April 27, 2018
Financial Stability Surveillance Division
Hong Kong Monetary Authority
55/F Two International Finance Centre
8 Finance Street, Central
Hong Kong
Supervision of Markets Division
Securities and Futures Commission
35/F Cheung Kong Center
2 Queen's Road Central
Hong Kong
Re:

Joint consultation paper on enhancements to the OTC derivatives regime for Hong
Kong to– (1) mandate the use of Legal Entity Identifiers for the reporting obligation,(2) expand the clearing obligation and (3) adopt a trading determination process for
introducing a platform trading obligation

Citadel 1 appreciates the opportunity to provide input to the Hong Kong Monetary Authority(the “HKMA”) and the Securities and Futures Commission (the “SFC”) on the continued
implementation of the G20 reforms to the OTC derivatives markets. 2 Citadel is a firm supporterof these reforms, including the clearing, trading, and reporting requirements. The ongoing
implementation of the G20 reforms has already begun to, and will continue to, reduce systemic
risk, improve market transparency, and foster an open, level, and competitive playing field formarket participants.
Below we provide our feedback on specific questions in the consultation.
Q4. Do you have any comments or concerns about our proposal not to introduce new
products for Phase 2 Clearing other than IRS denominated in AUD? If so, please provide
specific details.
We recommend that the HKMA and the SFC consider expanding the clearing obligation to (i)additional tenors in fixed-to-floating IRS denominated in the G4 currencies and to (ii) certain FX
non-deliverable forwards (“NDFs”).
First, with respect to fixed-to-floating IRS denominated in G4 currencies, we believe that thecovered tenors should be extended to include swaps with a duration of up to 50 years (or 30 years

1

Citadel is a global financial firm built around world-class talent, sound risk management, and innovative marketleading technology. For more than a quarter of a century, Citadel’s hedge funds and capital markets platforms havedelivered meaningful and measurable results to top-tier investors and clients around the world. Citadel operates inall major asset classes and financial markets, with offices in the world’s leading financial centers, including
Chicago, New York, San Francisco, Boston, London, Dublin, Hong Kong, and Shanghai.
2
See http://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180327e5a1.pdf.

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for JPY). 3 While longer-dated swaps may trade less frequently than other tenors, they represent amaterial segment of the market when considered from a risk perspective (including risk-sensitive
metrics such as DV01). Given that central clearing is designed to mitigate systemic risk, it isimportant that longer-dated swaps are brought into clearing in order to address counterparty credit
risk over the life of the swap. Increasing the scope of covered tenors will also further harmonise
the Hong Kong clearing obligation with those already successfully implemented in otherjurisdictions, such as the US, the EU, and Australia. All of the relevant factors under the clearing
obligation process are met for these instruments.
Second, we recommend that the HKMA and the SFC coordinate with global regulators toconsider whether certain FX non-deliverable forwards (“NDFs”) are now suitable for a clearing
mandate. NDFs constitute an important segment of the global foreign exchange market and datashows that NDFs account for more than $130 billion in average daily trading volumes. 4
Importantly, since the recent introduction of uncleared initial margin requirements, voluntary
clearing of NDFs has significantly increased. Data shows that clearing rates have increased acrossall of the most common currency pairs and that approximately 30% of the market is now centrally
cleared. 5 In light of this significant growth in voluntary clearing, it may be timely for global
regulators to reconsider whether a clearing mandate for FX NDFs is appropriate.
Q5. Do you have any comments or concerns about our proposal to maintain the current scopeof Prescribed Person? If you do, please provide specific details.
We have several concerns with maintaining the current definition of a “Prescribed Person,”which effectively limits the application of the clearing obligation to dealer-to-dealer activity. The
clearing obligation is a central pillar of the G20 reforms and its successful implementation is
critical to achieving the policy goals of mitigating systemic risk, promoting market stability andintegrity, and improving conditions for investors through increased transparency, morecompetition, and better pricing. These goals will not be fully achieved by applying the reforms
only to the inter-bank portion of the OTC derivatives market.
First, efforts to mitigate systemic risk are undermined to the extent there are material trading
volumes that are not covered by the clearing obligation. Recent data suggests that “other financial
institutions” (i.e. non-dealers) account for approximately 36% of trading activity in interest rate
derivatives in Hong Kong, with the daily volumes of these entities increasing by more than fourtimes from 2013 to 2016. 6 Similarly, a recent analysis of data from the Hong Kong Trade
Repository (“HKTR”) found that, following the implementation of Phase 1 clearing in July 2017,
still only approximately 40% of new fixed-to-floating IRS trades reported to the HKTR are
intended-to-be-cleared. 7 In contrast, approximately 95% of new fixed-to-floating IRS trades3

