Jul 22, 2014

Introduction

Unlisted margined derivatives, or derivatives that are traded off-exchange on a margin basis, have become more popular in Singapore, especially leveraged foreign exchange (LFX ) and contracts for differences (CFD ) which are leveraged bets on the direction of price movements of the underlying referenced asset.

The Monetary Authority of Singapore (MAS ) has stepped in to put in more regulatory safeguards in relation to unlisted margin derivatives, given the complexity of these products, the market risk of leveraged trading and also other risks such as counterparty risk and recovery risk of customer moneys.

Following a public consultation in May 2012 to review the regulatory framework for unlisted margined derivatives to retail customers, the had issued, on 14 March 2014, its response to the feedback received, as well as a consultation paper on four sets of draft regulations (Draft Regulations ) to effect the proposals set out in the 2012 public consultation paper and the MAS response. The public consultation on the Draft Regulations ends on 14 April 2014.

This article highlights the various focus areas of the Draft Regulations.

(1) Removing the Carve-Out for Banks which Carry on LFX Trading

Currently, banks licensed under the Banking Act do not need to be licensed under the Securities and Futures Act (SFA ) for carrying out LFX trading. The definition of LFX trading in the Second Schedule to the SFA excludes, amongst others, any act performed for or in connection with a contract or an arrangement arranged by a bank that is licensed under the Banking Act (Cap. 19) or a merchant bank approved as a financial institution under the Monetary Authority of Singapore Act (Cap. 186).

The MAS proposes to amend the Second Schedule to the SFA to remove the regulatory carve out for banks carrying on LFX trading with retail customers. The draft SFA (Amendment of Second Schedule) Order 2014 will amend the definition of LFX trading to exclude, amongst others, only acts performed for or in connection with a contract or an arrangement that a licensed bank or an approved merchant bank arranges for a customer who is an accredited investor, an expert investor or an institutional investor. As noted in the MAS response of 14 March 2014, expert investors and customers of specialised units will be excluded because of their more sophisticated profiles. However, corporations that do not qualify as accredited investors, institutional investors or expert investors will not be so excluded.

The MAS will also not allow banks to continue being exempted from the relevant business conduct rules under the SFA relating to their LFX dealings with non-retail investors (i.e. accredited investors, expert investors or institutional investors as defined in s 4A of the SFA). This proposal will be consulted at a later stage, as part of the development of the regulatory regime for intermediaries dealing in OTC derivatives.

(2) Tighter Trust Account Requirements

Under the Securities and Futures (Licensing & Conduct of Business) Regulations (SF(LCB)R ), a holder of a capital markets service licence (CMS Licensee ) is required to deposit all moneys and assets received on account of its customers in a segregated trust account maintained with a bank, merchant bank or finance company in Singapore. The MAS proposes to introduce a slew of additional safeguards for trust and custody accounts by amending the SF(LCB)R. In particular, the draft Securities and Futures (Licensing and Conduct of Business)(Amendment) Regulations 2014 provides that:

(a) a new regulation 16(5) will be added to require CMS Licensees offering CFDs and/or LFX to maintain separate trust accounts for the retail customers transactions in listed and unlisted products. This requirement will only apply for cash collateral deposited with the CMS Licensee;

(b) regulation 17(2) will be amended to require a CMS Licensee to hold customer moneys with licensed banks in Singapore;

(c) regulations 21(d) and 35(c) will be amended to prohibit a CMS Licensee from using the retail customers moneys and assets for meeting other obligations incurred in connection with the customers unlisted margined derivative transactions;

(d) regulation 37(1) will be amended to require a CMS Licensee to perform daily computation of all retail and non-retail customer money and assets; and

(e) a new regulation 47F will be added to require a CMS Licensee to act as a principal to the trade when dealing in unlisted margined derivatives with retail customers.

The above provisions will also apply to entities exempted under s 99(1)(a), (b) and (c) of the SFA, which include banks, merchant companies and finance companies (Exempt Financial Institutions ). Except for Regulation 37(1), the above provisions do not apply to accredited investors, expert investors or institutional investors.

A new definition of unlisted derivatives, together with the associated terms debentures of a real estate investment trust and real estate investment trust, will also be introduced.

(3) New Minimum Margin and Base Capital Requirements

To prevent excessive leveraging by customers and to mitigate the risks faced by retail customers during volatile market conditions, the MAS will impose a minimum margin rate of 5% on CMS Licensees dealing in CFDs on Foreign Exchange and other LFX contracts with retail customers. This minimum margin rate is also in line with practices in Hong Kong and Japan.

Also, to ensure business viability as a going concern and to facilitate a proper and orderly wind-up in the event of business failure, the MAS will impose a minimum base capital requirement of S$5 million for CMS Licensees dealing in unlisted derivatives with retail customers.

The draft Securities and Futures (Financial and Margin Requirements for Holders of Capital Markets Services Licences) (Amendment) Regulations 2014 will amend the First and Fourth Schedules to implement the new requirements.

(4) New Margin Requirements for Exempt Financial Institutions

Currently, Exempt Financial Institutions are not subject to the margin requirements stipulated in regulation 24A of the (Financial and Margin Requirements for Holders of Capital Markets Services Licences) Regulations, which only apply to CMS Licensees.

The MAS plans to introduce a new set of regulations, the Securities and Futures (Margin Requirements for Exempt Financial Institutions) Regulations. to prescribe margin requirements for Exempt Financial Institutions. As noted in the MAS response of 14 March 2014, margin requirements should be imposed consistently on all derivative dealers for the applicable unlisted margined derivatives transacted with retail investors, so as to mitigate the risk of over-leveraging by retail investors dealing in unlisted margin derivatives.

The Draft Regulations do not yet address all of the proposals that the MAS intends to carry out to improve the regulatory framework for unlisted margined derivatives offered to retail investors. In particular, the MAS intends to introduce an Additional Risk Fact Sheet to better highlight the key risks of trading in unlisted margined derivatives such as CFDs and LFX contracts in a way that can be easily understood by retail customers. It is envisaged that the MAS will introduce this Fact Sheet at a later stage after it has consulted with the industry and consumer associations.