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Sidley Derivatives | Q3 2017 • 1
IN THIS ISSUE
Q3 2017
SidleyDerivativesQUARTERLY
Visit sidley.com for more information on Sidley’s securities & derivatives enforcement and regulatory practice.
U.S. DERIVATIVES DEVELOPMENTS
CFTC and NFA ..................................... 1 Federal Reserve ................................... 6
U.S. ENFORCEMENT DEVELOPMENTS ...................................7
EUROPEAN DERIVATIVES DEVELOPMENTS ...................................9
ASIA DERIVATIVES DEVELOPMENTS .................................10
GLOSSARY OF FREQUENTLY USED TERMS ............... 17
U.S. DERIVATIVES DEVELOPMENTS: CFTC AND NFA
CFTC Grants SEF and DCO Registration to LedgerX LLC
On July 6, 2017, the CFTC issued an order to LedgerX LLC (LedgerX), granting it registration as a SEF (SEF Order). In addition, on July 24, 2017, the CFTC issued an order to LedgerX, granting it registration as a DCO (DCO Order). LedgerX indicated that it intends to offer a “multi-to-multi” trading and clearing platform for bitcoin options. A bitcoin option contract provides the option holder with the right to buy or sell bitcoin at a fixed price at a future date. With these orders, LedgerX will become the first federally regulated bitcoin options exchange and clearinghouse to list and clear fully collateralized, physically settled bitcoin options.
A copy of the SEF Order is available at: http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/orgledgerxord170706.pdf.
A copy of the DCO Order is available at: http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/ledgerxdcoregorder72417.pdf.
CFTC Grants Exemptive Relief to LedgerX From Certain DCO Financial Requirements
On July 24, 2017, the CFTC’s DCR issued No-Action Letter 17-35 (Letter 17-35) granting exemptive relief from certain DCO compliance obligations to LedgerX (which lists and clears fully collateralized, physically settled bitcoin options). Under CFTC rules, a DCO is required to maintain sufficient financial resources to withstand the default of its largest clearing member and to undertake certain risk management requirements to ensure the continued adequacy of those financial resources. In Letter 17-35, LedgerX was granted relief from several of these requirements on the basis that LedgerX is clearing only bitcoin options that are fully collateralized — that is, before LedgerX accepts a contract for clearing, it requires its participants to provide collateral sufficient to cover the maximum potential loss of the contract, as well as pass a pretrade credit check to ensure that the participant’s collateral is sufficient. Requiring full collateralization upfront eliminates many of the risks a DCO typically faces with respect to the continued adequacy of its financial sources and DCR granted LedgerX relief from certain requirements it determined to be unnecessary. Also, because LedgerX does not initially intend to admit FCMs as clearing members, DCR has exempted it from the requirement that it maintain rules to facilitate the transfer of a customer’s portfolio of positions from one clearing member to another so long as it has not more than one FCM participant.
Letter 17-35 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-35.pdf.
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CFTC Grants No-Action CPO Registration Relief for a Delegating Cayman Trustee
On July 18, 2017, the CFTC’s DSIO issued No-Action Letter 17-40 (Letter 17-40), providing relief from CPO registration to a Cayman Islands entity that is the trustee of two Cayman commodity pools, permitting the trustee to delegate the CPO responsibilities to another entity that is a registered CPO. Because both the delegator trustee and the delegatee CPO are entities (not natural persons), they were unable to satisfy criterion 6 of CFTC No-Action Letter 14-126, which requires as a condition of CPO delegation from one entity to another that “one such CPO controls, is controlled by, or is under common control with the other CPO.” The requesting trustee entity in Letter 17-40 is delegating to a registered CPO that is a corporation organized in Japan. The registered CPO is a subsidiary of a Japanese asset management company registered as a securities broker with the Financial Services Agency of Japan, owned by a publicly traded Japanese company. The registered CPO along with its asset management affiliates have approximately US$1.9 billion in assets under management. In waiving Letter 14-126’s criterion 6 common control requirement, the DSIO highlighted the regulated status of the delegatee CPO’s parent and the amount of assets under management by the CPO and its affiliates. Sidley Austin LLP represented the Japanese CPO in Letter 17-40. CPO delegation No-Action letters 17-38 and 17-39, also issued this quarter, are similar to Letter 17-40.
A copy of Letter 17-40 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-40.pdf.
NFA Modifies Submission and Review Process for Swap Dealers
On July 24, 2017, the NFA announced modifications to the process for swap dealers and MSPs to demonstrate compliance with CFTC rules implementing Section 4s of the CEA (the NFA Announcement). Pursuant to the NFA Announcement, swap dealers and MSPs are no longer required to submit Section 4 documentation for topic areas other than risk management but instead must submit an attestation that they have adopted policies and procedures or other appropriate documentation reasonably designed to ensure compliance. For the risk management topic area, new applicants will be required to submit both an attestation and their risk management policies and procedures. Attestations will be filed by responding to requests issued by NFA. Such requests will specify the filing deadline. NFA will continue to review policies and procedures as part of its ongoing examination process.
A copy of the NFA Announcement is available at: https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4828.
