RES 2B – Rules, Ethics and Skills for Derivatives Dealers of Non-Exchange Members

Correct: Under the Securities and Futures (Clearing of Derivatives Contracts) Regulations 2018, a Capital Markets Services (CMS) licensee that exceeds the S$20 billion gross notional outstanding threshold is classified as a specified person. For specified derivatives contracts, such as fixed-to-floating SGD Interest Rate Swaps, mandatory clearing requirements apply. However, Regulation 8 provides an exemption for intra-group transactions if the entities are part of the same consolidated group and meet specific conditions, including the absence of legal or practical impediments to the prompt transfer of funds or repayment of liabilities. The transaction with the corporate client does not qualify for such an exemption and must be cleared through a clearing house or a recognised clearing house (RCH) as defined under the Securities and Futures Act.

Incorrect: The suggestion to delay clearing based on a twelve-month grace period is incorrect because the obligation to clear specified derivatives contracts begins after the expiration of the specific transition period once the threshold is breached during the relevant calculation period. The belief that hedging purposes provide a blanket exemption for intra-group transactions is a misconception; while hedging is a common reason for such trades, the exemption specifically requires meeting the criteria for intra-group relationships and risk management protocols under MAS regulations. Finally, using any international central counterparty is prohibited unless that entity is specifically a clearing house or a recognised clearing house (RCH) under the Securities and Futures Act, as MAS maintains strict oversight of the systemic risk associated with clearing facilities.

Takeaway: Specified persons in Singapore must clear mandated OTC derivatives through MAS-approved clearing houses unless they satisfy the strict regulatory criteria and documentation requirements for an intra-group exemption.

Correct: Under MAS Notice SFA04-N02, when dealing with a customer that is a legal arrangement such as a trust, a financial institution is required to identify the natural persons who are the settlors, the trustees, the protector (if any), the beneficiaries (or class of beneficiaries), and any other natural person exercising ultimate effective control over the trust. In cases where the trustee is a legal person, the dealer must look through the corporate entity to identify the natural persons who ultimately control that trustee. This comprehensive approach ensures that the natural persons who can direct the trust’s assets or influence its administration are identified, fulfilling the requirement to verify the persons who ultimately own or control the client.

Incorrect: Focusing exclusively on a fixed percentage threshold of share ownership is insufficient for legal arrangements like trusts, as control is often exercised through non-ownership roles such as the protector or settlor. Relying on the senior managing official as the primary beneficial owner is only permitted as a last resort under MAS guidelines when no natural person can be identified through ownership interest or other means of control. Furthermore, while third-party declarations can be part of the due diligence process, relying solely on a legal counsel’s certification without independently verifying the natural persons behind the control roles fails to meet the ‘reasonable measures’ standard required for complex, high-risk structures in tax-neutral jurisdictions.

Takeaway: For trust arrangements under MAS regulations, firms must identify and verify all natural persons in key control roles, including the settlor, protector, and those controlling corporate trustees, rather than relying solely on ownership thresholds.

Correct: The Monetary Authority of Singapore (MAS) Guidelines on Environmental Risk Management require financial institutions to integrate environmental risk considerations into their risk management frameworks and business strategies. For a derivatives dealer, this involves looking beyond traditional credit risk to evaluate the reputational and transition risks associated with a client’s environmental footprint. By conducting a comprehensive assessment against the firm’s internal ESG risk appetite and escalating the matter to a specialized risk committee, the dealer ensures that the firm’s Corporate Social Responsibility (CSR) commitments are substantively applied to its core business activities, rather than treated as a separate marketing function.

Incorrect: Relying solely on a client’s written attestation of legal compliance fails to meet the proactive due diligence standards expected under MAS environmental risk guidelines and the firm’s own CSR pledges. Attempting to offset potential negative impacts by directing funds to a social impact fund is an inadequate ethical response that does not address the underlying environmental risk of the primary transaction. Implementing restrictive covenants that only trigger upon formal regulatory fines is a reactive measure that fails to demonstrate the forward-looking assessment and ethical leadership required to manage a firm’s broader role in a sustainable society.

Takeaway: Corporate Social Responsibility in the Singapore derivatives market requires the active integration of environmental and social risk assessments into the standard client onboarding and transaction approval processes.

Correct: Under the Securities and Futures Act (SFA), the Monetary Authority of Singapore (MAS) possesses broad statutory powers to issue directions to any holder of a capital markets services license, regardless of whether they are members of a specific exchange. Section 101 of the SFA specifically empowers MAS to issue directions to license holders if it is deemed necessary in the interest of the public, for the protection of investors, or to ensure the stability of the financial system. This authority is a cornerstone of Singapore’s regulatory framework, ensuring that even non-exchange members operating in the over-the-counter (OTC) derivatives space remain subject to MAS oversight and must comply with directives aimed at mitigating systemic risk or addressing market misconduct.

Incorrect: The suggestion that MAS directions only apply to firms utilizing centralized clearing facilities is incorrect because MAS’s regulatory reach extends to all licensed intermediaries to ensure holistic market integrity. The belief that MAS requires a court order to override private client contracts during an emergency is a misconception; the SFA grants MAS direct statutory authority to issue binding directions that supersede private agreements in the interest of financial stability. Furthermore, the idea that emergency powers are limited strictly to ‘Approved Exchanges’ ignores the reality that MAS maintains oversight of the broader capital markets, including OTC derivatives dealers, to prevent contagion and manage systemic threats across the entire financial ecosystem.