We note that both the US and Australian clearing mandates also cover AUD IRS up to 30 years in tenor.

4“NDF Clearing February 2018”, Clarus Financial Technology (March 14, 2018), available at:https://www.clarusft.com/ndf-clearing-february-2018/.
5
Id.
6
ISDA Asia-Pacific OTC Derivatives Study (November 2017) at pages 16-17, available at:https://www.isda.org/a/jRTEE/Asia-Pacific-Derivatives-Study-November-2017.pdf.
7“Overview of the Hong Kong Trade Repository”, Clarus Financial Technology (March 6, 2018), available at:https://www.clarusft.com/overview-of-the-hong-kong-trade-repository/.

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reported to US swap data repositories are intended-to-be-cleared. 8 This data suggests that too
many liquid and standardised OTC derivatives transactions entered into in Hong Kong remain
outside of the clearing obligation.
Second, efforts to mitigate systemic risk and improve market integrity are undermined when asignificant number of market participants are not covered by the clearing obligation. While thetrading activity and exposures of any given smaller financial institution may not present systemicrisk concerns in isolation, the sheer number of bilateral counterparty credit exposures that persist
outside of central clearing perpetuates systemic risk in aggregate, acting as a risk transmission
channel in the event of a significant counterparty default. In addition, this trading activity will
likely continue to occur on an over-the-counter bilateral basis, away from the monitoring andsurveillance performed by regulated trading platforms.
Third, applying the clearing obligation only to large banks deprives other market participants,
including the buy-side, of the potential benefits of the G20 reforms, such as increased transparency,
more competition, and better pricing. The ongoing counterparty credit exposure inherent in
uncleared derivatives transactions necessitates bilateral trading and credit support documentation
between each and every pair of trading counterparties. The cost and complexity of entering into
these agreements limits access to, and choice of, counterparties. Central clearing eliminates theneed for such documentation, as counterparties to cleared derivatives transactions do not haveongoing counterparty credit exposure to each other, and instead face a CCP via a clearing member.
As a result:•

Customers can access cleared markets more easily and enjoy a greater choice of trading
counterparties.

•

Competition is enhanced as a key barrier to entry – negotiating complex documentation
with each and every potential trading counterparty in the market – is removed.

•

New and innovative trading protocols and trading venues can emerge to facilitate pricediscovery and risk transfer among a more diverse set of counterparties.

•

Collectively, these developments deliver better pricing, deeper liquidity, and greatertransparency.

Central clearing has delivered these benefits in jurisdictions where the clearing obligation has
been fully implemented. Academic research has concluded that “the reduced counterparty risk
and increased post-trade transparency associated with central clearing have beneficial effects on
liquidity.” 9 In addition, Bank of England research has found that US clearing and trading reforms
led to a significant improvement in liquidity and a material reduction in execution costs, with end-

8

Id.
See Loon, Y. C., Zhong, Z. K. Does Dodd-Frank affect OTC transaction costs and liquidity? Evidence from realtime CDS trade reports. Journal of Financial Economics, 119 (3), 645–672 (2016) at page 4, available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2443654.

