Editor's note: In order to thoroughly implement the spirit of the Central Financial Work Conference and the Several Opinions of the State Council on Strengthening Supervision and Risk Prevention and Promoting the High-quality Development of the Capital Market, and solidly promote the high-quality development of the securities industry, the China Securities Quotation Investment Education Base has launched the special topic of "Risk Prevention and Development Promotion" to share the exploration and practical achievements of OTC derivatives in strengthening the risk prevention and control capabilities of the securities industry, doing a good job in five major articles, and providing high-quality services for economic and social development.
Authors: Zhang Chengyi and Chen Fangliang, Equity Derivatives Business Department of Guolian Securities.
The importance of compliance management of securities companies in OTC derivatives business
The OTC derivatives business, compared with the standardized business on the exchange, is that the exchange is the center of the transaction, and the securities company is only one of the links, and the responsibility of compliance management is actually scattered on different entities. However, OTC derivatives is a business with dealers as the core, and securities companies, as dealers of OTC derivatives business, not only undertake the design of the entire transaction structure, but also assume a series of roles such as risk transfer and active market through hedging, so the core of OTC derivatives business is dealer-centered supervision, which also means that the compliance management responsibility of securities companies as dealers is more important.
According to laws, regulations and regulatory policies, OTC derivatives business is a customized demand for risk management and asset allocation of institutional customers who meet the threshold requirements, and the core of OTC derivatives compliance management is: first, to serve institutional customers who meet the threshold requirements, requiring securities companies to understand the true identity of customers, and not allowing investors who do not meet the requirements to participate in the business in any way; The second is to serve the needs of customer risk management and asset allocation, requiring securities companies to understand the true purpose of customers, and not to meet other needs other than risk management and asset allocation, such as financing, speculation and even insider trading and market manipulation.
OTC derivatives business can be broadly divided into business processes such as publicity and promotion, customer access and agreement signing, product design, quotation inquiry, transaction execution, hedging transactions, and margin management. Focusing on the aforesaid core compliance management and business process nodes, we analyze the introduction of basic digital solutions and the construction of comprehensive digital systems, respectively, and explore the direction and mode of digital methods to strengthen the compliance management of securities companies' OTC derivatives business.
Introduce basic digital solutions to improve process efficiency
The basic digital solution mainly refers to the digital transformation of various business links, including the digitization of customer materials, the online approval of materials, the viewing and downloading of traces, and the classification and storage.
Publicity and promotion stage
It is recommended that securities companies explore the establishment of a derivatives business promotion management platform, the operating principle of which is that the OTC derivatives department of the securities company is responsible for producing electronic publicity and promotion materials (mainly roadshow PPT), and pushing the approval process to the compliance department through the platform, and in accordance with Article 28 of the Administrative Measures for the Income Swap Business of Securities Companies and other system requirements, the compliance department completes the approval and files it on the company's publicity and promotion management platform. If the sales staff or branch needs to access it, log in to the publicity and promotion management platform according to the authority, fill in the application form for use and download and use, and the relevant behaviors will be archived by the platform. Further, the platform can also explore the modularization of relevant materials, such as company introduction, department introduction, risk disclosure, exemption clauses, structure display, specific examples, etc., each module is from the PPT template approved by the compliance department, for the sales staff to assemble by themselves, to avoid repeated application to the compliance department.
Customer onboarding and agreement signing phases
Consideration can be given to the digital transformation of the current KYC process, that is, it is recommended that securities companies explore the establishment of a derivatives business customer access and agreement signing platform, allowing customers to fill in relevant forms and submit access materials remotely online, the platform can compare and confirm the relevant information, and push it online to the KYC materials review and access personnel of the derivatives business of securities companies, and automatically generate access documents and related agreements after the data is reviewed, and in accordance with the current "Administrative Measures for OTC Options Business of Securities Companies" (China Securities Association Issued [ Article 32 of the Administrative Measures for the Income Swap Business of Securities Companies (Zhong Zheng Xie Fa [2021] No. 276) and Article 16 of the Measures for the Administration of Income Swap Business of Securities Companies remind the derivatives departments of securities companies to carry out qualification verification and data update at least every year.
At the same time, it can be considered to embed the current process of signing the agreement on paper into the aforementioned access process: after the completion of the access, the system will automatically generate a series of documents such as the SAC master agreement and supplementary agreement online, and stamp the company's electronic seal for customers to print out and store.
Product design phase
For example, according to Articles 34, 35 and 38 of the Measures for the Administration of OTC Options Business of Securities Companies, the OTC options business of securities companies shall not be alienated into leveraged financing instruments, shall not become a trading channel for investors in disguise, and shall not facilitate regulatory arbitrage and other violations of laws and regulations. According to Articles 20, 33 and 34 of the Measures for the Administration of Income Swap Business of Securities Companies, securities companies shall not carry out OTC options business in disguise, income swap business shall not facilitate regulatory arbitrage and other illegal activities, and shall not become a trading channel for investors in disguise. There are only a few parts that can be quantitatively and digitally converted, and only according to the requirements of Article 20 of the Administrative Measures for OTC Options Business of Securities Companies, contracts with a contract period of less than 30 days and an exercise price that deviates more than 20% from the market price of the underlying asset can be quantitatively judged by the system and then subject to a prior compliance assessment.