CFTC Provides No-Action Relief From Margin Rules to Swap Dealers Entering Into Uncleared Swaps With the European Stability Mechanism
On July 25, 2017, the CFTC’s DSIO issued No-Action Letter 17-34 (Letter 17-34), which provides relief from the CFTC’s margin rules to non-prudentially regulated swap dealers (Covered SDs) entering into uncleared swaps with the European Stability Mechanism (ESM). Generally, the CFTC’s margin rules set forth initial and variation margin requirements for Covered SDs entering into uncleared swaps with “swap entities” or “financial end-users.” The ESM is an intergovernmental international financial institution, similar to the multilateral development banks excluded from the definition of “financial end user” under the CFTC’s margin rules, that the EU established to provide financial assistance to EU member states in financial distress. The ESM enters into uncleared swaps to hedge interest rate and currency risk associated with loans used to finance ESM’s activities. The ESM is expressly exempt from EMIR’s margin rules for uncleared swaps, and the capital support pledged by EU member states combined with ESM’s restrictions on lending, borrowing and other operations contributed to the ESM’s receiving favorable credit ratings from Fitch Ratings and Moody’s Investors Service. For these reasons,
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Letter 17-34 provides relief to Covered SDs that enter into uncleared swaps with the ESM and do not comply with the CFTC’s margin rules.
A copy of Letter 17-34 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-34.pdf.
CFTC Extends No-Action Relief for Non-U.S. Dealers on the Applicability of Transaction-Level Requirements to Certain Swaps
On July 25, 2017, the CFTC staff issued a time-limited no-action letter that extends relief to non-U.S. swap dealers registered with the CFTC from certain transaction-level requirements under the CEA (Letter 17-36). The relief relates to a CFTC staff advisory issued on November 14, 2013, in which the CFTC staff expressed its view that persons regularly arranging, negotiating or executing swaps for or on behalf of a swap dealer are performing core, front-office activities of that swap dealer’s business and, thus, a non-U.S. swap dealer (whether or not an affiliate of a U.S. person) regularly using personnel or agents located in the United States to arrange, negotiate or execute a swap with a non-U.S. person (Covered Swaps) generally would be required to comply with the CFTC’s transaction-level swap requirements.
Following the issuance of the advisory, and in response to requests by market participants for more time to come into compliance, the CFTC staff provided time-limited no-action relief to non-U.S. swap dealers from compliance with the transaction-level requirements when entering into Covered Swaps with non-U.S. persons that are not guaranteed affiliates or conduit affiliates of a U.S. person. That relief has been extended multiple times and was set to expire on September 30, 2017. Letter 17-36 further extends the relief with respect to each transaction-level requirement until the effective date of any CFTC action addressing whether such transaction-level requirement is or is not applicable to Covered Swaps. Letter 17-36 states that the CFTC continues to assess the issues that must be addressed to ensure an appropriate balance between domestic and foreign regulatory interests with respect to the domestic activity of non-U.S. swap dealers.
A copy of Letter 17-36 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-36.pdf.
CFTC Provides No-Action Relief From Registering as a CPO and/or a CTA for Activities Related to Oil Producer’s Hedging of Reserves
On August 2, 2017, the CFTC’s DSIO issued No-Action Letter No. 17-48 (Letter 17-48), which provides relief to a person for failing to register as a CTA and CPO in connection with such person’s management of swap transactions entered into by a family of affiliated entities that have working interests, mineral interests and overriding royalty interests in crude oil and natural gas producing and non-producing properties (the Energy Companies). The activities solely related to certain swaps to be entered into to hedge the commodity risk associated with the reserves held by the Energy Companies. The DSIO determined that the person managing the hedging for the Energy Companies is not required to register as a CPO or CTA for its advisory services provided that (i) the swaps reduce risk relative to the risk of an unhedged position, (ii) the swaps cannot be established, held, altered or terminated for speculative or trading purposes, (iii) the swaps hedge risks related only to the Energy Companies’ physical assets and not risks arising from the arrangement by which such assets are held or financed, (iv) the terms and conditions of the swaps are consistent with those generally available in the traditional swaps market, (v) the swaps entered into do not expose the Energy Companies to any risk other than counterparty risk, and (vi) the hedging manager and the Energy Companies develop risk management policies and procedures to ensure compliance with the terms of Letter No. 17-48. There is no indication in Letter 17-48 that the Energy Companies were actually
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investment trusts, syndicates or similar forms of enterprises operated for the purpose of trading swaps; the Energy Companies appear to be operating companies. Nor is there any indication that the hedging manager furnished commodity-trading advice to any persons other than the Energy Companies. It is therefore unclear why the DSIO did not simply issue an interpretive letter confirming that the Energy Companies are operating companies that are not commodity pools. The hedging manager may have requested Letter No. 17-48 out of an abundance of caution, and the DSIO issued the letter without including any explicit legal analysis, so it is not yet clear whether there are any important lessons to be learned from this relief.
A copy of Letter No. 17-48 is available here: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-48.pdf.
Senate Confirms CFTC Chairman Giancarlo and Commissioners Quintenz and Behnam
On August 3, 2017, the U.S. Senate approved the nomination of then-acting CFTC Chairman J. Christopher Giancarlo (Republican) to serve as permanent Chairman of the CFTC, as well as the nominations of Brian Quintenz (Republican) and Rostin “Russ” Behnam (Democrat) to serve as CFTC Commissioners. The Senate has not yet voted to confirm Dawn DeBerry Stump (Republican), who was approved by the Agriculture Committee at the same time as Quintenz and Behnam. Reports indicate that a vote by the full Senate on Stump’s nomination would likely be taken up in conjunction with the nomination of another Democratic Commissioner, once President Trump nominates a second Democratic Commissioner to the CFTC in addition to Behnam to avoid a temporary imbalance between Democratic and Republican Commissioners.
