Hong Kong eyeing $483-trillion global derivatives market

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This picture taken on October 22, 2015 shows high-rise buildings in Hong Kong. -- AFP

HONG KONG is gearing up to grab a bigger slice of the $483-trillion global derivatives market as regulatory upheaval in Europe increases demand for alternative trading centers.

With Brexit and Markets in Financial Instruments Directive (MiFID) II rules set to complicate transactions in Europe, Hong Kong’s appeal as a derivatives hub is growing. HSBC Holdings Plc and Standard Chartered Plc, two of Europe’s largest banks, have already started shifting portions of their derivatives books to the former British colony, according to people familiar with the matter.

To make Hong Kong even more attractive, the city’s Securities and Futures Commission (SFC) is planning a revamp of its derivatives rules, a person familiar with the effort said. The regulator hired Nanfeng Sun, a former Bank of America Corp. (BofA) quant who specializes in risk models, to vet banks’ submissions, another person said. Hong Kong’s monetary authority is preparing for an increase in derivatives-related oversight, a spokeswoman said.

While Hong Kong is already a hub for derivatives dealing, banks and other financial institutions have typically booked their Asian transactions on the balance sheets of units in Europe or the US. That used to make sense: a central hub produced economies of scale, and Western regulations were seen as more favorable.

The changes in Europe have spurred a rethink. MiFID requirements have increased compliance burdens, while financial firms have been shifting some operations out of London in preparation for Britain’s exit from the European Union.

More firms are likely to move parts of their derivatives books to Hong Kong if the city tweaks its rules to allow so-called advanced risk models, which would reduce capital requirements, industry participants said. Increased derivatives booking could bring more revenue to the city, as well as new jobs in areas including risk management, according to the Hong Kong Financial Services Development Council, a government advisory body.

The person familiar with the SFC’s plans said it will soon release a public consultation on over-the-counter derivatives covering topics from valuation to record keeping. The proposed changes would enable firms to more easily book their trades in Hong Kong, the person said.

The SFC consultation “could have a positive impact for Hong Kong as a major derivatives booking hub,” said Terry Yang, a partner in the financial services practice at Clifford Chance LLP.

The SFC and Sun, the former BofA banker, both declined to comment.

The Hong Kong Monetary Authority (HKMA), the city’s de-facto central bank, said it’s in favor of financial firms booking more of their trades in Hong Kong if the positions are supported by adequate capital and robust risk management.

“A number of international banks have told us that they see advantages in booking their Asian risks in Hong Kong,” an HKMA spokeswoman said in an e-mailed response to questions from Bloomberg News.

Singapore is also an option for firms looking to move their exposures outside Europe. Standard Chartered has starting booking some of its trades in the city-state along with Hong Kong, said people familiar with the matter, who didn’t provide details on the size of the positions. Morgan Stanley is considering moving some of its book to Asia, a person familiar with the discussions said.

The Monetary Authority of Singapore said in a response to questions that the rapid growth of Asian markets, client preferences and the ability to manage risks where trades originate are some of the reasons why financial institutions carry out such activities in Singapore.

HSBC is committed to supporting clients in Asia, and Hong Kong continues to be at the heart of the bank’s growth plans, a spokesman said in a statement. Standard Chartered and Morgan Stanley declined to comment.

Hong Kong’s derivatives push comes just three months before Europe’s revised Markets in Financial Instruments Directive rules are set to take effect. The overhaul will subject some derivatives to a raft of new trading, reporting and compliance obligations. Booking the trades in a Hong Kong entity instead of a European one would allow firms to avoid or reduce many of these obligations, according to market participants.

The Asian units of international banks will “reconsider how they trade and book,” Clifford Chance’s Yang said. “MiFID II will drive an increase in regionalization.” — Bloomberg