Capital markets and structured investments

No.

Since the global financial crisis in 2007-to-2008, and the G20 summit in 2009 the derivatives market has been subject to a significant amount of new regulation, and this has led to substantial compliance costs for market participants.

In January 2013, ASIC introduced the ASIC Derivative Transaction Rules (Reporting) 2013, together with the ASIC Derivative Trade Repository Rules 2013. Among other things, these Rules introduced mandatory reporting requirements for derivative transactions for the majority of derivatives users. These rules were subsequently softened by the ASIC Derivative Transactions Rules (Reporting) Amendment 2015 (no 1).

Other recent regulatory changes of note include the requirement for certain standardized over-the-counter derivative trades to be subject to clearing with a prescribed Central Clearing Counterparty, as implemented through the Corporations (Derivatives) Amendment Determination 2015 (No 1), and the requirement for reporting of certain trades to a licensed Trade Repository, as implemented through the Derivative Transaction Rules (Reporting) 2013 (both regulations have been subject to subsequent amendment).

The Prudential Standard CPS 226 (Margining and risk mitigation for non-centrally cleared derivatives), as published by the APRA in 2016, establishes the requirement for the posting and collection of variation and initial margin in transactions which include a covered entity (for example, deposit-taking institutions that are authorized under the Banking Act 1959 (Cth)).

In addition, it is important to note that the approach to market misconduct is generally the same for securities and for derivatives (including market manipulation and insider trading) although compensation orders for damages do not apply to derivatives.

Finally, the ATO has recently issued guidelines setting out risk factors applicable to cross-border related party derivatives.

Since the global financial crisis in 2007 to 2008, derivatives, and particularly over the counter derivatives, have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over the counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen, and continues to see, the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Netting arrangements have to be expressly agreed by the parties of any given transaction to be valid. This arrangement has to be documented in a specific agreement, either through a public or a private instrument. Alternatively, the financial institutions may have a global netting agreement with the client, covering all derivatives transactions entered into by then.

Those agreements have to be registered either with the Registry of Deeds and Documents or an authorized clearing system in Brazil within 15 days of their execution. The agreements must set out the conditions for an event of default to occur and the methodology for the calculation, set-off and liquidation of the transactions.

Although the new Brazilian Bankruptcy Law (Law No. 11.101 dated 9 February 2005) has brought additional protections for netting arrangements, there are still a number of risks involved in the exercise of netting in a bankruptcy situation.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. Canada, in line with the G20 Commitments, has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants. In particular, the new regulations are focused on trade reporting, dealer registration, mandatory clearing and margining to reduce credit and market risk.

In addition, derivatives are subject to normal market and counterparty credit risk and, as a result, are designed solely for sophisticated entities.

As a regulated entity, there are many risks regarding compliance with the regulation thereof (the CMF have issued a high amount of regulations regarding which derivatives they can enter into, with whom they can deal with and which underlying assets are acceptable). Therefore, regulated entities (banks, pension fund administrators, mutual funds administrators, brokers etc) must comply with this strict regulation if they do not want to be sanctioned by the CMF.

There are no specific risks or issues around entering into derivatives contracts.

The biggest issue is the level of regulation which became more stringent after the global financial crisis in 2008, which was partially caused by mortgages and over-the-counter derivatives. Therefore, there is now more central counterparty clearing and more standardized derivatives contracts, both to increase the transparency and safety of this kind of contracts.

It is likely that there will be even more regulation in upcoming years on both Czech national and EU levels.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought, in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen, and continues to see, the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Since the global financial crisis in 2007 to 2008, many regulations have been enacted with the intention of monitoring and/or regulating derivatives markets. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing, limiting the scope of title transfer, by generally prohibiting such type of collateral in case the counterparty to the financial counterparty is a non professional client (e.g. retail);
• improve the management of operational risk by increasing the standardization of derivatives contracts;
• provide rules for the collection and posting of initial and variation margins;
• improve banking secrecy (e.g. for redit derivatives); and
• provide rules on miscelling/good conduct.

Derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention in recent years. The European Commission has sought, in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation.

Legal risk 

Legislative provisions on netting remain untested. There is no case law interpreting these provisions. There is as yet no ISDA legal opinion on netting or on collateral.  There are elements in the corporate insolvency law regime which leave room for some uncertainty.