CFTC Staff Issues No-Action Relief From Certain Futures Position Aggregation Exemption Requirements, Including the Notice-Filing Requirement
On August 10, 2017, the staff of the CFTC’s DMO granted time-limited no-action relief (Letter 17-37) from a number of requirements applicable to persons who rely on certain exemptions from the CFTC’s position limit aggregation rules, including the requirement to file notices to rely on aggregation exemptions. In addition to granting relief from the controversial notice-filing requirement, Letter 17-37 broadened the applicability of the “independent account controller” and “owned entity” aggregation exemptions. Letter 17-37, which will remain in effect until August 12, 2019, replaced the notice-filing prerequisite with an “upon request” notice-filing requirement. Now, instead of an affirmative filing requirement, persons relying on an aggregation exemption must file a notice only upon the request of the CFTC or a U.S. futures exchange.
While Letter 17-37 does not directly alter the aggregation rules that each U.S. futures exchange has adopted, the DMO emphasizes that it expects several futures exchanges to adopt the CFTC’s upon-request notice-filing requirement. To date, CME Group exchanges have adopted the no-action relief with respect to the enforcement of their aggregation rules to align their notice requirements with those of the CFTC. Whether other U.S. futures exchanges will adopt the no-action relief remains to be seen.
A copy of Letter 17-37 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-37.pdf.
U.S. Banking Agencies Provide Guidance on Regulatory Capital Treatment of Centrally Cleared Derivatives Contracts That Are Settled-to-Market
On August 14, 2017, the staffs of the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the FDIC jointly issued supervisory guidance (Guidance) confirming, among other things, that under the regulatory capital rules,
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■ where a derivative contract is structured so that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity is deemed to equal the time until the next such specified date, and
■ with respect to variation margin payments, if, after accounting and legal analysis, a regulated institution determines that (i) the variation margin payment on a centrally cleared settled-to-market contract settles any outstanding exposure on the contract, and (ii) the terms are reset so that the fair value of the contract is zero, then the remaining maturity on the contract would equal the time until the next exchange of variation margin on the contract.
The Guidance indicates that in conducting the legal analysis described in the second item above, a regulated institution should evaluate whether the transferor has relinquished all legal claims to the variation margin, whether the payment of variation margin alone constitutes settlement under the applicable CCP’s rulebook, any other agreements governing the derivative contract, and applicable law.
Treating variation margin payments and similar interim payments as settlements in the manner described in the Guidance, rather than as posting of additional collateral, reduces the regulated institution’s regulatory capital requirements for derivatives where such requirements are affected by remaining maturity.
A copy of the Guidance is available at: https://www.federalreserve.gov/supervisionreg/srletters/sr1707a1.pdf.
CFTC Chairman Advocates for Deference in Cross-Border Regulation of CCPs
On September 11, 2017, CFTC Chairman Chris Giancarlo wrote an op-ed in a Paris financial daily newspaper, Les Échos, titled “Reconaissance Mutuelle est la Meilleure Methode pour la Supervision Transfrontiere des CCPs,” translated as “Deference Is the Path Forward in Cross-Border Supervision of CCPs.” Citing the 2009 G20 commitment at the Pittsburgh Summit to a “consistent implementation” (emphasis added) — and notably not an identical implementation — of global standards, Chairman Giancarlo advocated for regulatory deference in the cross-border regulation of futures and swaps markets, particularly in connection with the supervision of CCPs.
On September 12, 2017, Chairman Giancarlo reiterated his support for cross-border deference with respect to the regulation of CCPs in his speech at the Global Forum for Derivatives Markets 38th Annual Burgenstock Conference. In that speech, he addressed a proposed amendment to EMIR by the EC that would regulate third-country CCPs, which would include a process to introduce a CCP location policy. He warned that he would consider such an amendment to be “a violation of trust and cooperation between the U.S. and Europe.” Chairman Giancarlo later proposed in his September 14, 2017 speech to the Eurofi Financial Forum that once a home country authority implements a comprehensive supervisory framework, “it should have primary oversight over its domestic CCPs to which foreign regulators should defer.” He concluded that such deference should be subject to a “robust, outcomes-based comparability assessment of the consistency of the home regulator’s relevant regulations and supervisory programs.”
The CFTC’s translation of Chairman Giancarlo’s op-ed is available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlooped091117.
A transcript of Chairman Giancarlo’s Burgenstock speech is available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-27.
A transcript of Chairman Giancarlo’s Eurofi speech is available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-28.
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CFTC Modernizes Form 40 Filing Portal and Grants Relief From Ownership and Control Reporting Requirements
On September 19, 2017, the CFTC announced the launch of its improved online filing portal for submitting CFTC Form 40 (Statement of Reporting Trader). Although the online portal collects essentially the same information as the portal currently collects, the new portal adds more user-friendly features, including auto-save functionality.
On September 25, 2017, the CFTC’s DMO issued a no-action letter (Letter 17-45) extending current relief and providing additional relief from certain reporting obligations otherwise required by the CFTC’s ownership and control reports final rule (OCR Final Rule). The OCR Final Rule requires the electronic submission of trader identification and market participant data. Letter 17-45 provides reporting parties with relief from a number of OCR Final Rule requirements, including (i) the requirement to file annual refresh updates of Forms 102A, 102B and 102S (conditioned on filing timely and complete change updates), and (ii) the requirement to answer question 12 on Forms 40 and 40S, which asks about persons who have direct or indirect influence on, or exercise authority over but not control of, a reporting party’s trading.
The relief will remain in effect until the earlier of: (a) the later of the applicable effective date or compliance date of a CFTC action, such as a rulemaking or order, addressing such obligation, and (b) September 28, 2020.
A copy of the CFTC press release announcing the launch of the online filing portal available at: http://www.cftc.gov/PressRoom/PressReleases/pr7612-17.
A copy of Letter 17-45 is available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-45.pdf.
