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1     These Directions are adopted pursuant to Article 39 of the GreTai Securities Market ("GreTai") Regulations Governing Securities Trading on Over-the-Counter Markets (the "GreTai Market Regulations").
2     The term "convertible bond asset swap and structured note trading" as used in these Directions refers to trading of the following types of contracts by securities firms trading over the counter ("securities firms") that have obtained GreTai approval in accordance with these Directions:
  1. Convertible bond asset swap trading:
    1. Refers to a financial derivative transaction between a securities firm and a trading counterpart in which a position in OTC-traded convertible corporate bonds ("the bonds") held by the securities firm through underwriting or dealing in the bonds is the underlying subject of the transaction. The contract between the two parties stipulates that the securities firm may exercise a call option on the bonds at any time prior to maturity, and in addition, may take the transaction value of the bond trade between the securities firm and its trading counterpart as notional principal, stipulating that during the term of the contract, it will swap with the trading counterpart interest payments at a stipulated rate for the accrued coupon and interest premium on the bonds.
      Where the underlying subject of a bond swap is listed or OTC-listed stocks which may also be the underlying of a securities firm's asset swap, applicable provisions of these Directions regarding convertible bonds shall also be applied mutatis mutandis.
    2. Also refers to a transaction in which a securities firm sells to a trading counterpart a call option on a position it holds in convertible corporate bonds.
  2. Structured note trading:
    1. Equity-linked note trading: Refers to a financial derivative transaction in which options on domestic or foreign equities or equity indexes are combined with a fixed-income instrument. In trading this kind of product, the securities firm and its trading counterpart stipulate the sale of a fixed-income instrument by the securities firm according to the terms and conditions of the trade along with a simultaneous purchase from the counterpart of an option on domestic or foreign equities or equity indexes at a specific future maturity date. The term of contract for trading of these products shall be between 28 days and 3 years. In order to protect the rights and interests of the counterpart, the securities firm's exercise profit on the option shall not be higher than the transaction price paid by the trading counterpart.
    2. Principal-guaranteed note trading: Refers to a financial derivate transaction in which the right to participate in distribution of gains on domestic or foreign linked underlying assets is combined with a fixed-income product. In trades of this kind of product, the securities firm and its trading counterpart stipulate sale by the securities firm of a fixed-income product with a specific degree of guarantee in accordance with the terms and conditions of the transaction, while simultaneously obtaining from the trading counterpart rights to participate in the distribution of gains on domestic or foreign linked underlying assets at a specific future maturity date, to be settled in cash. The term of contract for trading of these products shall be between one month and ten years. Except in the case of early termination of contract, the aforementioned "specific degree of guarantee" shall not be less than 80 percent of the price of the transaction.
    The method of exercise of the structured notes referred to in the preceding paragraph may be in cash settlement at the contract price or payment by the securities firm of linked underlying assets from its hedge account in accordance with applicable provisions of the Regulations Governing Business Operation of the Taiwan Securities Central Depository Company.
    The "terms and conditions of the trade" for structured notes under paragraph 1 shall include the transaction price, transaction currency, contract principal, components of linked underlying assets, interest rate, interest payment period, contract period, and other rights and interests stipulated by the securities firm and the trading counterpart.
    The scope of the linked underlying assets of the structured notes in paragraph 1 are as shown in Appendix 1.
3     Securities firms shall file applications with GreTai to engage in convertible bond asset swap or structured note trading operations. Qualification conferred by approval from GreTai is continuous and does not require year-by-year applications. A securities firm may not engage in those types of trades without applying for and obtaining approval from the GreTai.
    The application and attached materials required for securities firms applying to engage in convertible bond asset swap and structured note trading operations in accordance with the preceding paragraph are shown in Appendices 2 and 3.
    Securities firms engaging in structured note trading operations that have linked foreign-currency financial products shall obtain approval from the Central Bank of China.
4     A securities firm applying to in convertible bond asset swap or structured note trading operations shall possess the following qualifications:
  1. It must be an integrated securities firm concurrently operating securities brokerage, underwriting, and dealership business, and be licensed as a dealer of OTC-traded bonds.
