under the Clearing Rules. This can happen, for example, when a comparable jurisdiction has in place a clearing obligation, but that particular transaction is exempted from mandatory clearing, for example, due to exemption on the types of persons or particular products that we do not provide similar exemption or relief for. In such a situation, under our stricter rule approach, we will then require the transaction to be cleared under the Clearing Rules. Q33. Which jurisdictions are on the list of comparable jurisdictions? The list of comparable jurisdictions has been gazetted and the initial list comprises of member jurisdictions of the OTC Derivatives Regulators Group (ODRG). They are set out in Annex 2.

Q34. Will more jurisdictions be added to the list of comparable jurisdictions? We have used member jurisdictions of ODRG as a starting point for the list of comparable jurisdictions. We anticipate that more jurisdictions will be added to the list as the global regulatory reform in respect of OTC derivative markets makes further progress. We will continue to monitor international developments in this area and consider whether new jurisdictions should be added to the list. The market will be consulted before the list is expanded. Exit from clearing obligation Q35. What is an exit threshold and how does it work? An exit threshold serves to determine how a person can exit from its clearing obligation when, for instance, there is a permanent change in the person’s trading profile or business model. An exit notice may be given by a person under Rule 6(3) when its applicable position (on a gross basis) as at the last day of each month falls below the exit threshold of US$14 billion (70% of the clearing threshold of US$20 billion) for a period of 12 consecutive months. A person that has reached the exit threshold may give an exit notice to the HKMA or the SFC (as applicable) confirming that its applicable position is below US$14 billion for 12 consecutive months and specifying the 12-month period and its applicable position on the last day of each month during the 12-month period. It must also confirm that its applicable position has not equalled or exceeded the exit threshold between the last day of the last month included in the 12-month period and the day on which the exit notice is given. Once an exit notice is given, the person will no longer be regarded as having reached the clearing threshold and thus released from the clearing obligation. Points to note:
For the purpose of determining whether a person has reached the exit threshold, the applicable position refers to: - (a) For a person that is a local AI/AMB/LC, the “total position” as defined in the Clearing Rules, being the aggregate notional amounts of all outstanding OTC derivative transactions (other than deliverable FX forwards and deliverable FX swaps);

(b) For a person that is an overseas AI/AMB/LC, the “local total position” as defined in the Clearing Rules, being the aggregate notional amounts of all outstanding OTC derivative transactions (other than deliverable FX forwards and deliverable FX swaps), excluding every outstanding trade that is recorded in the person’s overseas books. In other words, this calculation only counts the position that is booked at the person’s Hong Kong branch. Calculation of the applicable position is on a “gross” notional basis, without any netting. Q36. What happens when the person subsequent reaches the clearing threshold again, after it has given an exit notice to the relevant regulator? If the person subsequently reaches the clearing threshold after giving an exit notice, it will become subject to clearing obligation again. The calculation methodology for determining whether a person has reached the clearing threshold again will be the same as that for determining whether a person has reached the clearing threshold for the first time. In practice, we do not expect such a situation to arise since the exit mechanism is intended and designed for persons who have permanently changed their business model or trading profile. We will monitor the filing of exit notice and take appropriate action to stem any abuse. How to comply with clearing obligation Q37. What are the steps a person needs to take to comply with clearing obligation under the Clearing Rules? When a person has determined that the transaction it has entered into is subject to clearing obligation, it should ensure that the transaction is submitted to a designated CCP for central clearing, and that the transaction has been accepted for clearing by that CCP within the allowed timeframe. This includes taking the following steps- (a) The person must have taken all reasonable steps to ensure that the transaction will be cleared by the designated CCP. For example, it must at least have complied with all the relevant requirements of the CCP’s rules so that the CCP is not entitled to reject the transaction on account of anything that the person has done or failed to do.

(b) The person must have followed up on whether the transaction has been accepted for clearing by the designated CCP, and if not, it must have taken all reasonable steps to ensure that the transaction is cleared as soon as possible within the timeline, including through another designated CCP if necessary. Point to note:
The list of designated CCPs is set out in Annex 3.
Time allowed to clear
Q38. What is the time allowed to comply with clearing obligation? A transaction has to be cleared with a designated CCP within one business day after the transaction has been entered into, i.e. on a T+1 business day basis. The term “business day” refers to a business day in Hong Kong. Q39. What happens if a person is not able to clear the specified OTC derivative transaction in time? If the transaction remains uncleared due to factors outside the person’s control, the person may have to terminate the transaction with its counterparty within the T + 1 business day timeframe, in order to avoid breaching the Clearing Rules. Record keeping requirements Q40. What records do I need to keep in relation to the clearing obligation? The list of records to be kept is set out in Part 3 of the Clearing Rules, and in particular, Rule 14 sets out the types of records to be kept. Q41. For how long must the records be kept? Records required to be kept in relation to a specified OTC derivative transaction must be kept for at least 5 years after maturity or termination of the transaction. Q42. Are transactions of an overseas AI or overseas AMB that are booked outside of Hong Kong subject to the record keeping requirements?