Federal Reserve Adopts Rule Requiring Global Systematically Important Banks to Amend Qualifying Financial Contracts to Limit Termination Rights of Counterparties
On September 1, 2017, the Board of Governors of the Federal Reserve System (the Federal Reserve) adopted a rule (the Rule) that will require global systemically important U.S. bank holding companies (U.S. GSIBs) and most of their subsidiaries to amend a range of derivatives, short-term funding transactions, securities lending transactions and other qualifying financial contracts (QFCs). The Rule also covers the U.S. operations of global systemically important foreign banking organizations (non-U.S. GSIBs). Banks and other depository institutions regulated by the Office of the Comptroller of the Currency (OCC) or the FDIC are “excluded banks” under the Rule, but they will be subject to “substantively identical” rules adopted by those agencies.
The Rule will require covered entities, when entering into certain QFC transactions with buy-side counterparties (as well as with other covered entities and excluded banks), to include specific contract terms in related agreements. Those terms are intended to achieve two distinct regulatory goals: (i) ensure cross-border enforcement of the two U.S. special resolution regimes — the orderly liquidation authority (OLA) under Title II of Dodd-Frank and the Federal Deposit Insurance Act (FDIA) — as they may apply to covered entities, and (ii) prohibit counterparties of a covered entity from exercising a range of cross-default rights that are related, directly or indirectly, to an affiliate of the covered entity’s becoming subject to insolvency proceedings, including under Chapter 11 of the Bankruptcy Code.
The Rule includes a safe harbor for QFCs that are amended by a covered entity and a
U.S. DERIVATIVES DEVELOPMENTS:
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given counterparty through their adherence to a qualifying protocol published (or to be published) by the ISDA.
Compliance with the Rule will be phased in over one year beginning January 1, 2019. However, it seems likely that covered entities may seek to ensure Rule compliance with all counterparties by January 1, 2019, including those counterparties for which the phase-in date is later.
For more information, see the Sidley Update on this subject at: https://www.sidley.com/en/us/insights/newsupdates/2017/10/federal-reserve-adopts-rule-requiring-gsibs-to-amend-qfc-transactions.
A copy of the Federal Reserve’s adopting release for the Rule is available at: https://www.gpo.gov/fdsys/pkg/FR-2017-09-12/pdf/2017-19053.pdf.
CFTC Settles Spoofing Case and Indicates it Gave Credit for Cooperation and Voluntary Remediation
On August 7, 2017, the CFTC entered a settlement order In the Matter of Tokyo-Mitsubishi UFJ, Ltd., CFTC Dkt. 17-21 (Order). It is the latest CFTC case to settle involving alleged extended “spoofing” trading, in which a trader is said to have entered orders without any intention of consummating trades, an unlawful activity under section 4e(a)(5)(C) of the CEA. The emphasis of the Order, which settled the case without any admission or denial of the truth of the charges, was on the CFTC’s giving substantial credit for self-reporting and self-initiated remediation steps. Compared to other recent settlements, the Order appears to have required a notably milder sanction than the CFTC might have otherwise imposed. This suggests that affirmative steps to self-report and remediate misconduct may well reap benefits in dealing with the CFTC’s Enforcement Division going forward.
A copy of the Order is available here: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enftokyomitsubishiorder080717.pdf.
CFTC Levies Civil Penalty for CPO Registration Violations
On September 5, 2017, the CFTC ordered W Resources, LLC (W Resources), to pay a $150,000 civil penalty for operating three commodity pools without complying with the CPO registration requirements under the CEA (Order). The CFTC found that since October 2013, W Resources operated three funds as commodity pools by trading commodity options to hedge certain oil and gas assets owned by the funds. The CFTC concluded that W Resources violated the CEA by failing to register as a CPO, file a notice of exemption with the NFA or otherwise seek relief from the CEA’s registration requirements. Under the Order, W Resources agreed to pay the $150,000 fine, carry to expiration any commodity interests outstanding as of the date of the Order and refrain from transacting in any other commodity interests unless it registers with the CFTC, files a notice of exemption with the NFA or otherwise requests and receives no-action relief from the CFTC.
A copy of the Order is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfwresourcesorder09052017.pdf.
U.S. ENFORCEMENT DEVELOPMENTS
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CFTC Files its First Antifraud Enforcement Action Involving Bitcoin
On September 21, 2017, the CFTC filed a complaint in federal court in the Southern District of New York against Gelfman Blueprint Inc. and its CEO and head trader (Defendants) for allegedly operating a bitcoin Ponzi scheme. This is first time the CFTC has exercised its antifraud authority over a scheme involving bitcoin spot transactions. By charging the Defendants with fraud pursuant to CFTC Rule 180.1 (the CFTC’s general antimanipulation rule), the CFTC reiterated its position that bitcoin is a commodity and that the CFTC’s fraud rules thus apply to bitcoin trading.
A copy of the complaint is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfgelfmancomplaint09212017.pdf.
CFTC Updates Policy on Incentives for Self-Reporting and Full Cooperation by Companies and Individuals
On September 25, 2017, the CFTC’s Division of Enforcement (the Enforcement Division) released an Updated Advisory on Self-Reporting and Full Cooperation (the Updated Advisory) to build on the cooperation advisories it released on January 19, 2017 (the Prior Advisories). The Updated Advisory indicates that if a company or individual self-reports misconduct, fully cooperates with the Enforcement Division and remediates its policies, the Enforcement Division “will recommend that the [CFTC] consider a substantial reduction from the otherwise applicable civil monetary penalty.” To receive credit for self-reporting and cooperation, the company or individual must (i) voluntarily disclose all known relevant facts of the misconduct “prior to an imminent threat of exposure” of the misconduct and within a “reasonably prompt time after the company or individual becomes aware of the misconduct,” (ii) adhere to the Prior Advisories, and (iii) timely and appropriately remediate any flaws in its compliance and control programs.
