Can a more principles-based regulatory regime fill the regulatory gap in over-the-counter derivatives for end-users in Hong Kong?

Abstract

Abstract “Can a More Principles-based Regulatory Regime Fill the Regulatory Gap in Over-the-counter Derivatives for End-Users in Hong Kong?” Submitted by Woo Kam Wah Alex for the degree of Doctor of Legal Science at The University of Hong Kong in March 2019

The current regulations for over-the-counter (OTC) derivatives in Hong Kong have been inadequate in protecting the end-users of OTC derivatives products as exhibited by the huge financial losses due to derivatives transactions in the past two decades. Existing regulations rely heavily on detailed rules. They are neither unified nor sufficiently inclusive to tackle the complexity and innovations in the fast-moving derivatives market effectively. There have been regulatory changes made by the authorities addressing issues in the markets following various crises. However, the changes have not been effective as evidenced by the reoccurrences of issues. This thesis identifies the regulatory gaps in the regime and formulates a more principles-based regulatory model to better achieve the overall regulatory objectives, focusing on OTC derivatives transactions with non-professional end-users. There are four key weaknesses identified. Firstly, detailed rules are found to be unable to keep up with the market developments and the complexity of derivatives products. Secondly, the over-reliance on disclosure requirements, while important, does not effectively provide investor protection in many cases. Thirdly, the regulators are also found to have insufficient deterrence power. In addition, senior managers of the regulated members are not charged with enough accountability and responsibility to make the regulations effective. A regulatory model based on more principle-based regulations is formulated to tackle the regulatory gaps. This model advanced: (1) focuses on suitability; (2) puts the principle of treating customers fairly as its backbone; and (3) mandates the management accountability and responsibility as a legal requirement. Finally, the changes to the current regulations, which are needed in order to achieve an effective regulatory regime, are examined.