Takeaway: MAS’s authority to issue directions and conduct inspections under the SFA applies to all capital markets services license holders, ensuring regulatory compliance and systemic stability regardless of exchange membership status.

Correct: The primary distinction between these instruments lies in their structure and credit risk mitigation. OTC forward contracts are bilateral agreements between two parties, allowing for highly customized terms regarding delivery dates and underlying asset specifications, but they carry significant counterparty credit risk as they are not typically cleared through a central body. In contrast, exchange-traded futures are standardized contracts traded on a platform like the Singapore Exchange (SGX) and are cleared through a Central Counterparty (CCP) such as SGX-DC. The CCP interposes itself between the buyer and seller, effectively eliminating individual counterparty risk through a rigorous daily marking-to-market process and margin requirements, which ensures that delivery or cash settlement obligations are financially guaranteed.

Incorrect: The suggestion that all futures contracts must result in physical delivery while forwards are exclusively cash-settled is incorrect; in practice, many futures (such as the SGX Nikkei 225 Index Futures) are cash-settled, and forwards can be structured for either physical or cash settlement depending on the bilateral agreement. The claim that pricing models for forwards are more transparent because they are based on the spot price plus cost of carry ignores the fact that exchange-traded futures offer superior price discovery through a centralized, public order book. The assertion that non-exchange members are prohibited by the Securities and Futures Act (SFA) from facilitating physical delivery is a misunderstanding of the regulatory framework; while non-exchange members face different capital requirements, they are permitted to handle physical delivery provided they have the necessary operational infrastructure and risk management controls in place.

Takeaway: The fundamental difference between OTC forwards and exchange-traded futures is the presence of a Central Counterparty (CCP) and standardization, which shifts the risk from individual counterparties to a centralized clearing system.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on the Representative Notification Framework, a provisional representative is granted a non-extendable period of three months to satisfy the relevant CMFAS examination requirements. During this period, the principal firm must ensure the representative is under the direct supervision of a qualified supervisor who is physically present during client meetings or advice sessions. Furthermore, the representative is legally obligated to disclose their provisional status to every client before providing any financial advisory or trading services to ensure the client is aware that the individual has not yet met the full competency requirements.

Incorrect: The approach suggesting that end-of-day reviews are sufficient for independent trading with accredited investors fails because MAS requires active, concurrent supervision rather than retrospective oversight for provisional reps. The suggestion of a six-month training window is incorrect as the statutory limit for provisional status is strictly three months. The approach involving delegation of supervision to any senior representative with two years of experience is insufficient because the supervisor must be specifically appointed and meet the ‘fit and proper’ criteria defined by MAS, and weekly audits cannot replace the requirement for direct, ongoing oversight of client-facing activities.

Takeaway: Provisional representatives must operate under direct supervision, provide mandatory status disclosure to all clients, and complete all required CMFAS exams within a strict three-month timeframe.

Correct: In accordance with the MAS Guidelines on Risk Management Practices (Market Risk), a robust market risk oversight framework must recognize the inherent limitations of Value at Risk (VaR), particularly its inability to predict losses during extreme market conditions or structural shifts. The correct approach involves a multi-layered strategy where VaR is used for day-to-day monitoring but is strictly complemented by a comprehensive stress-testing program. This program must include both historical scenarios (e.g., the 2008 Global Financial Crisis) and hypothetical scenarios tailored to the firm’s specific derivatives concentrations. Furthermore, the establishment of granular position limits—covering factors such as duration, Greeks, and counterparty concentration—must be coupled with independent monitoring by a risk unit that is functionally separate from the front office to ensure objective oversight and adherence to the Board-approved risk appetite.

Incorrect: Relying primarily on a high-confidence interval VaR is a common misconception; even a 99.9% VaR does not account for the magnitude of losses beyond the threshold (tail risk), and gross notional exposure is an inadequate measure of actual market risk for complex derivatives. Implementing automatic liquidation systems based solely on VaR thresholds is often impractical for OTC derivatives due to liquidity constraints during stress and fails to incorporate the qualitative professional judgment required by MAS standards. Delegating the authority to set or adjust position limits to front-office heads creates a fundamental conflict of interest and violates the principle of segregation of duties, as the risk-taking unit should not be responsible for determining its own regulatory and internal risk boundaries.

Takeaway: A compliant market risk framework must integrate VaR with independent stress testing and granular position limits that are monitored by a function separate from the trading desk to capture both normal and tail-risk exposures.

Correct: Under MAS Notice 626, specifically the section regarding Reliance on Third Parties, a financial institution (FI) is permitted to rely on a third party to perform customer due diligence (CDD) measures only if specific conditions are met. Crucially, the FI must be satisfied that the third party is regulated and supervised for AML/CFT compliance and has adequate CDD measures in place. Most importantly, the FI remains ultimately responsible for its AML/CFT obligations, and it must ensure that the third party is able and willing to provide copies of all relevant CDD documentation and data without delay upon request. This ensures that the Singapore FI can independently verify the customer’s identity and risk profile whenever necessary, maintaining the integrity of the local financial system.