For the management of linked targets, it is recommended that securities companies explore the establishment of a pool management system for derivatives targets to achieve dynamic management, specifically with the manual participation of the derivatives business department, on a trading day basis, in accordance with Chapter 3 of the Administrative Measures for the OTC Options Business of Securities Companies, Chapter 4 of the Administrative Measures for the Income Swap Business of Securities Companies, according to the relevant information released by the Securities Industry Association, the Shanghai and Shenzhen Stock Exchanges, and the company's own target blacklist, etc., to ensure that the targets that do not meet the requirements are released from the pool in a timely manner.
Request for Quotation stage
The counterparty inquires with the traders of the derivatives business department of the securities company through the designated communication method, and the corresponding trader makes quotations through the designated communication method within the scope of authorization after completing the pre-review. It is suggested that securities companies can explore the establishment of designated communication systems, including network halls, e-mails, corporate WeChat, etc., and automatically archive them for subsequent verification and traceability.
Transaction behavior management
For this reason, securities companies may consider exploring the establishment of a counterparty trading behavior monitoring system on the basis of understanding the counterparty's trading purpose information during the access stage, so as to facilitate the monitoring of specific trading behaviors and the analysis and understanding of the transaction purpose. Specifically, if the counterparty is a state-owned enterprise, determine whether there is a real hedging demand in accordance with the Notice of the State-owned Assets Supervision and Administration Commission on Matters Concerning Effectively Strengthening the Management of Financial Derivatives Business (Guo Zi Fa Cai Appraisal Gui [2020] No. 8); If the counterparty is a listed company, it is necessary to determine whether information disclosure is required in accordance with the Self-Regulatory Guidelines for Listed Companies on the Shanghai Stock Exchange No. 5 – Transactions and Connected Transactions (SSE Fa [2023] No. 6) and the Self-Regulatory Guidelines for Listed Companies on the Shenzhen Stock Exchange No. 7 – Transactions and Connected Transactions (SZSE [2023] No. 21). In addition, due to the high timeliness of counterparty transaction execution, securities companies generally complete transaction execution and hedging based on the transaction instructions sent by the counterparty through designated methods (such as WeCom, email, etc.), and the formal transaction confirmation of the transaction is often completed behind schedule, and recovering the counterparty transaction confirmation and completing the archiving is also one of the important tasks of transaction behavior management.
Hedging trade management
According to Article 50 of the Administrative Measures for the OTC Options Business of Securities Companies and Article 30 of the Administrative Measures for the Income Swap Business of Securities Companies, the over-the-counter derivatives business of securities companies shall be hedged in the trading venue and shall not affect the normal order of on-exchange trading.
To this end, it is recommended that securities companies explore the establishment of abnormal trading management systems, and carry out tandem management together with their own proprietary trading behaviors, and carry out front-end control (in accordance with Article 7.2 of the Trading Rules of the Shanghai Stock Exchange (2023 Revision) (SSE Fa [2023] No. 32) and Article 6.2 of the Trading Rules of the Shenzhen Stock Exchange (2023 Revision) (SZSE [2023] No. 98), etc., to avoid false declarations, pulling up and suppressing, maintaining price limits on price increases and decreases, etc. Mutual counterparties, a large number of continuous transactions of a single security in a period of time, etc.), and then send the trading instructions to the stock exchange, and accept the stock exchange's abnormal transaction monitoring and verification.
Margin management
In accordance with Chapter 5 of the Administrative Measures for the Income Swap Business of Securities Companies and other regulatory rules, the margin of derivatives business shall be cash or other forms approved by the Securities Industry Association, and the margin ratio shall meet the relevant requirements of the China Securities Regulatory Commission and the Association, and the necessary internal approval procedures shall be performed. In accordance with the provisions of the system and regulatory requirements, the derivatives business department of the securities company shall determine a reasonable initial margin ratio according to the risk situation, trading mode, underlying varieties, etc., and perform the necessary internal approval process. In accordance with the system regulations and regulatory requirements, the derivatives business department of the securities company sets a reasonable maintenance margin ratio, clearly agrees on the maintenance line and the liquidation line, and is responsible for the calculation and implementation.
To sum up, it is recommended that securities companies explore the establishment of a margin management system, based on the daily mark-to-market margin management, when the counterparty's margin is lower than the maintenance line, the system will send a call notice to the counterparty in a timely manner; When the counterparty's margin is lower than the liquidation line, the counterparty must supplement the performance collateral or actively close the contract within the specified time in accordance with the requirements of the agreement to meet the company's call for insurance, otherwise the system will start the forced liquidation procedure.