  2. It shall have obtained a long-term credit rating of twBB- or above from Taiwan Ratings Corporation, or BB- (twn) or above from Fitch Ratings Limited, Taiwan Branch, or Ba3.tw or above from Moody's Investors Service Taiwan, or Ba3 or above from Moody's Investors Service, or BB- or above from Standard & Poor's Corp., or BB- from Fitch, Inc.
  3. Its self-owned capital adequacy ratio reported for each month of the half year preceding the application date must have exceeded 200 percent.
  4. It shall not have received any of the following sanctions:
    1. It shall not been subject within the past six months to any sanction equal or greater to that under Article 66, paragraph 1, subparagraph 2 of the Securities and Exchange Act, or Article 100, paragraph 1, subparagraph 2 of the Futures Trading Act.
    2. It shall not have been subject within the past year to any disposition of suspension of business by the competent authority.
    3. It shall not have been subject within the past two years to any disposition canceling approval of any part of its business by the competent authority.
    4. It shall not have been subject within the past year to suspension or restriction of trading privileges by a disposition of the GreTai pursuant to its operating rules or bylaws.
    In the case of a foreign securities firm with a Taiwan branch office, the head office may file the application with the GreTai after submitting an approval letter or undertaking to guarantee performance from its board of directors; the head office shall have business operations and a long term credit rating that both meet the respective standards of subparagraphs 1 and 2 of the preceding paragraph, and shall not have been subject to any disposition by the competent securities authority similar to any of those in subparagraph 4 of the preceding paragraph within the half year preceding the application date.
    A securities firm applying for qualification to engage in structured note trading shall pay to the GreTai a review fee of NT$200,000; the same shall apply for a securities firm re-applying for trading qualification after its structured note trading has been terminated.
5     A securities firm engaging in structured note trading operations involving linked foreign financial products denominated in foreign currency shall open a foreign exchange deposit account at a designated foreign exchange bank, from which it shall conduct all deposits and remittances in connection with payment and receipt of settlement money and offshore fees.
6     For a securities firm engaging in structured note trading operations involving linked foreign financial products, matters relating to settlement of funds, payment and receipt of fees, foreign exchange settlements, and payment of funds upon early termination or expiration of contracts shall be carried out according to the following:
  1. When denominated in New Taiwan Dollars, all settlement of funds and payment and receipt of fees with a client shall be carried out in New Taiwan Dollars. The client's yearly cumulative exchange settlement total shall be applied in foreign exchange settlement matters in accordance with the Regulations for Receipt/Payment of Foreign Exchange or Reporting of Foreign Exchange Transactions, with the securities firm attaching the following documents to carry out settlement at a designated foreign exchange bank:
    1. A foreign exchange settlement declaration filled out by the securities firm.
    2. A Power of Attorney from the client authorizing the securities firm to carry out foreign exchange settlements. If the structured notes contract between the securities firm and the client stipulates authorization of the securities firm to carry out foreign exchange settlement, the securities firm may produce a declaration attesting to such authorization in lieu of the client's Power of Attorney.
    3. Client information list, including: Case number, client's account number, client's name or title, the uniform invoice number of the individual, company, business entity or organization, national ID number or alien resident certificate number (must be valid for one year or more), date of birth (must be 20 years of age or above), and the amount of the foreign exchange settlement, provided for the bank's information in calculating the client's total yearly cumulative foreign exchange settlement amount.
  2. When denominated in a foreign currency, all settlement of funds and payment and receipt of fees with a client shall be carried out in foreign currency. The client's payment of funds may be carried out by transfer from its own foreign exchange deposit account; where foreign exchange settlement is required, it shall be carried out by the client at a designated foreign exchange bank in accordance with the Regulations for Receipt/Payment of Foreign Exchange or Reporting of Foreign Exchange Transactions.
  3. Upon expiry of the contract or early termination by the client, the securities firm shall deposit the funds receivable by the client in its New Taiwan Dollar or foreign exchange deposit account on the settlement date based on the currency stipulated in the contract.