Since the global financial crisis in 2007 and 2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought, in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Since the 2007-2008 global financial crisis, derivatives and over-the-counter derivatives have attracted significant regulatory attention.

 The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on OTC derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

EMIR has recently been amended and the changes, known as EMIR Refit, entered into force in June 2019. The EMIR Refit aims to simplify the EMIR regime and reduce regulatory and administrative burdens and cost for smaller counterparties. For example, under the EMIR Refit Regulation, those categorized as small non-financial counterparties do not need to comply with reporting and clearing requirements from specified dates.

Derivative contracts (in particular OTC derivative contracts) are also regulated by the European Market Infrastructure Regulation (EMIR) and the implementing regulation of Regulatory Technical Standards (RTS) which attempts to ensure the same degree of protection to clients within all EU countries by providing comprehensive information and transparency on over-the-counter derivative position, and reduce counterparty risk by increasing the use of central counterparty clearing.

It is worth noting that the derivatives market hassignificantly changed in light of the implementation of the MiFID II starting from January 2018, as summarised above.

Due to a recent increase in disputes over OTC derivatives in Italy, a specific focus is attributed to the following items:

• complete disclosure of all costs related to the initial mark-to-market of the OTC derivative contract (distinguishing each line item such as hedging cost and bank remuneration); and
• comprehensive information to be provided to the client before the entering into the derivative contract with particular reference to the appropriateness and suitability of the derivative.

The level of information required by law depends on the MiFID II classification of the client (retail or professional).

The risk related to the non-disclosure of the above information to the client is that the derivative contract might be declared null and void by an Italian court. Pursuant to current case law in Italy a client (professional or retail) shall explicitly receive detailed information and give its consent on the value of the hedging costs and any further charge applied to the derivative transaction to be concluded by it.

According to the provisions of EMIR the counterparties to derivatives transactions must verify the need to enter into specific arrangements for risk reducing. More particularly, for those transactions entered into between clients classified as FC (Financial Counterparties) or as NFC+ (Non-Financial Counterparties above a certain threshold) it will be necessary to establish security arrangements for the calculation and exchange, on a daily basis, of the “variation margin” to be exchanged between the parties to cover the relevant exposure under the master agreement governing the entire set of derivatives transactions.

• Market risk
• Liquidity risk
• Counterparty risk
• Commodity price risk
• Exchange rate risk
• Interest rate risk

Risks are not that notable as the majority of the activities are conducted between sophisticated persons and are to a certain extent reserved for banks, and national and regional financial institutions which have a depository account with the Central Bank.

Residents are authorized to conduct transactions on foreign exchange derivative markets through licensed intermediaries or foreign banks (Article 12 of Regulation 09/2010).

Since the global financial crisis of 2007–2008, derivatives and particularly over-the-counter (OTC) derivatives have attracted significant regulatory attention.

A notable transparency initiative introduced in 2012 for the purposes of the regulation of OTC derivatives is the requirement to use an electronic trading system for certain types of OTC derivatives transactions.

As of September 2016, new regulations under the Financial Instruments and Exchange Act require financial institutions to collect and post collateral for OTC derivative transactions which do not use a central clearing house to effect the transaction. This requirement aims to enhance the security of large derivative transactions by limiting the instances of default.

ased on the recent amendments to the Financial Instruments and Exchange Act in May 2019, which are effective as of June 2020, derivative transactions backed by cryptocurrency defined under the Payment Service Act are also subject to registration requirements.

Since the global financial crisis in 2007-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought, in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulations and this has led to substantial compliance costs for market participants.

Since the financial crisis, the Financial Services Commission has been closely following international developments to keep pace and act accordingly.

The derivatives market regulation relies on general provisions encompassing the Ministry of Finance and Public Credit (SHCP), Banco de México (BANXICO) and the National Banking and Securities Commission (CNBV). There is no regulation for OTC derivatives, which impairs enforcement and supervisory efforts by CNBV in this area, however, the CNBV aims at maintaining oversight of OTC derivatives transactions to ensure that participants do not engage in regulated activities, such as trading with securities.

It should be mentioned the application of the general instruction of foreign exchange applicable to forward financial instruments.

