New proposal to boost OTC derivatives market

SINGAPORE – To further safeguard investor interest in the over-the-counter (OTC) derivatives market here, the Monetary Authority of Singapore (MAS) has proposed a framework to regulate intermediate parties dealing in such contracts.

Suggestions put forth in a consultation paper published yesterday include subjecting OTC intermediaries to a prescribed capital and business conduct requirements. They must also meet the admission criteria of the Capital Markets Services licensing guidelines, which will require them to have a minimum five-year track record if they serve retail investors.

MAS also proposed to have capital markets services licensees dealing in all capital market products, including OTC derivative contracts, disclose risks to their customers. These include any material risks of the product such as those concerning counterparties or liquidity, and whether licensees are acting as a principal or an agent.

“The risk disclosure will have to be furnished to and acknowledged by the customer or counterparty in writing prior to the capital markets services licensee entering into a contractual relationship with the customer,” the central bank said.

“MAS recognises that retail investors are likely to benefit most from such risk disclosure and where appropriate, may prescribe the specific form of the risk disclosure document. To date, MAS has prescribed the specific risk disclosure documents for futures contracts, leveraged FX contracts and overseas-listed investment products.”

These proposals follow an earlier consultation paper launched in February where the central bank proposed to expand the scope of the Securities and Futures Act to cover OTC derivative contracts, including the expansion of the capital markets services licensing requirement to OTC intermediaries.

MAS had embarked on reforms three years ago to make the trading of OTC derivatives safer and more transparent. The Securities and Futures Act had previously been amended to cater to the mandatory reporting and central clearing of OTC derivatives trades as well as the regulation of OTC derivatives trade repositories and clearing facilities.

Derivatives are contracts that derive their value from the performance of an underlying asset, such as stocks, bonds, commodities, currencies and market indices.

The derivatives market was blamed for the collapse of Lehman Brothers, which triggered the financial crisis in 2007 and 2008.

The latest round of public consultation will end on July 3. MAS also proposed a set of risk mitigation requirements for intermediaries that deal in non-centrally cleared OTC derivatives to enhance legal certainty, foster effective management of counterparty credit risk, and facilitate timely dispute resolution.

Besides suggestions to enhance the OTC derivatives market, the central bank also laid out refinements to rules governing the financial advisory services. This includes exempting trading representatives or brokers from the Financial Advisers Act when they handle clients’ investments in stocks, real estate investment trusts and simpler exchange-traded funds.

MAS said it has received feedback from the brokerage industry that it is challenging to comply with existing rules as customers are often not willing to disclose their investment objectives and financial situation to said industry.

“Unlike financial planners or wealth managers, dealers do not typically offer personalised financial advice … the advice provided is primarily based on the merits of the investment product and not tailored to the customer’s needs, circumstances and risk profile,” the central bank said.

MAS also proposed to allow financial advisers to help customers transact in collective investment schemes when such an investment recommendation has been accepted by customers.

The proposal is made in response to industry feedback and will help financial advisers better serve their clients.