In his September 25, 2017 speech to the New York University Program on Corporate Compliance & Enforcement/Institute for Corporate Governance & Finance, James McDonald, Director of the Enforcement Division, clarified that a company or individual who cooperates with the Enforcement Division but does not self-report misconduct “stands to earn a substantial benefit in terms of a reduced penalty…but all else equal, it will be significantly less than for those companies that self-report the misconduct at the outset.” The Updated Advisory further indicates that in “extraordinary circumstances,” for example, where misconduct is “pervasive across an industry” and the company or individual is the first to self-report, the Enforcement Division may “recommend a declination of prosecution.” Because the CFTC calculates monetary penalties on a case-by-case basis without reference to publicly available penalty guidelines, it is unclear how much of a reduction a company or individual that self-reports misconduct and/or cooperates with the CFTC will receive.
A copy of the Updated Advisory is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfadvisoryselfreporting0917.pdf.
A transcript of James McDonald’s speech is available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opamcdonald092517.
A copy of the Prior Advisory on cooperation by companies is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfadvisorycompanies011917.pdf.
A copy of the Prior Advisory on cooperation by individuals is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfadvisoryindividuals011917.pdf.
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CFTC Issues Enforcement Action Against CPO for Supervision Failures
On September 28, 2017, the CFTC issued an enforcement order against a CPO for failure to supervise its fund administrator’s operation of the CPO’s bank account containing pool participants’ funds. The order finds that over the course of 21 days, the CPO’s fund administrator processed five fraudulent fund transfer requests from the commodity pool’s bank account totaling $5.9 million. The requests originated from an unknown party who spoofed the CPO’s managing member’s email address and imitated the CPO’s typical transfer requests. The CFTC found the CPO’s supervision of its agent regarding wire transfers to be insufficient, in part because the CPO reviewed the pool bank account’s balance only once during the period during which the fraud was ongoing. The CFTC also found the CPO’s policies and systems insufficient because the CPO had no procedures to monitor the administrator’s operation of its account and no system to alert it when transactions cleared the account. The order required the CPO to pay a $150,000 civil penalty.
A copy of the order is available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enftillageorder09282017.pdf.
Review of the European Supervisory Authorities
On September 20, 2017, the EC published a proposal to reform the European Supervisory Authorities (ESAs). The ESAs are the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA). To date, the ESAs have been charged largely with coordinating supervisory practice across the EU while national authorities remain responsible for supervising firms and infrastructure domestically. The proposed reforms seek to further “integrate” financial supervision, with the ESAs’ powers enhanced and with budgets increased, in part — for the first time — through direct contributions from EU firms. In particular, ESMA will have responsibility for direct supervision of certain types of investment funds and for monitoring cross-border delegation arrangements. This is consistent with recent proposals on CCP supervision that would give ESMA a greater role in authorizing and supervising both the EU and third-country CCPs operating in the EU. The draft regulation follows a public consultation undertaken last spring and is now subject to review by the European Parliament and Council.
A copy of the proposal is available at: https://ec.europa.eu/info/law/better-regulation/initiatives/com-2017-536_en.
Revised Trade Reporting Requirements Under EMIR
On November 1, 2017, revised technical standards come into force across the EU under EMIR. The revisions amend and supplement the original standards, which have been in force since 2014. Reporting requirements continue to apply to all financial counterparties and non-financial counterparties with respect to all derivative transactions. The changes will result in some reporting fields being removed, some new fields being added and some fields and/or the required reporting formats being amended. Overall, the number of fields to be reported has increased from 85 to 129, which is requiring significant system changes for some market participants. The changes include requirements for additional information on collateral. Further amendments include the mandatory use of Legal Entity Identifiers.
Further information is available at: https://www.esma.europa.eu/policy-rules/post-trading/trade-reporting.
EUROPEAN DERIVATIVES
DEVELOPMENTS
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Hong Kong
Resolution Regime for Financial Institutions Begins
On July 7, 2017, the resolution regime established under the Financial Institutions (Resolution) Ordinance (Ordinance) commenced operation. The Ordinance establishes a cross-financial sector resolution regime designed to meet the international standards set by the Financial Stability Board. It aims to strengthen Hong Kong’s financial system and enhance Hong Kong as an international financial center.
Under the Ordinance, the Monetary Authority of Hong Kong, the Insurance Authority of Hong Kong and the Securities and Futures Commission of Hong Kong (SFC) are the resolution authorities vested with a range of powers to effect the orderly resolution of nonviable systemically important financial institutions. These include the power to attribute losses to an institution’s shareholders and creditors, thus minimizing the risk of using public funds to salvage financial institutions in the event of a financial crisis.
A copy of the Ordinance is available at: http://www.hkma.gov.hk/media/eng/doc/key-functions/banking-stability/resolution/FIRO_Eng.pdf.
Further information is available at: http://www.fstb.gov.hk/en/docs/pr20170707_e.pdf; and http://www.hkma.gov.hk/eng/key-functions/banking-stability/resolution.shtml.
SFC and Autorité des Marchés Financiers Sign Memorandum of Understanding on France-Hong Kong Mutual Recognition of Funds
On July 10, 2017, the SFC and the Autorité des Marchés Financiers (AMF) of France signed a Memorandum of Understanding (AMF MoU) on France-Hong Kong Mutual Recognition of Funds to allow eligible Hong Kong public funds and French Undertakings for Collective Investment in Transferable Securities (UCITS) funds to be distributed to retail investors in the respective jurisdictions through a streamlined authorization process.