Rule 6(1)(a)(ii) of the Clearing Rules excludes a transaction of an overseas AI or overseas AMB that is booked outside of Hong Kong from clearing obligation. Accordingly, there is also no record keeping obligation for such a transaction. Consequences of breaches Q43. What are the consequences of breaching the clearing or record keeping obligation? Compliance with the clearing and record keeping obligations is a legal requirement. In the event of a breach, the HKMA (in the case of a breach by an AI or AMB) or the SFC (in the case of a breach by any other person) may apply to the Court of First Instance, which may then inquire into the case. If satisfied that there is no reasonable excuse for the breach, the Court may impose a financial penalty of up to HKD 5 million. Additionally, the HKMA (in the case of a breach by an AI or AMB) and the SFC (in the case of a breach by an LC) may take disciplinary action against the person in respect of the breach. Q44. What is the consequence when a person has obtained confirmation from a counterparty that it has not reached the clearing threshold, and subsequently it comes to light that the counterparty has in fact reached the clearing threshold at the relevant time? Where the person has received the confirmation in good faith, the confirmation should provide a reasonable excuse (in the case of any action under section 101F or 101G of the SFO) and a mitigating factor (in any disciplinary proceedings against the person) for not having centrally cleared the transaction in question. Hong Kong Monetary Authority Securities and Futures Commission 1 September 2016

Annex 1
List of designated financial services providers

1. Banco Santander S.A.

2. Bank of America, N.A.

3. Barclays Bank PLC

4. Barclays Capital Inc.

5. BNP Paribas Fortis SA/NV

6. BNP Paribas SA

7. BNP Paribas Securities Corp.

8. Citibank, N.A.

9. Citigroup Global Markets Inc.

10. Citigroup Global Markets Japan Inc.

11. Citigroup Global Markets Limited

12. Credit Agricole Corporate and Investment Bank

13. Credit Foncier de France

14. Credit Suisse AG

15. Credit Suisse International

16. Credit Suisse Securities (Japan) Limited

17. Credit Suisse Securities (USA) LLC

18. Deutsche Bank AG

19. Deutsche Bank Securities Inc.

20. Goldman Sachs & Co.

21. Goldman Sachs Bank USA

22. Goldman Sachs International

23. Goldman Sachs Japan Co., Ltd.

24. HSBC Bank plc

25. HSBC Bank USA, N.A.

26. HSBC France

27. HSBC Securities (USA) Inc.

28. ING Bank N.V.

29. ING Bank Slaski S.A.

30. ING-DiBa AG

31. JPMorgan Chase Bank, N.A.

32. JPMorgan Securities Japan Co., Ltd.

33. J.P. Morgan Securities LLC

34. J.P. Morgan Securities plc

35. Merrill Lynch Capital Services Inc.

36. Merrill Lynch International

37. Merrill Lynch Japan Securities Co., Ltd.

38. Merrill Lynch, Pierce, Fenner & Smith Incorporated

39. Mitsubishi UFJ Morgan Stanley Securities Co., Ltd.

40. Mizuho Bank, Ltd.

41. Mizuho Capital Markets Corporation

42. Mizuho Capital Markets (UK) Ltd.

43. Mizuho International plc

44. Morgan Stanley & Co. International plc

45. Morgan Stanley & Co. LLC

46. Morgan Stanley Capital Services LLC

47. Morgan Stanley MUFG Securities Co., Ltd.
    48 MUFG Securities EMEA PLC

48. NATIXIS

49. Nomura Global Financial Products, Inc.

50. Nomura International plc

51. Nomura Securities Co., Ltd.

52. Nomura Securities International, Inc.

53. Nordea Bank AB

54. Nordea Bank Danmark A/S

55. Nordea Bank Finland Plc

56. Nordea Bank Norge ASA

57. SG Americas Securities LLC

58. SMBC Capital Markets Inc.

59. SMBC Nikko Securities Inc.

60. Societe Generale

61. Societe Generale Newedge UK Limited

62. Standard Chartered Bank

63. Sumitomo Mitsui Banking Corporation

64. Sumitomo Mitsui Trust Bank, Limited

65. The Bank of New York Mellon

66. The Bank of Tokyo-Mitsubishi UFJ, Ltd.

67. The Royal Bank of Scotland plc

68. UBS AG

69. UBS Limited

70. UBS Securities LLC

71. UniCredit Bank AG

72. UniCredit Bank Austria AG

73. UniCredit S.p.A.

74. Wells Fargo Bank, N.A.

75. Wells Fargo Securities, LLC

Annex 2
List of comparable jurisdictions

1. Australia
2. Austria
3. Belgium
4. Brazil
5. Bulgaria
6. Canada
7. Croatia
8. Czech Republic
9. Denmark
10. Estonia
11. Finland
12. France
13. Germany
14. Greece
15. Hungary
16. Ireland
17. Italy
18. Japan
19. Latvia
20. Lithuania
21. Luxembourg
22. Malta
23. Netherlands
24. Poland
25. Portugal
26. Republic of Cyprus
27. Romania
28. Singapore
29. Slovakia
30. Slovenia
31. Spain
32. Sweden
33. Switzerland
34. United Kingdom
35. United States

Annex 3
List of designated CCPs

1. Chicago Mercantile Exchange Inc
2. Japan Securities Clearing Corporation
3. LCH.Clearnet Limited
4. OTC Clearing Hong Kong Limited