Since the global financial crisis in 2007 to 2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

The issuing of derivatives in New Zealand was largely unregulated until the coming into effect of the Financial Markets Conduct Act 2013 (FMCA) on 1 December 2014. A small number of issuers were approved as Authorized Futures Dealers by the previous regulator, the Securities Commission, under the now-repealed Securities Markets Act 1988. Those issuers were transitioned to the FMCA by 1 December 2016, and there are currently 25 licensed derivatives issuers. The FMA has taken enforcement action against derivatives issuers operating from outside of New Zealand who have registered to the Register of Financial Service Providers and claimed to be regulated in New Zealand without being licensed. Several of these businesses have been struck off the register.

In order to ensure close out netting, the derivatives agreements must be in writing and provide for valuations at market prices. In addition the derivatives must be of the kind described in the Norwegian Securities Trading Act 2007.

Considering that the market for derivative contracts in Peru is limited and that there is no regulation applicable to that type of operation, no notable risks are apparent other than the limitations established by the Superintendence of Banking, Insurance and Private Pension Fund Management Companies (SBS) in relation to the level of exposure from authorized financial companies.

Since the global financial crisis in 2007-to-2008, derivatives – and particularly over-the-counter derivatives – have attracted significant regulatory attention. The European Commission has sought to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Portuguese courts have reviewed several cases relating to derivatives since the financial crisis of 2007-to-2008. In general, Portuguese courts tend to uphold these types of agreements. However, where derivatives are traded with non-qualified investors, certain issues should be considered carefully, namely the provision of pre-contractual information, contracts subject to foreign law and usage of standard form documentation as these are issues that are considered by the courts in order to nullify or uphold such agreements.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. In 2010, the US adopted the Dodd-Frank Wall Street Reform and Consumer Protection Act. As a result the derivatives market has seen, and continues to see, the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Over-the-counter derivative contracts, unlike those made on an organized exchange, do not have any system of centralized control, guarantees of performance, risk-management system or requirements on the participants. This risk analysis is carried out by the market player itself.

However, at the moment the Central Bank of the Russian Federation is developing amendments to the relevant laws in order to mitigate the mentioned risks and improve the infrastructure of the over-the-counter derivatives market, including centralized clearing, accreditation of price centers and repository activities. In particular, in 2019 the CBR introduced its new approach to further enactment of the new rules for variation margin for non-exchange traded derivatives that should be put into effect in several stages. This area of law is therefore subject to possible changes.

• Market risk
• Liquidity risk
• Counterparty risk
• Commodity price risk
• Exchange rate risk
• Interest rate risk

Risks are not that notable as the majority of the activities are conducted between sophisticated persons and are to a certain extent reserved for banks, and national and regional financial institutions which have a depository account with the Central Bank.

Residents are authorized to conduct transactions on foreign exchange derivative markets through licensed intermediaries or foreign banks (Article 12 of Regulation 09/2010).

The derivatives market has seen, and continues to see, the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative positions;
• reclearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

As discussed above, South Africa has not been exempt from the regulatory attention afforded to OTC derivative trading, particularly in the last seven to ten years. As such the reporting requirements in respect of derivative transactions have become increasingly onerous and as South Africa begins licensing CCPs there will be additional compliance and regulatory costs imposed on people transacting in derivatives.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

There has been a number of national courts decisions (even from the Spanish Supreme Court confirming the jurisprudence) within the last years in relation to derivatives entered into with non-institutional/professional borrowers (mainly, consumers) in which the hedge provider has been sentenced to pay large sums given that, pursuant to the decisions, there was an error of understanding and a lack of information on the side of the borrower and, therefore, it executed the derivative not being duly aware of its possible consequences and costs (the courts understand that the providers, inter alia, breached any information requirements, ignored the financial knowledge of the customer and/or made available complex documentation and contracts without the due explanation of the underlying products). As a result, the institutions offering derivatives are nowadays really keen on their duties of information and clear documentation (including several pre-signing processes) and have ceased to offer certain kinds of products which were contentious.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought, in particular, to:

• enhance transparency by requiring the provision of comprehensive information on the over-the-counter derivative positions;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

The Thai derivatives market has developed in recent years. Significant regulatory focus has been placed on transparency and minimizing counterparty defaults in over-the-counter derivatives in particular. The Bank of Thailand has also implemented Basel III.

