On 20 November 2019, the Monetary Authority of Singapore (“MAS”) issued a consultation paper on “Proposed Regulatory Approach for Derivatives Contracts on Payment Tokens”, seeking feedback on its proposal to allow derivatives contracts that reference payment tokens as underlying assets (“Payment Token Derivatives”) to be traded on approved exchanges and to regulate the activity under the Securities and Futures Act (“SFA”). The consultation closes on 20 December 2019.
Regulation of Payment Token Derivatives
Unlike derivatives that reference securities tokens, Payment Token Derivatives are currently not regulated under the SFA, unless the payment token is also an “underlying thing” as defined under the SFA (e.g. a unit in a collective investment scheme or a commodity).
Examples of payment tokens include Bitcoin and Ether.
Will be regulated under SFA where offered by approved exchange
MAS notes that international institutional investors have expressed a need for a regulated product to gain and hedge their exposure to payment tokens, given allegations of fictitious trades, cornering and market manipulation. A well-regulated market for derivatives can serve as a more reliable reference of value for the underlying asset. In this connection, MAS has received enquiries for Payment Token Derivatives to be listed and traded on approved exchanges in Singapore.
Given the systemic importance of approved exchanges and the central market infrastructure role that they serve, MAS regards it as important to have effective oversight over products offered on approved exchanges due to the risk of contagion spreading to the wider financial system.
The stricter requirements and oversight over the approved exchanges (such as rules and/or laws on governance of members and participants, the conduct of members, and market manipulation) provide greater certainty that the systems and processes of approved exchanges can cope with the new risks posed by these products. Transactions on approved exchanges are also subject to robust margining, clearing and settlement processes through a regulated clearing facility, which mitigates the counterparty risks that can be aggravated by large price movements inherent in highly volatile products.
Given the above, MAS proposes to regulate Payment Token Derivatives offered by approved exchanges.
To reflect the intended regulatory scope of Payment Token Derivatives under the SFA, MAS proposes to amend the Securities and Futures (Prescribed Underlying Thing) Regulations 2018. The draft amendments are set out in the consultation paper.
Will not be regulated under SFA if not offered by approved exchange
MAS states that it does not intend to include, within the regulatory scope of the SFA, Payment Token Derivatives that are not offered by an approved exchange, i.e. those traded on other types of trading platforms such as on recognised market operators or unregulated trading platforms, or over-the-counter on a bilateral basis.
Payment Token Derivatives as a general asset class do not pose systemic risks to the financial system. Therefore, MAS is of the view that it is not critical to regulate Payment Token Derivatives unless they are offered by an entity that is systemically important.
Measures to protect retail investors will be implemented
MAS’ general position is that Payment Token Derivatives are not suitable for most retail investors to trade. This is because the underlying payment tokens tend to exhibit high volatility and are intrinsically difficult to value. MAS therefore plans to introduce a number of measures for retail investors who trade in Payment Token Derivatives offered or distributed by financial institutions regulated by MAS. According to MAS, these measures are expected to be implemented by 30 June 2020.
MAS proposes to implement margin requirements to reduce the amplification of losses experienced by retail investors. In this regard, MAS’ regulated financial institutions will have to collect from retail investors 1.5 times the standard amount of margin required for contracts offered by approved exchanges (“1.5x margin requirement”), subject to a floor of 50%. The 1.5x margin requirement will apply to both listed and over-the-counter Payment Token Derivatives. In addition, to discourage retail investors from trading in these highly risky products, measures such as tailored risk warnings and restrictions on advertising will be implemented.
Such measures will also be extended to cover products like debentures that are based on payment tokens. MAS strongly encourages issuers to engage MAS in advance if they intend to offer such products to the public.
Notwithstanding these measures, MAS strongly advises retail investors not to trade in Payment Token Derivatives.