    A securities firm engaging in structured note trading operations involving linked foreign financial products shall submit a monthly operations statement to the foreign exchange authority and the GreTai, by the fifth of the following month, on its structured note trading operations involving linked foreign financial products and showing payables remitted into clients' designated foreign exchange accounts.
7     If a securities firm engaging in convertible bond asset swap or structured note trading operations exceeds the scope set out in these Directions, or combines or packages those operations with other securities or financial products or services, they shall be deemed to fall into a different category of derivative financial products, and may not be handled if the securities firm has not applied for and received permission to operate those items under applicable acts and regulations, or has not obtained trading permission from the relevant competent authorities.
8     A securities firm may not engage in convertible bond asset swap or structured note trading with any of its directors, supervisors, managers, or shareholders holding 10 percent or more of its issued shares, or with such persons of the issuer of linked shares, or with the spouse or minor children of any of the aforementioned persons, or others in whose names shares are held by such persons, or with any investee company in which it directly or indirectly holds 10 percent or more of the total shares.
9     Before engaging in convertible bond asset swap or structured note trading with a trading counterpart, a securities firm shall provide the trading counterpart with a risk disclosure statement, specifying the structure and characteristics of the transaction, and in bold black font shall indicate the maximum possible risk or principal guarantee ratio and provide a description of the principal risks, such as liquidity risk, interest rate risk, tax risk, and early cancellation risk.
    The securities firm may be exempt from the requirement to provide a risk disclosure statement when its trading counterpart is an institutional juristic person such as a banking, insurance, or securities institution.
10     Before a securities firm engages in convertible bond asset swap trading with a trading counterpart or when payment in securities is the exercise method of a structured note, the trading counterpart shall first complete account opening procedures in accordance with Chapter 4, Section 3 of the GreTai Market Regulations.
    Before a securities firm and its trading counterpart undertake a convertible bond asset swap, the trading counterpart shall sign an affidavit stating that the counterpart is not a related party under any of the definitions set forth in Article 8 herein.
    Before engaging in convertible bond assets swap trading with a trading counterpart, a securities firm shall first enter into an International Swaps and Derivatives Association, Inc. (ISDA) Master Agreement and Schedule with the trading counterpart, and sign separate written trade confirmations regarding stipulations for subsequent transactions. The above Schedule and written confirmations shall be in Chinese, or have the terms and conditions set out bilingually in English and Chinese, provided that if the trading counterpart of the securities firm is a financial institution, overseas Chinese, or foreign national, they may be in English.
    Before engaging in structured note trading with a trading counterpart, a securities firm shall first enter into a master agreement with the trading counterpart, and shall enter into separate contracts with the trading counterpart outlining the rights and obligations of both parties with regard to each trade to be undertaken.
    In signing a contract with a trading counterpart, the securities firm shall clearly stipulate the conditions governing repayment of the notional principal under the contract at its expiry and matters regarding compensation for and handling of breach of agreement. The content of a convertible bond asset swap trading contract shall stipulate the securities firms' automatic early exercise of buyback rights in the event of an early bond redemption by the issuer pursuant to the terms of issuance, and the termination price and means of terminating the given contract. A securities firm engaging in structured note trading operations involving linked foreign financial products and denominated in New Taiwan Dollars shall explicitly set forth in the contract the foreign exchange settlement matters involved; those settlements shall be carried out in accordance with the Regulations for Receipt/Payment of Foreign Exchange or Reporting of Foreign Exchange Transactions, and added to the client's total yearly cumulative foreign exchange settlement amount.
11     A securities firm engaging in convertible bond asset swap or structured note trading shall enter information on the trade in the prescribed format into the GreTai information system on the date the contract is transacted, the date of early termination of the contract, and the date of its expiry. Those undertaking convertible bond asset swap trading shall additionally enter such trading information on the date of exercise of the related option.