Since 2010, Thai law has recognized the derivative warrant, which is an instrument that that gives the holders rights to buy and sell underlying securities or the right to earn profits from derivative warrant prices or an underlying asset's index. The SEC allows only derivative warrants with securities as the underlying asset. The issuer of a derivative warrant must be a third party and not the listed company issuing the underlying securities.

Generally, there are two types of derivative warrant as follows.

Non-collateral derivative warrant

The risk of this derivative warrant will be the issuer's obligation to deliver the underlying securities or pay the differences. The SEC will consider the issuer's risk management, financial condition and operating system as criteria for granting approval for offering of non-collateral derivative warrants. Issuers can be securities companies or commercial banks having in place robust risk management systems, financial stability and effective controls operations.

Collateral derivative warrant

The risk of this derivative warrant will depend on the collateral, not the issuer's risk management. The SEC will consider the safekeeping of the underlying securities by trustee, as specified by the Trust for Transactions in Capital Market Act B.E. 2550 (2007).

Ukrainian law lacks a number of derivative-related concepts, including: close-out netting, novation of trades, margin requirements (in relation to title security) and effective disclosure rules. There is not sufficient legal regulation in respect of title security or escrow arrangements, reporting requirements, trade repository and central counterparty. However, the aforementioned concepts have been addressed in the draft law ‘On Amending Certain Legislative Acts of Ukraine in relation to Investment Attraction and Introducing of New Financial Instrument’ already approved by the Ukrainian Parliament in the first reading.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter (OTC) derivatives have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

The European Market Infrastructure Regulation (EMIR) formed part of the European regulatory response to the global financial crisis and sought to address the issues highlighted above. For example, EMIR requires:

• all transactions to be reported to regulators;
• some more standardised OTC transactions between certain categories of counterparties to be cleared with a central counterparty (i.e. a third party intermediary in the trade); and
• for those transactions not subject to mandatory clearing, certain other risk mitigation techniques to be applied including the posting and collection of initial margin and/or variation margin.

EMIR was amended by the EMIR Refit Regulation in June 2019 with the primary aim of simplifying certain requirements and reducing compliance costs for smaller counterparties. For example, under the EMIR Refit Regulation those categorised as 'small non-financial counterparties' do not need to comply with reporting and clearing requirements from specified dates.

Since the global financial crisis in 2007 to 2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. The European Commission has sought in particular, to:

• enhance transparency by requiring the provision of comprehensive information on over-the-counter derivative position;
• reduce counterparty risk by increasing the use of central counterparty clearing; and
• improve the management of operational risk by increasing the standardization of derivatives contracts.

As a result, the derivatives market has seen and continues to see the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

UAE courts are in general not very experienced in dealing with complex financial transaction structures, and will often require an expert to be appointed to guide the court on such matters. The Netting Law is relatively new and remains largerly untested with very few case law dealing with derivatives transactions. Accordingly, the parameters around its implementation remain to be seen.

The ISDA has commissioned a law firm to provide a netting-law opinion in respect of the enforceability in the UAE of the ISDA Master Agreement.

Since the global financial crisis in 2007-to-2008, derivatives and particularly over-the-counter derivatives have attracted significant regulatory attention. As a result, the derivatives market has seen, and continues to see, the introduction of a significant amount of new regulation and this has led to substantial compliance costs for market participants.

There are business risks that need to be considered – although hedging is seen as a tool to minimize risk, an entity needs to consider whether the derivatives product is appropriate and assess the down-side risk. In most cases, a derivatives trading relationship requires the posting of margin; entities should consider whether they are in a position to post margin and, if so, the types of margin that are available as in some instances applicable rules limit the types of margin that may be posted. In addition, margin that is posted to a counterparty may be at risk and an entity may want to consider posting margin to a third-party custodian instead of directly to its counterparty.

Regulatory compliance

Rules promulgated by the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) pursuant to the Dodd-Frank Act may impose a compliance burden such as record keeping or trade reporting. In addition, European regulations or the regulations of another jurisdiction may be relevant depending on the location of the parties. As a result of new global regulations that affect the derivatives market, an entity may be required by its counterparty to sign up to certain industry protocols or provide information.

Operations

Derivatives trading often involves the exchange of margin and an entity must be operationally capable of posting, calling for and calculating margin. In addition, the entity needs to have processes and systems in place to manage trading activity and the related documentation.