Incorrect: The approach of shifting legal liability to a third party through indemnity clauses is incorrect because MAS regulations explicitly state that the ultimate responsibility for compliance with CDD requirements remains with the financial institution, regardless of any contractual arrangements. The suggestion that being regulated in a FATF-member jurisdiction automatically exempts the dealer from performing its own risk assessment is a common misconception; while the jurisdiction’s status is a factor in due diligence on the intermediary, the FI must still assess the specific risks of the underlying clients. Finally, assuming that intra-group reliance removes the need for formal access agreements is a subtle misunderstanding; even within a financial group, the FI must still document the reliance and ensure that the specific requirements for immediate document retrieval are practically and legally enforceable across different entities.

Takeaway: While MAS allows reliance on third parties for CDD, the Singapore financial institution retains ultimate legal responsibility and must ensure immediate access to all underlying customer documentation.

Correct: Under the Securities and Futures Act (SFA) and the associated MAS Guidelines on Fair Dealing, a capital markets intermediary must ensure that any product recommendation is suitable for the client’s specific circumstances. In the context of commodity derivatives, physical delivery introduces unique operational risks, including storage costs, insurance, quality degradation, and logistical bottlenecks. The intermediary has a professional obligation to assess whether the client possesses the necessary infrastructure and expertise to handle the physical asset. If the client lacks these capabilities, recommending a cash-settled derivative is the more appropriate strategy to achieve the hedging objective without exposing the client to unmanageable operational hazards. This approach aligns with the requirement to act in the client’s best interest and provide adequate risk disclosure regarding the complexities of physical settlement versus cash settlement.

Incorrect: Proceeding with a physical delivery contract based solely on client preference without verifying their operational capacity fails the suitability test and ignores the intermediary’s duty to mitigate foreseeable operational risks. Focusing exclusively on price correlation or counterparty risk diversification is insufficient because it neglects the primary risk identified in the scenario: the client’s inability to manage the physical underlying asset. Deferring the discussion of delivery logistics until the contract approaches maturity is a violation of the disclosure requirements under the SFA, as clients must be made aware of all material risks and obligations at the point of sale to make an informed decision.

Takeaway: Intermediaries must validate a client’s operational capacity for physical delivery in commodity derivatives to ensure product suitability and prevent significant logistical and financial losses.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on Risk Management Practices, financial institutions must implement a robust framework to manage conflicts of interest. This involves maintaining effective information barriers (Chinese walls) to prevent the unauthorized flow of price-sensitive information between departments, such as proprietary trading and sales. Furthermore, when a firm’s interests diverge from its clients, the firm must provide clear and timely disclosure of the conflict to the client, enabling them to make an informed decision. For personal account dealing (PAD), MAS expects firms to have a pre-approval process (pre-clearance) to ensure that employees do not trade on non-public information or front-run client orders, thereby maintaining market integrity and the priority of client interests.

Incorrect: Suspending all proprietary trading activities is an overly restrictive measure that is not a regulatory requirement if the conflict can be effectively managed through disclosure and internal controls. Relying exclusively on Chinese walls while withholding disclosure of the firm’s opposing position fails to meet the transparency standards required for fair dealing with clients. Allowing personal trades to be reported after execution without a formal pre-clearance process is insufficient, as it does not proactively prevent the misuse of confidential information or potential conflicts with the firm’s fiduciary duties to its clients.

Takeaway: Effective conflict management in Singapore requires the integration of physical and logical information barriers, explicit disclosure of divergent interests to clients, and a rigorous pre-clearance framework for personal account dealing.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on Fit and Proper Criteria (FSG-G01), an applicant for a Capital Markets Services (CMS) license must demonstrate that its directors and representatives are fit and proper, which includes an assessment of their honesty, integrity, and reputation. A past regulatory warning, even if not a criminal conviction and from a different sector, is a material fact that must be disclosed and evaluated to determine if it affects the individual’s suitability. Furthermore, a firm seeking to deal in OTC derivatives as a non-exchange member must satisfy the base capital requirements set out in the Securities and Futures (Licensing and Conduct of Business) Regulations, which is generally SGD 5 million for a full dealer, ensuring the firm has sufficient financial substance to manage the risks associated with derivatives trading.

Incorrect: The approach of focusing only on financial requirements while dismissing the director’s past warning is flawed because the Fit and Proper Guidelines require a holistic assessment where any past conduct reflecting on integrity is relevant, regardless of the industry. The suggestion that serving only accredited investors allows for a total exemption from CMS licensing for derivatives dealing is incorrect; while certain exemptions exist for specific activities, a firm regularly dealing in OTC derivatives generally requires a license and must undergo the full fit and proper scrutiny. Finally, submitting an application without internal due diligence on the director’s suitability or maintaining a base capital of only SGD 250,000 is insufficient, as the latter threshold is typically reserved for firms with restricted activities that do not involve the higher risk profile of derivatives dealing.