93

users saving as much as $7 million - $13 million per day. 10 However, the clearing obligation mustbe generally applied to all types of market participants in order to realise these benefits. In theabsence of the full implementation of clearing obligations, the OTC derivatives market may appear
largely unchanged from the perspective of a buy-side market participant, with the price discovery
process opaque and fragmented and liquidity providers continuing to focus on providing liquidity
bilaterally in uncleared instruments.
For these reasons, both the US and EU have applied the clearing obligation to a broad rangeof financial counterparties. In the US, the clearing obligation was phased-in over a 9-month period
in 2013 and applied to all financial counterparties, with a narrow exemption for credit institutions
with less than $10 billion in assets. In the EU, the clearing obligation was phased-in for larger
financial counterparties beginning in 2016 and will be applied to smaller financial counterparties
in 2019.
We note that we appreciate the logic behind phasing-in new regulatory requirements, such as
the clearing obligation, starting with the most active banks. However, given that Phase 1 clearing
has now been implemented successfully, we believe that it is important to continue to expand thescope of financial institutions subject to the clearing obligation, consistent with how the clearing
obligation is applied in other jurisdictions such as the US and the EU. Therefore, we respectfully
request that the HKMA and the SFC provide further detail regarding the proposed timeline forfully implementing the clearing obligation and reconsider the definition of a “Prescribed Person.”Q9. Do you have any comments or concerns regarding our proposal to maintain the Clearing
Threshold and the calculation method of outstanding positions to be measured against thethreshold? If you do, please provide specific details.
As further detailed in our response to Question 5 above, applying the clearing obligation to abroader array of market participants is critical to realizing the G20 reform objectives of mitigating
systemic risk, promoting market stability and integrity, and improving conditions for investors
through increased transparency, more competition, and better pricing. In connection with applying
the clearing obligation to a broader set of financial institutions, the current “Clearing Threshold”
will need to be either lowered or eliminated. At a minimum, the “Clearing Threshold” should bealigned with the $8 billion threshold employed for purposes of applying the uncleared initial
margin requirements to financial institutions.
Q12. Do you have any comments or concerns regarding our proposed trading determination
process and criteria? If you do, please provide specific details.
We agree with the proposed criteria to be used in connection with implementing a trading
obligation for the Hong Kong market. As stated in the consultation, these criteria are consistent
with those used in other jurisdictions, such as the US and the EU. Below, we highlight additional
topics that merit consideration when designing a trading obligation for OTC derivatives.

10

See Staff Working Paper No. 580 “Centralized trading, transparency and interest rate swap market liquidity:
evidence from the implementation of the Dodd-Frank Act”, Bank of England (July 2016), available at:
http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp580.pdf.

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1. Scope of Covered Market Participants
As discussed in our responses to Question 5 and Question 9 above, the G20 reforms should beapplied to both the dealer-to-dealer and dealer-to-customer segments of the market in order to fully
realise the benefits of these reforms. This is particularly true for the trading obligation, which isdesigned specifically to benefit end investors through the transparency, competition, and better
pricing that results from transitioning trading in liquid and standardised OTC derivatives onto
regulated trading venues.
Market experience with the implementation of the trading obligation in other jurisdictions has
demonstrated the tangible benefits to end investors that result from open and competitive execution
on regulated trading venues. For example, the Bank of England found that end-users transacting
USD IRS are already saving as much as $7 million - $13 million per day, due to lower transaction
costs resulting from the implementation of the clearing and trading obligations in the US. In
addition, a staff paper from the Monetary Authority of Singapore concluded that, even in smallermarkets, “we consider the main beneficiaries of a trading mandate to likely be buy-side
participants (e.g. fund managers and insurers), who are generally price-takers in OTCD markets.
Increased pre-trade transparency for buy-side participants improves their price discovery process
and reduces information asymmetry.” 11
For these reasons, both the US and EU have applied the trading obligation to a broad range offinancial counterparties. In the US, the trading obligation applies to all financial counterparties,
with a narrow exemption for credit institutions with less than $10 billion in assets. In the EU, thetrading obligation was applied to larger financial counterparties in January 2018 and will beapplied to smaller financial counterparties in 2019.
Applying the trading obligation only to the inter-bank portion of the OTC derivatives market
deprives other market participants of these important benefits and leaves the market structure
largely unchanged from a trading perspective compared to prior to the financial crisis.
2. Scope of Covered Instruments - Outrights
We believe that market experience with trading obligations in other jurisdictions should beconsidering when determining the scope of OTC derivatives to be covered by a trading obligation.
This experience has demonstrated that, at a minimum, most benchmark tenors in USD, EUR, and
GBP fixed-to-floating IRS are suitable for a trading obligation given their standardisation andglobal liquidity, taking into account factors such as the number of liquidity providers regularly
offering quotes, average daily volume, average size of trades, and number and type of active
market participants. The US and EU have applied the trading obligation to a nearly identical set
of OTC derivatives, 12 and a significant amount of OTC derivatives trading activity in Hong Kong

