2016.11.24 XIE, Qing (Natasha)、Brigitte（Bing）Lu
Last month, a regulatory circular regarding the over-the-counter (“OTC”) derivatives trading conducted by securities and fund management institutions once again caught our attention. This circular named the Circular of Further Regulation on OTC Derivatives Trading of Securities and Fund Operational Institutions within Jurisdiction (“Notice”) was issued by the China Securities Regulatory Commission Shanghai Bureau (“CSRC Shanghai Bureau”) on October 28, 2016 to the securities companies, mutual fund management companies and their subsidiaries (“Institutions”) within the area under its jurisdiction, the content of which is brief and clear.
Requirement on Investor Suitability
The Circular requires the Institutions to be fully aware of the clients with which the Institutions conclude OTC derivatives transactions, and to ensure sale of products to suitable clients. We believe it is not really a new concept. Owing to the specialty and complexity of the OTC derivatives businesses, there is no doubt that the Institutions engaging in the OTC derivative business must comply with the requirement on investor suitability administration.
The Circular requires the Institutions to be fully aware of the true purpose of their clients’ engagement in the OTC derivatives trading, and outlines four types of prohibited conduct, respectively: (i) no financing or surreptitious financing service shall be provided to any client; (ii) no margin significantly beyond the need for contract performance guarantee shall be collected; (iii) it is prohibited for an Institution to use the margin based on the instructions of the relevant client, and (iv) no service or facilitation shall be provided to any Non-standardized Asset for the purpose of evading regulations. We believe that more focus should be placed on the prohibited conduct under the items (iii) and (iv). The purpose of the regulators prohibiting the aforementioned conduct is to prevent any evasion against regulation by using OTC derivatives trading as a channel. Apart from that, the Circular also specifically requires that no renewal is allowed upon the expiry of a contract under which the OTC derivatives trading is used as a channel for those off-the-balance-sheet non-standardized credit assets of banks (i.e. “Non-Standardized Asset”) or is used for serving or facilitating any evasion against other regulations.
The Circular declares the OTC derivatives businesses to be brought under day-to-day supervision, including collecting information regarding the business model, trading volume, risk involved and counterparty clients of the OTC derivatives trading engaged by the Institutions, as well as taking regulatory measures for violations.
Following the regulatory thoughts after the abnormal volatility of stock market in 2015, the prior mission of the regulators was the “penetration supervision”, which aimed to block various channel businesses facilitating illegal conducts for preventing regulatory arbitrage. Upon clarification of the regulatory policy, we believe that enforcement will ultimately define the impact of the regulatory policy.