Takeaway: Obtaining a CMS license for derivatives dealing requires simultaneous compliance with high minimum base capital thresholds and a rigorous, transparent assessment of the fitness and propriety of all key appointment holders.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on Individual Accountability and Conduct, financial institutions must maintain robust internal reporting channels that allow for the escalation of misconduct without fear of reprisal. When a firm identifies reasonable grounds to suspect market abuse, such as prohibited conduct under Part XII of the SFA (e.g., false trading or market rigging), it is required to notify the Monetary Authority of Singapore (MAS) promptly. Establishing a direct line to the Head of Compliance or an independent Audit Committee ensures that potential conflicts of interest, such as a supervisor being involved in the misconduct, do not impede the reporting process. This approach aligns with the regulatory expectation for transparency and the timely disclosure of material breaches that could affect market integrity.

Incorrect: Requiring a second opinion from external legal counsel before reporting creates an unnecessary delay that violates the principle of prompt notification to the MAS once reasonable suspicion is formed. Allowing a committee of senior traders to determine if an action constitutes market abuse introduces significant conflict of interest and lacks the necessary independence required for compliance oversight. Relying solely on internal remediation and annual reporting is insufficient for market misconduct; the SFA and MAS expectations require immediate notification for suspected market abuse to allow the regulator to assess systemic risks and maintain market order.

Takeaway: Firms must ensure independent escalation paths for whistleblowers and prioritize prompt notification to the MAS when reasonable grounds for suspecting market misconduct are identified.

Correct: Under Section 4A(1)(b) of the Securities and Futures Act (SFA), an expert investor is defined as a person whose business involves the acquisition and disposal, or the holding, of capital markets products, whether as principal or agent. In this scenario, a proprietary trading firm whose primary business activity is trading its own capital for profit fits this definition. When a client is classified as an expert investor, the dealer is exempted from several business conduct requirements under the Securities and Futures (Licensing and Conduct of Business) Regulations, such as the requirement to provide a formal risk disclosure statement in the prescribed form under Regulation 13, as these investors are deemed to have the necessary professional proficiency to understand the risks involved in derivatives trading.

Incorrect: The approach suggesting the firm must be treated as an accredited investor is incorrect because the accredited investor regime involves specific financial thresholds and, for individuals and certain entities, a mandatory ‘opt-in’ process that is distinct from the ‘expert investor’ definition. The approach that classifies the firm as an institutional investor is also flawed; institutional investors are specifically defined in Section 4A(1)(c) of the SFA as entities like banks, insurance companies, or statutory boards, and a private proprietary trading firm does not automatically fall into this category. Finally, the suggestion that the firm must be treated as a retail investor because it lacks a Capital Markets Services license is incorrect, as the expert investor status is determined by the nature of the client’s business activities rather than their regulatory licensing status in Singapore.

Takeaway: The expert investor classification is a functional category under the SFA based on the client’s core business of trading capital markets products, allowing for specific conduct of business exemptions without the opt-in requirements of the accredited investor regime.

Correct: Under MAS Notice SFA04-N02 and the Guidelines on Non-Face-to-Face (NFTF) Customer Due Diligence, financial institutions in Singapore must implement additional measures to mitigate the higher risk of impersonation when not meeting customers in person. While MyInfo provides verified data, the use of facial recognition technology requires liveness detection to prevent spoofing attacks (such as using photos or videos). Furthermore, MAS expects at least one additional verification measure for NFTF onboarding, such as a confirmatory transfer from a bank account in Singapore or the use of a digital signature. This multi-layered approach ensures that the technological solution is robust enough to meet the same standards as face-to-face verification.

Incorrect: Relying solely on a high confidence interval from a biometric API is insufficient because it fails to address the specific regulatory requirement for additional verification measures in a non-face-to-face environment. While video calls are a recognized method of verification, simply reverting to them for high-risk clients does not address the systemic need for robust controls across the entire digital platform. Increasing post-onboarding monitoring is a useful secondary control but does not fulfill the primary obligation to properly verify a customer’s identity at the point of account opening as part of the customer due diligence process.

Takeaway: Digital onboarding in Singapore requires a multi-layered verification approach that includes liveness detection and at least one additional confirmatory measure to mitigate the impersonation risks associated with non-face-to-face interactions.

Correct: Under the MAS regulatory framework for Capital Markets Services (CMS) licensees, representatives are required to complete a minimum of 6 Continuing Professional Development (CPD) hours per calendar year. Crucially, this must include a minimum of 2 hours of Core CPD, which focuses on ethics, rules, and regulations relevant to the specific regulated activity. Maintaining comprehensive records, including attendance logs and certificates, for a minimum of five years is a mandatory requirement to demonstrate compliance during MAS inspections or internal audits.

Incorrect: Focusing solely on the aggregate 6-hour threshold is insufficient because it neglects the mandatory 2-hour Core CPD requirement specifically dedicated to ethics and rules. Implementing a carry-forward system for CPD hours is generally not permitted under MAS guidelines to satisfy the annual minimum requirements of a subsequent year. Substituting Core CPD with technical derivatives modeling or other supplementary content is a regulatory failure, as technical skills do not fulfill the requirement for training in ethics and regulatory updates. Furthermore, relying on statutory declarations instead of primary attendance records for senior management does not meet the expected standard for robust record-keeping.