11

MAS Staff Paper No. 54, Liquidity and policy analyses for platform trading of OTC derivatives: A perspective ofsmaller markets (December 2016) at page 8, available at:
http://www.mas.gov.sg/~/media/resource/news_room/Staff%20Papers/MAS%20Staff%20Paper%20No54%20%20
Liquidity%20and%20Policy%20Analyses%20for%20Platform%20Trading%20of%20OTC%20Derivatives.pdf.
12
See list of instruments subject to the US trading obligation at
http://www.cftc.gov/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf and list of instruments

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involves US and EU counterparties that are already subject to these trading obligations. In
addition, maximising harmonisation in terms of instrument scope may assist in efforts to achieveequivalence determinations with other jurisdictions.
3. Scope of Covered Instruments – Package Transactions
Ensuring that the trading obligation applies to standardised and liquid packages transactions
will also be important when determining the scope of OTC derivatives covered by a trading
obligation. Over 50% of benchmark USD IRS are executed as part of a package transaction 13 andtherefore it is critical that standardised and liquid packages are not exempted from the trading
obligation. In both the US and EU, the general rule is that an OTC derivative subject to a trading
obligation must be executed on a regulated platform even if a market participant executes it as partof a package transaction along with other instruments. Certain targeted exemptions have been
provided from the trading obligation for specific types of packages in both jurisdictions. 14
However, it is important to note that no exemptions have been provided to the most liquid andstandardised packages traded by market participants. These include (a) packages with one
component subject to the trading obligation and the other components subject to the clearing
obligation and (b) packages comprised of a USD IRS component subject to the trading obligation
and a US Treasury.
Packages with one component subject to the trading obligation and the other components
subject to the clearing obligation include (i) interest rate curves (2 interest rate swaps of different
maturities), (ii) interest rate butterflies (3 interest rate swaps of different maturities), (iii) IMM
rolls (trading out of an existing IMM swap and replacing it with the next longest maturity), and(iv) CCP basis swaps (two or more interest rate swaps that are cleared at different CCPs). Market
data shows that interest rate curves and butterflies alone typically constitute approximately 1/3 ofthe total risk transfer in USD IRS and one analysis found that up to 45% of vanilla, spot starting
USD IRS were traded as part of a curve or butterfly. 15 These types of packages are also extremelycommon for EUR and GBP IRS.
In turn, packages comprised of a USD IRS component subject to the trading obligation and a
US Treasury (“spread over packages”) appear to be the single largest category of package

subject to the EU trading obligation at https://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32017R2417&from=EN.
13
See “Spreadovers: US Treasury Spreads in the Swaps Data,” Clarus Financial Technology (March 23, 2105),
available at: https://www.clarusft.com/spreadovers-us-treasury-spreads-in-the-swaps-data/.
14
US: CFTC Letter No. 17-55 (Oct. 31, 2017), available at:
http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-55.pdf.
EU: ESMA Opinion on the treatment of packages under the trading obligation for derivatives (March 21, 2018),
available at: https://www.esma.europa.eu/sites/default/files/library/esma70-156-322_opinion_packages_and_to.pdf.
15
See “September 2016 Swaps Review,” Clarus Financial Technology (Oct. 12, 2016) at Table 2, available at:https://www.clarusft.com/september-2016-swaps-review/; and “USD Swaps: Spreads and Butterflies Part II,” Clarus
Finan-cial Technology (Sept. 30, 2014), available at: https://www.clarusft.com/usd-swaps-spreads-and-butterfliespart-ii/.