The AMF MoU is the first agreement between Hong Kong and a member of the EU establishing a regulatory framework for distributing eligible Hong Kong and French funds. These funds include general equity funds, bond funds and mixed funds. The AMF MoU also promotes cooperation between the two regulatory authorities, thus enabling the SFC and the AMF to fulfill their respective supervisory and regulatory mandates, which include protecting investors and ensuring that the financial markets function properly.
A copy of the AMF MoU is available at: http://www.sfc.hk/web/EN/files/ER/PDF/MOU/AMF-SFC%20MoU.pdf. Further information is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=17PR95.
SFC and UK Financial Conduct Authority Sign Memorandum of Understanding on Enhanced Supervision of Cross-Border Regulated Entities
On July 20, 2017, the SFC entered into a memorandum of understanding (FCA MoU) with the UK Financial Conduct Authority (FCA) providing for consultation, cooperation and exchange of information in connection with the supervision and oversight of regulated entities that operate on a cross-border basis in Hong Kong and the UK.
The FCA MoU covers financial market participants and other entities regulated by the SFC or FCA. It enables the SFC and FCA to cooperate in the interest of fulfilling their respective regulatory mandates.
A copy of the FCA MoU is available at: http://www.sfc.hk/web/EN/files/ER/PDF/MOU/MOU_FCA%20Supervisory_Jul%202017.pdf.
ASIA DERIVATIVES DEVELOPMENTS
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HKEX Launches Offshore Renminbi and US$-Traded Gold Futures
On July 10, 2017, Hong Kong Exchanges and Clearing Limited (HKEX) launched its offshore Renminbi and US$ Gold Futures contracts. On the first trading day, total volume exceeded 3,000 contracts and 20 exchange participants traded the new contracts.
The Gold Futures contracts are the initial products that HKEX has introduced to the market and they complement the gold futures introduced on the same day by the London Metal Exchange, a wholly owned subsidiary of the HKEX.
Further information is available at: http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170710news.htm.
OTC Clear Welcomes its First Clearing Member From Australia
Australia and New Zealand Banking Group Limited became a clearing member of the OTC Clearing Hong Kong Limited (OTC Clear) effective July 10, 2017.
OTC Clear, a subsidiary of the HKEX, was established in 2013 to provide clearing services for over-the-counter (OTC) derivatives. As of October 3, 2017, OTC Clear has 16 clearing members, including seven Hong Kong subsidiaries or branches of Chinese banks.
Further information is available at: http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170712news.htm.
OTC Clear Welcomes its First Clearing Member From France
On September 19, 2017, OTC Clear welcomed BNP Paribas (BNP) as its first clearing member from France.
BNP expects that OTC Clear’s product offering will help BNP manage its capital requirements and counterparty risk exposure for Renminbi OTC derivatives. In addition, OTC Clear’s clearing member network, including major Chinese and local members, will enable BNP to offer value-added services to many of its existing clients that have already joined OTC Clear.
Further information is available at: http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170919news.htm.
SFC Publishes Conclusions on Changes to Financial Resources Rules
On July 24, 2017, the SFC published Consultation Conclusions and Further Consultation on Proposed Changes (SFC Rules Publication) to the Securities and Futures (Financial Resources) Rules (FRR) on the proposed regulatory capital regime for corporations licensed with the SFC that are engaged in OTC derivatives activities and other proposed changes to the FRR.
The SFC Rules Publication will proceed to implement the proposed regulatory capital regime subject to certain modifications, which include:
■ reducing the minimum capital requirements for fund managers’ central dealing desks that meet certain conditions;
■ extending the transactional period for full compliance with the new FRR requirements from six months to one year; and
■ introducing an internal models approach to the FRR that references the latest standards set by the Basel Committee on Banking Supervision.
The proposed changes are intended to align Hong Kong’s regulations with international standards.
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The SFC Rules Publication also solicited input on various FRR-related proposals with written comments due August 23, 2017. One proposal would add four Mainland China commodity exchanges to the list of specified exchanges under the FRR to facilitate licensed corporations’ participation on those exchanges and to recognize credit ratings issued by Fitch Ratings.
A copy of the SFC Rules Publication is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=15CP3.
Further information is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=17PR100.
HKEX Plans to Implement Proposed After-Hours Trading Enhancements
On August 11, 2017, the Hong Kong Exchanges and Clearing Limited (HKEX) published consultation conclusions on its proposed after-hours trading enhancements (AH Conclusions).
After considering the responses received with respect to its consultation paper issued June 28, 2017, HKEX determined that there is substantial market support for the proposed after-hours trading enhancements and implementation roadmap. Subject to regulatory approval from the SFC, the enhancements will be introduced in the T+1 session in three phases.
■ Phase 1: extension to 1 a.m. (from 11:45 p.m.) of the T+1 session for equity index futures — Hang Seng Index (HSI), H-shares Index (HHI), Mini-HSI and Mini-HHI futures — in November 2017.
■ Phase 2: inclusion of index option contracts and a trading halt mechanism for index options in the T+1 session in the first half of 2018.
■ Phase 3: extension to 3 a.m. (from 1 a.m.) of the T+1 session and alignment of the T+1 session cutoff time (the deadline for system input of post-trade after the T+1 session) with the close of trading hours in the fourth quarter of 2018.
A copy of the AH Conclusions is available at: http://www.hkex.com.hk/eng/newsconsul/mktconsul/Documents/cp2017063cc.pdf.
Further information is available at: http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/1708112news.htm.
SFC and Hong Kong Police Sign MoU for Cooperation in Combating Financial Crime
On August 25, 2017, the SFC and the Hong Kong Police entered into an MoU (HK MoU) to formalize and further strengthen the cooperation of the two regulatory authorities in combating financial crimes. The HK MoU covered a range of matters, including referral of cases, joint investigations, exchange and use of information, mutual provision of investigative assistance and the establishment of a framework for closer collaboration on policy, operational and training issues.