Takeaway: Representatives must complete at least 6 CPD hours annually, including a mandatory 2-hour Core CPD component on ethics and rules, while retaining all supporting documentation for five years.

Correct: Under Regulation 39 of the Securities and Futures (Licensing and Conduct of Business) Regulations, a holder of a capital markets services license in Singapore must maintain books that sufficiently explain the transactions and financial position of its business. For client asset protection, this necessitates a granular audit trail of every movement, including the date, time, and specific nature of the transaction. Furthermore, the records must be kept in a manner that enables them to be conveniently and properly audited, and they must be retained for a minimum of five years. Maintaining distinct valuation logs for collateral is essential for demonstrating compliance with segregation and margin requirements, ensuring that the firm can accurately account for each client’s equity at any given point in time.

Incorrect: The approach focusing on high-level daily balance reconciliations and archiving granular data after two years fails because the Securities and Futures (Licensing and Conduct of Business) Regulations require records to be retained for at least five years and to be detailed enough to explain individual transactions, not just balances. The strategy of using simplified net-position reporting for OTC derivatives is non-compliant because the SFA requires comprehensive documentation for all capital markets products, and netting does not replace the requirement to record individual asset movements. Relying solely on an outsourcing provider’s proprietary system and quarterly certificates is insufficient because the licensed firm retains ultimate regulatory responsibility for record-keeping integrity and must ensure that the data is accessible and compliant with specific Singapore MAS standards rather than generic international benchmarks.

Takeaway: Licensees must maintain granular, contemporaneous records of all client asset movements for at least five years to ensure a clear audit trail and facilitate regulatory oversight under the Securities and Futures Act.

Correct: Under the Monetary Authority of Singapore (MAS) Guidelines on Risk Management Practices, particularly those concerning Internal Controls, financial institutions are required to establish robust procedures for the timely issuance and receipt of trade confirmations. For over-the-counter (OTC) derivatives, it is critical that all material economic terms—including notional amounts, reference rates, and business day conventions—are documented and agreed upon by both counterparties as soon as practicable after trade execution. This process ensures legal certainty and mitigates operational risk by identifying discrepancies early. In the Singapore regulatory context, a non-exchange member must maintain high standards of conduct by ensuring that the documentation accurately reflects the agreement reached, typically aiming for confirmation by the next business day (T+1) to align with international best practices and MAS expectations for risk mitigation.

Incorrect: Delaying the issuance of a confirmation until the first interest payment period has commenced is a significant failure in operational risk management, as it leaves the trade unconfirmed during the period of highest market sensitivity and contradicts MAS expectations for timely documentation. Relying on default provisions in a master agreement without specifying the actual agreed-upon terms in the trade confirmation is insufficient because the confirmation is the definitive document for the specific transaction’s economics; omitting details like business day conventions can lead to settlement failures. Placing the burden on the client to initiate the confirmation process is inappropriate for a regulated dealer, as the intermediary has the primary responsibility under the Securities and Futures Act and related conduct of business regulations to ensure that trade records and disclosures are accurate and timely.

Takeaway: Regulated dealers in Singapore must proactively issue and reconcile trade confirmations immediately following execution to ensure mutual agreement on all economic terms and to fulfill MAS risk management requirements.

Correct: Under Section 199 of the Securities and Futures Act (SFA), it is a prohibited conduct to disseminate information that is false or misleading in a material particular if it is likely to induce the purchase or sale of capital markets products or affect the market price. The strongest safeguard is a verification and pre-approval process. This ensures that the firm does not facilitate price distortion or engage in fraudulent inducement under Section 200. By mandating that information be substantiated by official sources, the firm mitigates the risk of spreading rumors that could lead to market manipulation, which carries both civil and criminal penalties in Singapore.

Incorrect: Using caveats or disclaimers is insufficient because the SFA focuses on the act of dissemination and the potential effect on the market; if the information is false and the representative ought to have known it, a disclaimer does not provide immunity. Restricting information to accredited investors is also incorrect because market integrity rules apply to the protection of the entire financial system, and sophisticated investors are not a safe zone for spreading misleading data. Releasing information as a market sentiment update after internal assessment is a flawed approach that could be interpreted as front-running or further contributing to price distortion if the underlying information remains unverified and false.

Takeaway: Compliance with SFA market conduct rules requires proactive verification of all disseminated information to prevent price distortion, as disclaimers and investor sophistication do not excuse the spread of false or misleading statements.

Correct: In a zero-cost collar, the client purchases an interest rate cap and simultaneously sells an interest rate floor. The ‘zero-cost’ aspect is achieved because the premium received from selling the floor offsets the premium paid for the cap. Under the MAS Fair Dealing Guidelines and the Securities and Futures Act (SFA), dealers must ensure that clients understand the mechanics of these OTC derivatives, specifically that the strike price of the sold floor represents a potential liability. If the reference rate (such as SORA) falls below the floor’s strike price, the client is obligated to pay the difference to the counterparty, effectively negating the benefit of falling interest rates on their underlying loan.