    Securities firms engaging in structured note trading shall enter hedging information in the prescribed format into the GreTai information system daily for the duration of the trading contract. Where its reported estimated hedge position differs from its actual hedge position by more than plus or minus 20 percent for any three business days of the most recent six business day period, except where the difference is less than one trading unit or where the GreTai has otherwise provided, the GreTai may request an explanation by the securities firm and conduct an on-site inquiry. If the securities firm's explanation is found unreasonable, one demerit point will be issued, and where a total of three demerits have been issued, the GreTai will restrict it from handling structured note trading for a period of one month thereafter. When the difference exceeds plus or minus 50 percent, except where the difference is less than one trading unit or where the GreTai has otherwise provided, the GreTai may require the securities firm to adopt a hedge offsetting strategy.
    Adoption of a risk hedging method by a securities firm engaging in structured note trading as referred to in the preceding paragraph may use offsetting with the hedge positions employed for structured notes issued for the same underlying securities handled by them, or it may engage another institution for hedging. GreTai shall conduct on-site inquiries into securities firms' hedging operations on either a regular or an irregular basis. Securities firms engaging in convertible bond asset swap trading shall remit payment through the Taiwan Securities Central Depository Co., Ltd. on the date the contract is transacted, the date of buyback of the swap from the trading counterpart, the date of exercise of option in accordance with Article 83 of the GreTai Market Regulations, Article 17 of the Regulations Governing Trading of Convertible Bonds and Bond Conversion Entitlement Certificates and the applicable provisions of the Rules of Business Operation of Taiwan Securities Central Depository Co., Ltd.
    Securities firms engaging in structured note trading operations shall produce a monthly statement showing utilization of structured note funds, to be retained for recordation.
    Guidelines for securities firms engaging in structured note trading shall be separately adopted by GreTai.
    A foreign securities firm shall issue an undertakings stating that it will not remit transaction price money obtained through structured note trading out of the country until after the maturity of the trade, provided that this shall not apply for notes linked to foreign financial products where remittance of trade price money is necessary.
12     The transaction prices obtained by securities firms engaging in structured note trading may be invested only in domestic or foreign fixed income instruments, linked underlying securities, index-type funds, or trading in futures or derivative financial products for hedging related to the transaction currency or the linked underlying subject, with the exception of mainland China area financial products and MSCI Taiwan Index Futures.
13     A securities firm trading structured notes shall submit a performance bond to GreTai. Standards for performance bonds are as follows:
  1. For securities firms with long-term credit rating of twBBB+ or above from Taiwan Ratings Corporation, or BBB+ (twn) or above from Fitch Ratings Limited, Taiwan Branch, or Baa1.tw or above from Moody's Investors Service Taiwan, or Baa1 or above from Moody's Investors Service, or BBB+ or above from Standard & Poor's Corp., or BBB+ or above from Fitch, Inc. shall submit 3 percent of the outstanding balance of the structured note contract.
  2. For securities firms with credit ratings below those of the preceding subparagraph, but with a long-term credit rating of twBBB- or above from Taiwan Ratings Corporation, or BBB- or above from Fitch Ratings Limited, Taiwan Branch, or Baa3.tw or above from Moody's Investors Service Taiwan, or Baa3 or above from Moody's Investors Service, or BBB- or above from Standard & Poor's Corp., or BBB- or above from Fitch, Inc. shall submit 5 percent of the outstanding balance of the structured note contract.
  3. Securities firms with other credit ratings shall submit 10 percent of the outstanding balance of the structured note contract.
    Securities firms submitting the above performance bond may do so in the form of cash, bank certificates of deposit, or central government bonds, and according to monthly changes in the outstanding balance of the structured note contract and the firm's credit rating, may arrange with GreTai on or before the 10th of each month for deposit of additional performance bond amounts or refund of the same.
14     Before engaging in convertible bond asset swap or structured note trading operations, a securities firm shall, in accordance with the competent authority's Regulations Governing the Acquisition and Disposal of Assets by Public Companies, adopt a set of procedures for handling those types of financial derivatives transactions, or adopt the existing Procedures for Handling Trading of Derivatives Products. The securities firm shall report relevant information [to GreTai] monthly in order to perform necessary risk management and information disclosure, and incorporate it into its own internal control systems and internal auditing procedures for management and control purposes.