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transactions involving USD IRS in terms of overall risk transfer and constitute up to 20% of overall
trade count. 16
All of the package types highlighted above already trade successfully on both US SEFs and
EU MTFs and OTFs, further indicating than an exemption for these types of packages from thetrading obligation is not necessary.
4. Pre-Trade and Post-Trade Transparency
Pre-trade and post-trade transparency requirements typically apply to OTC derivatives that are
subject to a trading obligation. In the US, pre-trade transparency is achieved by requiring
instruments subject to the trading obligation to be transacted by RFQ-to-3 or on an Order Book,
which is designed to ensure that market participants are provided with competing quotes orbids/offers that are visible prior to execution. In contrast, the EU provides greater flexibility withrespect to methods of execution but has separate pre-trade transparency requirements that require
the disclosure of quoted prices to the wider market. Pre-trade transparency is important tounlocking the potential benefits of a trading obligation, as it empowers investors to demand better
pricing from their liquidity providers, increasing competition and reducing transaction costs.
In both jurisdictions, real-time post-trade public reporting requirements apply to OTC
derivatives subject to the trading obligation (as well as to other OTC derivatives), with time delays
for large block transactions. Post-trade transparency removes information asymmetries andenables investors to more accurately assess execution quality. Importantly, research suggests that
increased post-trade transparency has contributed to improvements in liquidity. 17
5. Non-Discriminatory Access to Regulated Trading Venues
As part of implementing a trading obligation, it is important to ensure that all market
participants have the ability to access the regulated platforms where OTC derivatives subject tothe trading obligation will be executed. Unfortunately, inter-dealer broker (“IDB”) platforms havehistorically denied access to other market participants, including the entire buy-side as well as
potential new entrants on the sell-side. This denial of access achieves two objectives. First, it
prevents end investors from directly accessing the competitive pricing and liquidity found on the
dealer-only trading venues. Second, it makes it extremely difficult for new liquidity providers tocompete with the incumbent dealers on any trading venue, as potential new entrants are blockedfrom accessing necessary pools of liquidity for pricing and hedging purposes.

16

See “September 2016 Swaps Review,” Clarus Financial Technology (Oct. 12, 2016) at Table 2, available at:https://www.clarusft.com/september-2016-swaps-review/; and “Spreadovers: US Treasury Spreads in the Swaps
Data,” Clarus Financial Technology (March 23, 2105), available at: https://www.clarusft.com/spreadovers-ustreasury-spreads-in-the-swaps-data/.
17
See, e.g., Loon, Y. C., Zhong, Z. K., 2014. The impact of central clearing on counterparty risk, liquidity, andtrading: Evidence from the credit default swap market. Journal of Financial Economics 112 (1), 91-115; Loon, Y.
C., Zhong, Z. K., 2015. Does Dodd-Frank affect OTC transaction costs and liquidity? Evidence from real-time CDS
trade reports. forthcoming, Journal of Financial Economics.