Incorrect: Focusing only on the cap’s strike price as a protection mechanism is insufficient and misleading, as it ignores the significant downside risk and cash flow obligations created by the sold floor component. Classifying a collar as a standard interest rate swap is technically inaccurate; while both manage interest rate risk, a collar consists of distinct option components with different payoff profiles that require specific disclosure of strike prices and premium mechanics. Suggesting that premiums are simply waived by the counterparty misrepresents the economic reality of the transaction and fails to disclose the contingent liability the client assumes by selling an option to the dealer.

Takeaway: When structuring zero-cost OTC derivatives, dealers must clearly disclose that the lack of an upfront premium is an offset of costs and benefits, and they must explicitly explain the risks associated with the strike price of any sold components.

Correct: Under Section 2 of the Securities and Futures Act (SFA), ‘capital markets products’ include securities, units in a collective investment scheme, and derivatives contracts. Derivatives contracts encompass both exchange-traded derivatives (like interest rate futures) and over-the-counter (OTC) derivatives (like credit default swaps). However, spot foreign exchange contracts are generally excluded from the definition of capital markets products unless they are entered into for the purposes of leveraged foreign exchange trading. A facility used for the physical settlement of cross-border payments within a standard 48-hour (T+2) window for commercial purposes does not meet the criteria for a capital markets product under the SFA.

Incorrect: The approach of excluding OTC derivatives is incorrect because the SFA explicitly includes all derivatives contracts, whether traded on an organized market or over-the-counter, within its jurisdiction. The claim that spot FX for commercial settlement is a capital markets product is a misunderstanding of the regulatory perimeter; the SFA only captures spot FX when it is part of a leveraged trading activity. The suggestion that OTC derivatives are governed by the Commodity Trading Act instead of the SFA is inaccurate for financial derivatives like credit default swaps, which fall squarely under the MAS’s oversight via the SFA.

Takeaway: Derivatives contracts (both OTC and exchange-traded) are capital markets products under the SFA, but spot foreign exchange is only included if it is for leveraged trading purposes.

Correct: Under the MAS Guidelines on Fair Dealing and the conduct of business requirements in the Securities and Futures Act, capital markets intermediaries are required to treat all clients equitably. Implementing a standardized, objective order allocation policy, such as first-in-first-out (FIFO) or pro-rata, ensures that no client is unfairly disadvantaged based on their size or the revenue they generate for the firm. This approach maintains market integrity by ensuring that price improvements and available liquidity are distributed according to a pre-defined, transparent methodology rather than through subjective favoritism.

Incorrect: Prioritizing institutional clients based on their trading volume or revenue contribution constitutes a breach of the fair dealing principle, as it systematically disadvantages smaller clients. Relying on broad disclosures and client consent to justify preferential treatment is insufficient because the obligation to act fairly and avoid favoritism is a fundamental conduct requirement that cannot be contracted out of through standard terms of business. Allowing discretionary allocation by senior staff during periods of volatility introduces significant conflict-of-interest risks and lacks the objective transparency needed to demonstrate that all clients were treated fairly regardless of their commercial importance to the firm.

Takeaway: Professional ethics and MAS fair dealing expectations require objective, non-discriminatory order allocation and pricing systems to ensure equitable treatment for all clients regardless of their size or assets under management.

Correct: Under the Securities and Futures (Licensing and Conduct of Business) Regulations, specifically Regulation 47E, a holder of a capital markets services license must provide every retail investor with a Risk Disclosure Statement in the prescribed form (such as Form 13) before opening an account for trading in derivatives. This regulatory requirement is non-negotiable for retail clients and serves to ensure they are explicitly warned about the complexity of the products, the effects of leverage, and the fact that losses can exceed the initial amount invested. The licensee must also ensure the client acknowledges receipt and understanding of these risks in writing or through a secure electronic signature before any transactions are executed.

Incorrect: Allowing a client to waive the risk disclosure process based on their prior investment experience or self-declared sophistication is a violation of the Securities and Futures Act, as the mandatory disclosure for retail investors cannot be bypassed. Providing a generic firm-branded brochure instead of the prescribed MAS form fails to meet the specific documentation standards required by Singapore law. Relying on a general indemnity clause within a Master Service Agreement is insufficient because the regulations require a distinct and specific acknowledgment of the unique risks associated with derivatives trading, separate from general terms of business.

Takeaway: Licensees must provide the MAS-prescribed Risk Disclosure Statement to all retail clients and obtain a formal acknowledgment before account opening, regardless of the client’s previous investment experience.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on Business Conduct, representatives have a fiduciary-like duty to act in the best interests of their clients. Churning is characterized by excessive trading in a client’s account for the primary purpose of generating commissions. The first step in a professional compliance review is to establish objective metrics, such as the turnover ratio and the cost-to-equity ratio. These metrics allow the firm to determine if the trading volume is disproportionate to the client’s financial objectives and risk tolerance, which is essential for identifying market misconduct and breaches of conduct of business requirements.

Incorrect: Contacting the client to obtain a waiver or confirmation of authorization is insufficient because client consent does not excuse a representative from the regulatory obligation to provide suitable advice and avoid exploitative trading patterns. Implementing a hard cap on trades is an arbitrary operational measure that may interfere with legitimate investment strategies and does not address the underlying ethical breach of the representative. Reviewing the commission structure or execution prices focuses on the mechanics of the trade rather than the quantitative pattern of excessiveness that defines churning, thereby failing to address the core issue of client detriment through volume.