A copy of the HK MoU is available at: http://www.sfc.hk/web/EN/files/ER/MOU/MoU_SFC-%20HKP_25%20Aug%202017.pdf.
SFC Issues Circular to Licensed Corporations Engaged in Asset Management Business in Relation to Common Noncompliance
The SFC issued two circulars, on July 31, 2017 and September 15, 2017, respectively, in which it identified certain common instances of noncompliance among asset managers. Examples include:
■ inappropriate receipt of cash rebates giving rise to apparent conflicts of interest;
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■ failure to ensure suitability of funds or discretionary account mandates when making solicitations or recommendations of funds under their management, or providing discretionary account management services, to clients;
■ failure to put in place a proper liquidity risk management process to ensure that liquidity risks of funds and discretionary accounts under management are adequately addressed;
■ deficiencies in setting up a proper governance structure and implementing comprehensive policies and procedures for fair valuation of assets;
■ deficiencies in systems and controls to ensure best execution; ■ failure to ensure fair order allocation; ■ inadequate systems and controls in relation to protection of client assets; ■ inadequate systems and controls for ensuring compliance with investment restrictions and guidance; and
■ inadequate systems and controls to address the risk of market misconduct.
The SFC urged asset managers to review their existing internal control procedures and operational capabilities and enhance them as needed to ensure that standards of conduct and control procedures meet its expectations. The SFC also indicated that it may take enforcement actions against the asset managers that have instances of noncompliance, as identified and listed by the SFC in the circulars.
The circular of September 15, 2017 is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/circular/openFile?refNo=17EC57; and http://www.sfc.hk/edistributionWeb/gateway/EN/circular/openAppendix?refNo=17EC57&appendix=0.
The circular of July 31, 2017 is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/circular/openFile?refNo=17EC48.
SFC and Stock Exchange of Hong Kong Limited Conclude Joint Consultation on Listing Regulation
On September 15, 2017, the SFC and the Stock Exchange of Hong Kong Limited (SEHK), a wholly owned subsidiary of Hong Kong Exchanges and Clearing Limited (HKEX), published their conclusions (Joint Conlcusions) to their joint consultation on proposed enhancements to SEHK’s decision-making and governance structure for listing regulation.
The Joint Conclusions clarify the SFC’s role as the statutory regulator that administers the Securities and Futures Ordinance and the Securities and Futures (Stock Market Listing) Rules. The SFC is also mandated to supervise, monitor and regulate the activities carried on by SEHK. SEHK’s role is to administer the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (Listing Rules). In other words, the SFC’s role as a statutory regulator has evolved so that it will now be more involved in administering the listing regulations and have supervisory and monitoring powers over the regulatory role that SEHK performs.
A new Listing Policy Panel will be established and will act as an advisory, consultative and steering body aside from the SFC and SEHK to initiate and centralize discussions relating to listing policies that have broader regulatory or market implications. The Listing Committee’s role under the Listing Rules will remain unchanged.
Going forward, the Chief Executive of HKEX will attend Listing Committee meetings as a nonvoting member representing the HKEX’s board only where listing policy matters are discussed and will not attend Listing Committee meetings where individual cases will be discussed.
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The SFC will discharge its statutory oversight of SEHK’s listing function through a materially enhanced and published audit of the Committee and the Listing Department.
A copy of the Joint Conclusions is available at: http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=16CP2.
Further information is available at: http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170915news.htm.
SEHK Seeks Views on Proposed Rule Changes Relating to Capital Raisings by Listed Issuers and its Delisting Framework
On September 22, 2017, SEHK published consultation papers on (a) capital raisings by listed issuers, and (b) delisting and other rule amendments. Both papers include proposed changes to the Listing Rules.
The Consultation Paper on Capital Raisings by Listed Issuers introduces targeted measures in the Listing Rules to address potential abuses related to large-scale, deeply discounted capital raising activities. It also contains proposals to address specific issues concerning other capital raising and share issuance transactions.
The Consultation Paper on Delisting and other Rule Amendments proposes changes to the Listing Rules to improve the effectiveness of the delisting framework and address the issue of prolonged suspension of trading in issuers’ listed securities. This is in the interest of maintaining market quality and reputation.
SEHK invites market feedback on the proposals. The deadline for responses is November 24, 2017. Separately, SEHK is undergoing discussions on refining the Listing Rules governing backdoor listings and continuing listing criteria. SEHK indicates that separate consultation papers about these topics will be published.
Further information is available at:
http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170922news.htm;
http://www.hkex.com.hk/eng/newsconsul/mktconsul/Documents/cp2017092.pdf;
http://www.hkex.com.hk/eng/newsconsul/mktconsul/Documents/cp2017091.pdf.
HKEX Announces Plans for Iron Ore Futures
On September 27, 2017, HKEX announced plans to introduce cash-settled TSI Iron Ore Fines 62 per cent Fe CFR China Futures (Iron Ore Futures), to be launched tentatively in November 2017, subject to market readiness.
Adding to existing product offerings in precious and base metals, Hong Kong Futures Exchange Limited will introduce Iron Ore Futures as its first ferrous metal commodity product. This new asset class is expected to provide an additional investment and risk management tool to address the market’s trading, hedging and asset allocation needs.
Further information is available at:
http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170927news.htm;
http://www.hkex.com.hk/eng/market/partcir/hkfe/Documents/Eng_DraftHKFEIronOreFuturesIntroductionCircular0927vf.pdf.