    Before engaging in convertible bond asset swap or structured note trading operations, a securities firm shall complete necessary revisions to its internal control system and internal auditing procedures. Points relevant to such revisions will be separately promulgated by GreTai.
15     The content of the procedures under Point 14 shall set out basic principles and policies governing trades, and shall include limits on contract amounts for convertible bond asset swaps and structured note trading, both for aggregate totals and for individual trading counterparts; stop loss provisions on contracts, individually and in total; policies for selection and credit review of trading counterparts; hedging policies; procedures and essential factors in performance evaluation; market information equipment and data; accounting procedures and statement disclosure methods; background requirements for traders and risk management personnel and related provisions for their training; and clear demarcation of responsibility for approval of trades.
    When a securities firm engages in structured note trading involving linked foreign financial products, its traders and risk-management personnel shall have relevant work experience in the market for the linked underlyings.
    The "market information equipment and data" shall be capable of ensuring real-time, accurate information for the relevant market.
16     A securities firm engaging in convertible bond asset swap or structured note trading shall calculate the market risk equivalent and counterparty risk equivalent for the convertible bond asset swap or structured note trading position in accordance with the competent authority's Rules Governing Securities Firms, in order to perform calculation of its self-owned capital adequacy ratio.
17     A securities firm engaging in convertible bond asset swap or structured note trading operations shall perform its accounting in accordance with the competent authority's Criteria Governing the Preparation of Financial Reports by Securities Firms and its Guidelines for Information to be Published in Financial Reports of Public Companies Engaging in Derivatives Trading, the Statements of Financial Accounting Standards No. 27 published by the Accounting Research and Development Foundation of the Republic of China, and the relevant directives of the competent authority regarding derivative financial product accounting disclosures. The securities firm shall also, in its financial statements or notes thereto, disclose the amount of the notional principal for these types of transaction contracts, the nature of the trades and the relevant terms and conditions (to include at least the credit risk, market risk, and possible liquidity risk involved in these trades, as well as cash flows and relevant accounting
    policies).
18     In addition to public disclosure of information pursuant to the Regulations Governing the Acquisition and Disposal of Assets by Public Companies, securities firms engaging in convertible bond asset swap or structured note trading shall additionally file a monthly accounting statement with the GreTai each month, and shall also submit therewith in duplicate a declaration of the monetary amounts of the derivates trades engaged in, a summary of stipulated trading conditions, and related contractual content for review and recordation by GreTai auditors.
    The additional filing information to be submitted with the monthly accounting report as set out in the preceding paragraph shall be in the formats shown in Tables 4 and 5.
19     For a securities firm engaging in structured note trading, total unmatured contract principal may not exceed the applicable total principal for trades, while that in trading positions for equity-linked product trades or principal-guaranteed product trades shall not exceed two-thirds of the applicable total principal for trades.
    The applicable total principal for trades shall be determined according to the following standards:
  1. If it has obtained a long-term credit rating of twA- or above from Taiwan Ratings Corporation, or A- (twn) or above from Fitch Ratings Limited, Taiwan Branch, or A3.tw or above from Moody's Investors Service Taiwan, or A3 or above from Moody's Investors Service, or A- or above from Standard & Poor's Corp., or A- or above from Fitch, Inc., its combined total unmatured contract principal for convertible bond asset swap trading shall not exceed four times the securities firm's net worth.
  2. If it has not met the credit rating standard in the preceding subparagraph, and has obtained merely a credit rating of twBBB- or above from Taiwan Ratings Corporation, or BBB- (twn) or above from Fitch Ratings Limited, Taiwan Branch, or Baa3.tw or above from Moody's Investors Service Taiwan, or Baa3 or above from Moody's Investors Service, or BBB- or above from Standard & Poor's Corp., or BBB- or above from Fitch, Inc., its combined total unmatured contract principal for convertible bond asset swap trading shall not exceed three times the securities firm's net worth.