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Typical access barriers used by these IDB platforms include (a) requiring direct clearing
membership at a CCP in order to join the trading platform, and (b) providing mechanisms thatallow platform participants to selectively “turn-off”, or otherwise restrict trading with, certain
other participants (i.e. “enablement” or “credit control” mechanisms). These access barriers havebeen specifically prohibited in both the US and EU for cleared OTC derivatives traded on SEFs
and MTFs/OTFs in order to ensure that market participants are provided with impartial and nondiscriminatory access to these new regulated trading platforms. 18
We respectfully request that the HKMA and the SFC, as part of implementing a trading
obligation, require that Hong Kong trading platforms provide impartial and non-discriminatory
access to market participants. This will maximise harmonisation with the US and EU regulatory
frameworks and ensure the prohibition of arbitrary and discriminatory practices that could prevent
market participants in Hong Kong from accessing certain liquidity pools.
6. Straight-Through-Processing Standards
The trading obligation is also intended to mitigate systemic risk and improve market stability
and integrity by transitioning trading activity in OTC derivatives to a safer and more transparent
regime, where market participants trade on a well-regulated platform subject to monitoring andsurveillance and then immediately face a CCP without having to worry about the bilateralcounterparty credit risk of their original executing counterparty.
In order to maximise these benefits, both the US and EU have successfully implemented
straight-through-processing (“STP”) requirements in connection with a trading obligation. 19
These requirements reduce market risk, credit risk, and operational risk by creating a robust
execution-to-clearing workflow for market participants trading on a regulated platform. The main
STP requirements include:(a) Submission timeframes. Each step in the operational workflow from execution to clearing
must occur within a certain amount of time in order to prevent transactions from being leftin an uncertain, pending-clearing state during which the client is unsure whether its
exposure is to the CCP or to its original executing counterparty.

18

EU: ESMA Q&A on MiFID II and MiFIR market structure topics, Section 5.1, Question 3, available at:https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-38_qas_markets_structures_issues.pdf.
US: “Staff Guidance on Swap Execution Facilities Impartial Access” (Nov. 14, 2013), available at:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmostaffguidance111413.pdf and “Core
Principles and Other Requirements for Swap Execution Facilities”, (June 4, 2013) at page 33508, available at:
http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2013-12242a.pdf.
19
US: “Staff Guidance on Swaps Straight-Through Processing” (Sept. 26, 2013), available at:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/stpguidance.pdf; and CFTC Letter No. 15-67(Dec. 21, 2015), available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/15-67.pdf.
EU: Commission Delegated Regulation (EU) 2017/582, available at: http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32017R0582&from=EN8

1) Submission to the CCP after execution. Both US and EU rules require that a transaction
executed on a trading platform be submitted to the CCP no later than 10 minutes after
execution. 202) Acceptance or rejection by the CCP. Both US and EU rules require that a CCP accept
or reject a transaction submitted for clearing within 10 seconds of receipt. 21(b) Pre-execution credit checks. Both US and EU rules require pre-execution credit checks
by a client’s clearing member in order to ensure that both executing counterparties are able
to successfully clear a transaction executed on a trading platform. 22(c) Providing certainty in the event a trade is rejected from clearing. Both US and EU
rules address the rare circumstance of a trade being rejected from clearing after being
executed on a trading platform, including voiding the trade in order to prevent thereintroduction of bilateral counterparty credit risk. 23
These STP requirements have been critical in reducing systemic risk and are standard market
practice in other jurisdictions that have implemented a trading obligation. Therefore, we
respectfully request that the HKMA and the SFC apply similar standards to Hong Kong trading
platforms in order to increase global harmonisation and to ensure market participants in Hong
Kong benefit from the same operational efficiencies that are available when trading on regulated
platforms in other jurisdictions.
*

*

*

*

*

We appreciate the opportunity to provide our perspective to the HKMA and the SFC. Pleasefeel free to call the undersigned at +1-646-403-8200 or my colleague, Andrew Fong, our Chief
Administrative Officer for Asia Pacific at 852-36675500 with any questions regarding thesecomments.

Respectfully,/s/ Stephen John Berger
Managing Director, Government & Regulatory Policy

20

See CFTC Letter No. 15-67 and Article 3 of Commission Delegated Regulation (EU) 2017/582.
See CFTC “Staff Guidance on Swaps Straight-Through Processing” and Articles 3 and 4 of Commission
Delegated Regulation (EU) 2017/582.
22
See CFTC “Staff Guidance on Swaps Straight-Through Processing” and Article 2 of Commission DelegatedRegulation (EU) 2017/582.
23
See CFTC “Staff Guidance on Swaps Straight-Through Processing” and Article 5 of Commission DelegatedRegulation (EU) 2017/582.
21

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