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SFC Launches Regulatory Sandbox for Fintech
On September 29, 2017, the SFC issued a circular announcing the launch of the SFC Regulatory Sandbox (Sandbox) to provide a confined regulatory environment for qualified firms to conduct regulated activities (under the Securities and Futures Ordinance, or SFO) using financial technology (Fintech) under the SFO before the Fintech is used on a broader scale.
The salient features of the Sandbox are as follows:
Eligibility: The Sandbox is available to both licensed corporations and startup firms that intend to carry on a regulated activity. The qualified firm must be fit and proper, use innovative technologies and be able to demonstrate a genuine and serious commitment to carry on regulated activities through the use of Fintech. The establishment or activities of these firms should also increase the range and quality of products and services for investors and benefit the Hong Kong financial services industry.
Licensing conditions: The SFC may impose licensing conditions when a qualified firm operates in the Sandbox.
Closer monitoring and supervision by the SFC: The SFC may place qualified firms under closer monitoring and supervision when they operate in the Sandbox.
Investor protection measures: Qualified firms are expected to have adequate investor protection measures in place to address actual or potential risks or concerns identified when they operate in the Sandbox. For instance, qualified firms should notify their clients that they are operating in the Sandbox and provide full disclosure of the potential risks and any available compensation arrangements.
Exit: Once a qualified firm has demonstrated that its technology is reliable and fit for intended purposes, and its internal control procedures have adequately addressed the risks identified, the firm may apply to the SFC for removal or variation of some or all of the licensing conditions imposed so that it may conduct regulated activities and be subject to SFC supervision on the same basis as licensed corporations that operate outside the Sandbox. If the SFC considers that a qualified firm operating in the Sandbox is not fit and proper to remain licensed (e.g., because its internal controls fail to meet the regulatory requirements), its license may be revoked.
Further information is available at http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=17PR126; and http://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=17EC63.
China
China Financial Futures Exchange Revises the Rules Relating to Investor Suitability System for Financial Futures Investors
On June 28, 2017, the China Financial Futures Exchange released the Circular on Revising the Implementing Measures on the Investor Suitability System for Financial Futures Investors (Measures) and the Operating Guidelines on the Investor Suitability System for Financial Futures Investors (Guidelines). Both came into force on July 1 and amended the existing measures and guidelines implemented on August 30, 2013. The Measures and Guidelines aim to ensure that market risks are monitored and that investors’ rights and interests are protected pursuant to the Administrative Measures on Securities and Futures Investors’ Suitability (Administrative Measures) issued by the China Securities Regulatory Commission (CSRC), which also came into force on July 1, 2017. According to the Measures, both individual and institutional investors are required to, among other things, maintain a certain minimum balance
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during the five consecutive trading days before their application to open an account for financial futures trading.
Further information is available at: http://www.cffex.com.cn/xwgg/jysgg/201706/t20170628_20316.html.
China Futures Association Releases Guidelines on the Administration of Investor Suitability for Futures Operators
On June 28, 2017, the China Futures Association (CFA) released the Circular on Issuing and Implementing Guidelines on the Administration of Investor Suitability for Futures Operators (for Trial Implementation) (CFA Guidelines), which came into force on July 1, 2017. The CFA Guidelines aim to protect investors’ rights and interests pursuant to the Administrative Measures. The CFA Guidelines repealed certain prior regulations on this subject matter. Under the new CFA Guidelines, ordinary investors are classified into five categories based on their risk tolerance, and suitable futures products and services are indicated, based on risk level, for each category.
Further information is available at: http://www.cfachina.org/ggxw/XHGG/201706/t20170628_2258388.html.
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Abbreviation Definition
BaFin German Bundesanstalt für Finanzdienstleistungsaufsicht
BCBS Basel Committee on Banking Supervision
BHC Bank Holding Companies
Bundesbank Deutsche Bundesbank
CBOT Chicago Board of Trade
CCP Central Counterparty
CDS Credit Default Swaps
CFTC Commodity Futures Trading Commission
CEA Commodity Exchange Act
CME Chicago Mercantile Exchange, Inc.
CPO Commodity Pool Operator
CTA Commodity Trading Advisor
DCM Designated Contract Market
DCO Derivatives Clearing Organization
DCR Commodity Futures Trading Commission, Division of Clearing and Risk
DMO Commodity Futures Trading Commission, Division of Market Oversight
DSIO Commodity Futures Trading Commission, Division of Swap Dealer and Intermediary Oversight
Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
DTCC Depository Trust & Clearing Corporation
EC European Commission
EEMAC Commodity Futures Trading Commission, Energy and Environmental Markets Advisory Committee
EMIR European Market Infrastructure Regulation
ESMA European Securities Market Authority
EU European Union
FBO Foreign Banking Organization
FCM Futures Commission Merchant
FDIC Federal Deposit Insurance Corporation
FinCEN U.S. Department of the Treasury, Financial Crimes Enforcement Network
FINRA Financial Industry Regulatory Authority, Inc.
IB Introducing Broker
IHC Intermediate Holding Company
IOSCO International Organization of Securities Commissions
ISDA International Swaps and Derivatives Association
MiFID Markets in Financial Instruments Directive
GLOSSARY OF FREQUENTLY USED TERMS
Glossary
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Sidley Derivatives | Q3 2017 • 18Glossary
Abbreviation Definition
MiFIR Markets in Financial Instruments Regulation
MSP Major Swap Participant
NFA National Futures Association
RIC Registered Investment Company
RTS Regulatory Technical Standards
SDR Swap Data Repository
SEC Securities and Exchange Commission
SEF Swap Execution Facility
SIDCO Systemically Important Derivatives Clearing Organization
TAC Commodity Futures Trading Commission, Technology Advisory Committee
GLOSSARY OF FREQUENTLY-USED TERMS
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