  3. If it has not met the credit rating standards in either of the two preceding subparagraphs, and has obtained merely a credit rating of twBB+ or above from Taiwan Ratings Corporation, or BB+ (twn) or above from Fitch Ratings Limited, Taiwan Branch, or Ba1.tw or above from Moody's Investors Service Taiwan, or Ba1 or above from Moody's Investors Service, or BB+ or above from Standard & Poor's Corp., or BB+ or above from Fitch, Inc., its combined total unmatured contract principal for convertible bond asset swap trading shall not exceed two times the securities firm's net worth.
  4. If it has not met the credit rating standards in any of the three preceding subparagraphs, and has obtained merely a credit rating of twBB- or above from Taiwan Ratings Corporation, or BB- (twn) or above from Fitch Ratings Limited, Taiwan Branch, or Ba3.tw or above from Moody's Investors Service Taiwan, or Ba3 or above from Moody's Investors Service, or BB- or above from Standard & Poor's Corp., or BB- or above from Fitch, Inc., its combined total unmatured contract principal for convertible bond asset swap trading shall not exceed the securities firm's net worth.
    For foreign securities firms engaging in convertible bond asset swap or structured note trading operations, the net worth of its Taiwan branch shall be taken as the benchmark for determining the total unmatured contract principal allowable as pursuant to the preceding paragraph.
    After obtaining qualification for trading of structured notes, a securities firm shall undergo a credit rating yearly, and shall report its credit rating to GreTai within seven business days after receiving the credit rating report, enclosing the report. Where there is any change in the credit rating, the applicable total principal amount shall be set according to the most recent credit rating.
    Securities firms that have obtained qualification for structured note trading but whose self-owned capital adequacy ration falls below 200 percent may not undertake additional trades even when their unmatured contract principal amount has not exceeded the applicable total principal amount. Such firms must wait until the self-owned capital adequacy ratio is restored to 200 percent before undertaking any additional trades.
    In addition to the regular audits performed pursuant to the preceding two paragraphs, GreTai may require the securities firm to submit relevant documents for an ad hoc audit, and when necessary, may place a limit on the firm's total trade principal.
20     In addition to specifying in a trading contract the venue of litigation in the event of a dispute, when a dispute actually arises a securities firm underwriting a structured product shall handle the matter in accordance with the business dispute resolution procedures provided for under its internal control system.
21     Given any of the following circumstances, GreTai may notify a securities firm to make correction within a prescribed period:
  1. Undertaking convertible bond asset swap or structured note trading in a manner other than that specified in its application.
  2. Violation of the provisions of Points 7, 8, 9, 10, 11, 12, 13, 16, 17, 18, 19, or 20.
  3. The firm's self-owned capital adequacy ratio is less than 200 percent, and it executes trades in a manner not conforming with its own procedures governing convertible bond asset swap or structured note trading, its own procedures for handling trading of derivatives products, or the rules of its own internal control system or internal auditing procedures.
22     When a securities firm has not made rectification or improvement within the time period prescribed pursuant to Point 21, the GreTai may issue a warning, and notify it to make rectification or improvement within a prescribed period of time.
23     In any of the following circumstances, the GreTai may impose a penalty on the securities firm of not less than NT$50,000 and not more than NT$300,000:
  1. Engaging in convertible bond asset swap or structured note trading while having failed to submit an application to the GreTai and obtain approval pursuant to Point 3, paragraph 1.
  2. Failure to make rectification or improvement within the prescribed period of time pursuant to Point 21.
24     In any of the following circumstances, the GreTai may suspend or terminate a securities firm's convertible bond asset swap or structured note trading operations, without prejudicing the validity of trades under existing contracts:
  1. Failure to make rectification or improvement within the prescribed period of time pursuant to Point 22.
  2. A self-owned capital adequacy ration that remains below 200 percent for three consecutive months, with a credit rating lower than those listed in Point 4, paragraph 1.
  3. Loss of the qualifications listed under Point 4, paragraph 1.
    Given the circumstances under subparagraphs 1 and 2 of the preceding paragraph, GreTai may restore a securities firm's status for the relevant operations subsequent to its improvement and GreTai's re-examination and confirmation thereof.
25     These Directions, and any amendments hereto, shall be implemented after submission to and approval by the competent authority.