Institutional investors increasingly turning to listed and OTC derivatives as a means to access desirable Asian markets should be prepared for regulatory reform in the sector, according to a new report by financial research firm TABB Group.
Historically, direct investment in the region has been hindered by low market capitalisation, restrictive regulatory environments and capital constraints that prohibit direct access to cash markets. But TABB suggests Asian exchanges now stand to gain from the current restricted access international investors have to many Asian markets, by providing tools that can provide exposure to specific companies domiciled in Asia.
“Asian exchanges can be expected to aggressively seek out new opportunities for growth through innovative product launches seeking to capture the attention of investors,” said the report. “Pent up demand from investors will contribute to innovation and new product launches by these emerging Asian exchanges to capture investment flows from both international investors and Asian-domiciled hedge funds.”
Products that replicate the characteristics of plain vanilla OTC instruments such as equity swaps and contracts for difference will likely take pride of place, since these can provide exposure to single stocks or broad market indices.
Investment managers are already active users of OTC equity derivatives, including contracts for difference, equity swaps, participation notes and other structured products, but global regulatory efforts to reduce concentration of counterparty risk have driven investment managers to explore alternatives for exposure, leading them to centrally-cleared, exchange-traded products that can lower overall levels of risk, according to report author and TABB principal Andy Nybo.
As part of the global trend, led by the G20 nations, towards the transfer of OTC trading onto centrally-cleared platforms, many Asian jurisdictions will be pushing OTC instruments onto exchanges and central clearing mechanisms. Asian clearing houses and exchanges able to launch products and clearing solutions that mitigate risk, increase transparency and lower overall trading costs will reap the rewards, Nybo said.
In Asia, Japan and Singapore have taken the lead in setting up clearing houses for OTC derivatives such as credit default swaps and interest rate swaps. In November 2010, SGX Derivatives Clearing, Singapore’s CCP for OTC financial derivatives, began operations. The Japan Securities Clearing Corporation began the clearing of iTraxx Japan credit default swaps in July 2011 and is expected to begin clearing interest rate swaps soon, possibly in collaboration with a foreign clearing houses such as LCH.Clearnet.
The firm’s research suggests 33% of US and European hedge funds are targeting the Asia Pacific region for new investments. Since September 2008, foreign investors have brought US$67 billion into the emerging markets of Asia, according to TABB figures. The fact that in 2011, just 8% of US hedge fund investments were in Asia, suggests that significant inflows to the region lie ahead.