Japanese swaps growth steady

Derivatives markets in Japan are continuing to grow thanks to the introduction of central clearing, exchange mergers, increased use of high-frequency trading, and steady growth of foreign exchange transaction volumes.

Derivatives markets in Japan are continuing to grow thanks to the introduction of central clearing, exchange mergers, increased use of high-frequency trading (HFT), and steady growth of foreign exchange transaction volumes.

A new report from financial research consultancy Celent has found while Japan’s derivatives market as a whole has continued to grow gradually, there is a significant gap between various instruments, with some demonstrating remarkable growth and others not.

Last year, listed derivatives in the country recorded 404.3 million transactions and Celent forecasts the market will continue to trace a moderate growth curve. OTC derivatives in 2011 recorded 5.1 million transactions, accounting for one-quarter of the world’s OTC derivative trading volume.

“Efforts continue to boost both the stability and transparency of Japan’s derivatives market. These efforts include attempts to shore up the legal infrastructure as well as the merging of exchanges,” said KyongSun Kong, an analyst with Celent’s Asian financial services group and author of the report. “More of the same can only be expected moving ahead, and, by virtue of this, the nation’s derivatives market will in all probability enjoy substantial growth.”

Merging trends 

Kong points to repeated mergers of and integration among Japan’s derivative exchanges as one cause for increased growth of the markets. As of February 2012, five exchanges in Japan deal in listed derivative products – the Tokyo Stock Exchange (TSE), Osaka Securities Exchange, Tokyo Commodity Exchange (TOCOM), Tokyo Grain Exchange and Tokyo Financial Exchange.

“Each of these exchanges handles a varied selection of derivative products, and each has a particular orientation,” wrote Kong, adding the merging of the Tokyo and Osaka stock exchanges is scheduled for January 2013, with the latter expected to take charge of managing the derivatives market. “This merger is being closely watched to determine how it will affect Japan’s derivatives market.”

Kong also cited the adoption of central counterparty clearing as a factor which will propel growth in the market. The use of CCPs was mandated in by the G20 in 2009, when countries agreed OTC derivative contracts should be centrally cleared by the end of 2012.

“Japan is no exception, and efforts are afoot to prepare a CCP in time,” wrote Kong. “The details related to CCP deployment remain uncertain, but what is certain is that it is incumbent upon market participants to do their due diligence and actively research, analyse, and prepare for their introduction.”

Derivatives growth in Japan is also due to increased numbers of foreign investors in the country. Kong said one reason behind the large number of overseas investors that trade on Japan’s listed derivatives market is the availability of HFT, which is gaining ground in Japan but still a far cry from the level seen in US or Europe.

“As indicated by the introduction of the high-speed processing systems at TSE and TOCOM, the proliferation of HFT in Japan is a certainty and only a matter of time,” said Kong. “In conjunction with the spread and increased use of HFT domestically, Japanese investors can also be expected to take part more actively in trading derivatives contracts. With an environment in place allowing for short-term trading, the overall market liquidity is envisaged, rising further and contributing to heightened trade volume.”