Takeaway: To detect churning, compliance must quantitatively analyze the turnover and cost-to-equity ratios against the client’s documented investment profile to ensure trading serves the client’s interests rather than the dealer’s commission goals.

Correct: In accordance with the MAS Guidelines on Risk Management Practices and the expected standards for Capital Markets Services licensees in Singapore, the Internal Audit function must be independent of the business activities it audits. To ensure this independence, the Head of Internal Audit should have a functional reporting line to the Audit Committee or the Board of Directors, rather than executive management. Furthermore, a risk-based audit approach is essential, meaning the audit plan must be dynamic and prioritized based on the firm’s specific risk profile, such as the complexity and volume of OTC derivatives transactions, rather than a static calendar rotation. The internal audit team must also demonstrate sufficient technical competence to provide a meaningful review of specialized areas like derivatives valuation and risk modeling.

Incorrect: Maintaining a functional reporting line to the Chief Executive Officer is inappropriate because it compromises the independence of the third line of defense, as the CEO is responsible for the very operations the audit function must objectively review. Increasing the frequency of a fixed rotation cycle still fails to meet the requirement for a risk-based methodology, which demands that audit focus shifts in response to changing risk assessments and market conditions. While outsourcing is permitted, allowing the Chief Risk Officer to approve the audit plan creates a conflict of interest between the second and third lines of defense, as the internal audit function must remain independent of the risk management department. Restricting the audit scope to financial reporting and compliance is insufficient, as the internal audit function must evaluate the effectiveness of all internal controls, including operational and market risk management systems.

Takeaway: The Internal Audit function must maintain functional independence through direct reporting to the Board or Audit Committee and utilize a risk-based methodology to ensure the effectiveness of the firm’s internal control systems.

Correct: Under MAS Notice SFA04-N02, the definition of a Politically Exposed Person (PEP) explicitly includes family members, such as siblings, and close associates of the primary PEP. For any foreign PEP, or a domestic PEP assessed as high risk, a Capital Markets Services (CMS) licensee must perform Enhanced Due Diligence (EDD). This process requires the firm to take reasonable measures to establish the customer’s source of wealth and source of funds. Furthermore, the firm is strictly required to obtain approval from senior management before establishing the business relationship. This ensures that the institution’s leadership is directly accountable for the risks associated with high-profile clients who may be susceptible to corruption or money laundering.

Incorrect: Treating the client as a standard risk based on their residency status or private business role fails to comply with the MAS requirement that family members of PEPs inherit the PEP classification regardless of their personal occupation. Relying on the Head of Compliance for final approval is insufficient because the regulation specifically mandates approval from senior management (such as the CEO or Board) for high-risk PEP relationships. Establishing the relationship before completing the approval process is a regulatory breach, as MAS guidelines require that senior management approval and enhanced due diligence be completed prior to the commencement of the business relationship for high-risk categories.

Takeaway: All family members of Politically Exposed Persons must be classified as PEPs, requiring mandatory source of wealth verification and senior management approval prior to account opening.

Correct: Under the MAS Guidelines on Fair Dealing and the Securities and Futures Act (SFA), financial institutions must prioritize the interests of their clients above their own. Even when dealing with Accredited Investors, the duty to act with integrity and provide products that are suitable for the client’s specific objectives remains paramount. In this scenario, the firm’s internal research suggests a high probability of hedge failure, meaning the proposed product likely contradicts the client’s stated goal of risk mitigation. By requiring a redesign or a transparent comparison with a standard hedge, the compliance officer ensures that the client is not being steered into a sub-optimal product simply to maximize the firm’s proprietary gains, thereby upholding the principle of client interest primacy.

Incorrect: Relying solely on the client’s status as an Accredited Investor or the presence of a signed risk disclosure is insufficient because disclosure does not absolve a firm of its duty to act in the client’s best interest or to avoid recommending clearly unsuitable products. Focusing only on the firm’s internal risk management or the legality of disclaimers ignores the ethical and regulatory expectation that the client’s hedging outcome should not be sacrificed for firm profit. Simply reducing commissions is an inadequate remedy because it fails to address the fundamental structural flaw of the product—the high probability that the hedge will fail to protect the client against the very risk they are seeking to mitigate.

Takeaway: Client interest primacy requires that derivatives dealers ensure product structures align with the client’s actual hedging objectives, regardless of the client’s regulatory classification or the existence of general risk disclosures.

Correct: Under Section 197 of the Securities and Futures Act (SFA), it is an offence to create a false or misleading appearance of active trading in any capital markets product. This includes transactions that involve no change in beneficial ownership, commonly referred to as wash trades. The SFA’s market misconduct provisions in Part XII are not limited to exchange-traded securities; they extend to all capital markets products, which explicitly include over-the-counter (OTC) derivatives. Consequently, the firm and the individuals involved could face criminal prosecution under Section 204 or civil penalty actions initiated by the Monetary Authority of Singapore (MAS) under Section 232, where the penalty can be the greater of three times the profit gained/loss avoided or a statutory minimum.