In the income swap business, if the counterparty does not meet the requirements of the external regulations due to the passive excess of the underlying position, the margin management system can continuously remind the derivatives business department of the securities company to check whether the adjustment has been completed within a certain period of time. At the same time, the margin management system will record the cumulative number of over-standard of the counterparty and the time limit for margin calls, and restrict or suspend the customer's long and short swap trading privileges in accordance with the management requirements of the derivatives business department of the securities company.
Build a comprehensive digital system to strengthen compliance management
From the item-by-item analysis of the second part above, in fact, securities companies can consider establishing an internal digital technical system or platform for management of the compliance requirements existing at each business node, and most of these systems are the focus of internal audit and external inspection, such as the derivatives business publicity and promotion management platform, the derivatives business customer access and agreement signing platform, the derivatives business target pool management system, the derivatives business transaction designated communication system, the counterparty trading behavior monitoring system, Abnormal transaction management system and derivatives business margin management system, etc.
In addition to the basic digitalization of derivatives business processes, considering that the OTC derivatives business is centered on the supervision of securities companies, that is, securities companies bear the core responsibility of compliance management, it is necessary for securities companies to further explore the establishment of a comprehensive digital compliance management system on the basis of information digitization.
Comprehensive digital compliance system database
Data on counterparties can be divided into identity data and behavioral data, which in turn can be divided into internal data and external data because of the sources. The basic principle is "based on internal databases, supplemented by external information sources".
In terms of identity data, most of the internal data comes from the KYC and AML processes in the counterparty access stage, and the information is provided by the counterparty and supported by materials (including the identity documents and actual beneficiaries of the institutional counterparty, the manager, custodian, and actual beneficiary of the product counterparty, etc.). Most of the external data comes from external collected data, including enterprise information query databases, regulatory websites such as the China Securities Regulatory Commission and the Stock Exchange, as well as the judgment website, etc., involving relevant information of the counterparty. For this reason, counterparty identity data mainly focuses on the information supplement of externally collected data and the consistency with internal data.
In the part of behavioral data, most of the internal data comes from the various behavior monitoring carried out by the counterparty in the process of trading with securities companies, including continuous monitoring of trading behaviors, abnormal transactions caused by its trading strategies, margin conditions, regulatory inquiries and concerns about specific subjects, cooperation with window guidance, cooperation with return visits and verifications, etc. External data also comes from externally collected data, i.e., other administrative penalties and sensitive public opinion of relevant entities (or related parties) during the term of the agreement.
For external data, the simple and straightforward way is to purchase a certified external enterprise database, such as a mature database such as Qichacha, but the implementation difficulties lie in the cost of data purchase and the unified user interface for the IT department to integrate the interface data into the internal system.
Comprehensive digital compliance system analysis
On the basis of the previous data set, the analysis of counterparties can also be divided into identity analysis and behavioral analysis. Most of the relevant analysis is difficult to limit with quantitative indicators, and subjective judgment is required.
In terms of identification, the materials provided by the counterparty and the data obtained by the third party are synthesized to mine the real identity information of the counterparty, to ensure that no investor who does not meet the threshold requirements participates in the derivatives business in any way, and that investors who are not related to the linked target participate in the derivatives business of the linked target in any way in violation of regulations, and at the same time, through information combing, capture the related relationship between the counterparty, so as to merge into the same counterparty in terms of credit granting and behavior analysis.
In terms of behavior monitoring, through continuous monitoring of counterparty trading behaviors, special attention is paid to special behaviors, focusing on preventing counterparties from using derivatives trading to engage in insider trading, illegal option platforms or illegal capital allocations and other violations of laws and regulations. Suppose that Counterparty A and Counterparty B conduct call option transactions with a securities company on December 1 that are linked to the target of listing A and the amount is relatively large, and on December 5, Listed Company A announces its plan to acquire other companies, the comprehensive digital compliance system should remind the derivatives business department of the securities company to verify the two derivatives transactions on December 1 to prevent the counterparty from being suspected of insider trading or market manipulation, as shown in the following figure:
Epilogue:
The compliance management of OTC derivatives business runs through the whole business link, covering all nodes of the business, and is immersed in the details of each transaction. However, we believe that there is still a long way to go for securities companies to explore and research on the compliance management of OTC derivatives business by securities companies on how to ensure the steady development of business compliance, how to effectively improve risk prevention and control capabilities, and how to avoid OTC derivatives from facilitating regulatory arbitrage and other illegal activities. Securities companies should be clear about their roles and responsibilities, strengthen the understanding and implementation of regulatory ideas, improve the compliance awareness of business personnel, always combine business development and pursuit with the healthy growth of the capital market, continue to improve the ability and level of compliance management of OTC derivatives business, and jointly promote the development of the industry.
Disclaimer: The information in this article is for investor education purposes only and does not constitute any investment advice to investors, and investors should not substitute their independent judgment or make decisions based solely on such information. The information in this article is intended to be accurate and reliable, but the accuracy or completeness of such information is not guaranteed, and no liability is accepted for any loss or damage that may arise from the use of such information.