Incorrect: The argument that OTC transactions are exempt from market misconduct rules is incorrect because the SFA’s definition of capital markets products encompasses OTC derivatives, ensuring market integrity across both transparent and private markets. The belief that legal consequences are limited to administrative fines or private litigation ignores the dual-track enforcement regime in Singapore, which allows for both criminal sanctions and significant civil penalties. Furthermore, claiming that internal balance sheet management justifies wash trades is a common misconception; Section 197(3) of the SFA establishes that a transaction involving no change in beneficial ownership is deemed to create a false appearance of active trading, making the underlying motive secondary to the prohibited nature of the act itself.

Takeaway: Part XII of the SFA applies to all capital markets products, including OTC derivatives, and wash trades are prohibited regardless of whether the transaction occurs on an organized exchange or in a private OTC setting.

Correct: Under the Securities and Futures Act (SFA) and the MAS Guidelines on Business Conduct, capital markets intermediaries are strictly required to give priority to client orders over proprietary trades. Front running, which involves trading on the firm’s own account with prior knowledge of a pending client order that is likely to affect the price of the instrument, is a serious ethical breach and a violation of market conduct rules. The correct professional approach is to ensure the client’s order is executed first, thereby preventing the firm from gaining an unfair advantage or causing price slippage for the client. This maintains market integrity and fulfills the intermediary’s fiduciary duty to act in the client’s best interest.

Incorrect: Allowing a proprietary trade to proceed first under the guise of risk management is a common misconception; the knowledge of the client’s order makes such a trade a violation of priority rules regardless of the stated intent. Bundling client and proprietary orders into a block trade to share a weighted average price is incorrect because the firm should not compete with the client for liquidity or price improvement. Relying on disclosure waivers for Accredited Investors is insufficient, as the regulatory requirement for client order priority and the prohibition against market misconduct under the SFA apply broadly to ensure fair and efficient markets, and cannot be waived through standard client agreements.

Takeaway: The duty of client priority is a fundamental requirement under Singapore’s regulatory framework, necessitating that client orders are executed before any proprietary trades that are influenced by knowledge of those pending orders.

Correct: The correct approach aligns with the MAS Fair Dealing Outcomes by addressing the root causes of potential misconduct rather than just the symptoms. Outcome 5 requires an independent and effective complaint handling process, which is achieved by involving a department not linked to sales. Furthermore, Outcome 1 emphasizes a corporate culture where fair dealing is central; investigating whether incentive structures (like sales targets) compromised the client’s interests is a key part of this. Even if a client is an Accredited Investor (AI), the Fair Dealing Guidelines expect financial institutions to ensure that recommendations are suitable for the client’s financial objectives, especially when a conflict between a ‘capital preservation’ goal and a ‘high-risk’ product is evident.

Incorrect: The approach focusing on legal formalities and the Accredited Investor status fails because the Fair Dealing Guidelines represent a standard of conduct that goes beyond mere legal ‘check-the-box’ compliance; relying on the AI opt-in to dismiss a suitability grievance ignores the requirement for quality advice. The approach of offering a settlement and technical training is insufficient because it fails to investigate systemic issues like incentive structures and does not ensure the complaint handling is ‘independent’ if it aims for a quick resolution over a fair one. The approach of enhancing call-back procedures while shifting all responsibility to the investor is flawed as it contradicts the principle that financial institutions must take responsibility for the quality of recommendations made by their representatives.

Takeaway: Fair dealing in Singapore requires a holistic commitment to customer centricity where independent complaint handling and the alignment of staff incentives with client interests take precedence over legalistic reliance on a client’s Accredited Investor status.

Correct: Under the Securities and Futures (Licensing and Conduct of Business) Regulations (SFR), specifically Regulation 17, a holder of a capital markets services license must ensure that client assets are strictly segregated from its own proprietary assets. Regulation 20 further mandates that a licensee must perform reconciliations of client assets at least once every month. The discovery of commingled assets in a depository account represents a significant breach of these custodial requirements. The correct professional response involves immediate remedial action to segregate the assets into a designated ‘Trust’ or ‘Client’ account, notifying the Monetary Authority of Singapore (MAS) of the regulatory breach as per standard reporting expectations for material non-compliance, and performing a comprehensive retrospective reconciliation to ensure the integrity of client holdings is restored and documented.

Incorrect: The approach of waiting until the next annual audit to report the discrepancy fails to meet the regulatory expectation for prompt notification of material breaches to the Monetary Authority of Singapore. Seeking retroactive consent from accredited investors is ineffective because the statutory requirement for segregation under the SFR cannot be waived by client agreement in this manner, and maintaining a proprietary buffer does not satisfy the legal requirement for physical or account-level segregation. Updating disclosure documents to permit temporary commingling is legally invalid as it contradicts the fundamental investor protection principles of the Securities and Futures Act, which require the clear separation of client and firm assets to mitigate insolvency risk.

Takeaway: Strict segregation of client non-cash collateral and regular monthly reconciliations are mandatory under the SFR to ensure client assets are protected from the firm’s creditors and operational errors.