The global regulatory push towards bringing over-the-counter (OTC) derivative transactions into central clearing counterparties (CCPs) has piled pressure on dealers in Japan to upgrade infrastructure that is currently unable to cost-effectively provide sufficient visibility and risk management, says Andrew Gordon, head of BNY Mellon’s broker-dealer services business in Asia Pacific.
In view of the rapidly increasing operational complexity for many Japanese OTC derivatives participants, the US custodian and asset servicing bank recently launched an enhanced version of its derivatives collateral servicing platform for Japanese institutional clients with new margin management capabilities delivered through a secure web-based portal. “The enhancements give greater automation to the process, thus contributing to operating efficiency and more timely processing of collateral transactions,” Gordon said.
Globally, the regulatory landscape for OTC derivative markets is undergoing dramatic change while the global market volatility has increased the hedging and risk management needs of corporations and institutions and hence usage of currency, interest rate and commodity derivatives.
“Considerable investment is required in the operational and risk infrastructure needed to support the change and the new paradigm,” Gordon noted, adding, “OTC derivative volumes have rapidly returned to pre-financial crisis levels or higher. And reflecting a global trend, regulators in Japan have moved to require that a large share of derivatives contracts go through central clearing houses to prevent a domino-like collapse of the financial system if a major dealer were to fail. This has significant cost and compliance implications for Japanese OTC derivatives market participants.
According to the Bank of Japan, major Japanese financial institutions had a combined notional value of interest rate and foreign exchange OTC derivatives contracts outstanding of US$55.0 trillion as at 30 June 2011, up 20.9% from the end of 2010. “There is an element of double counting, as reporting dealers who transact with each other both report the trade, but the volume is still large,” Gordon noted. ??
The G20 has agreed that OTC derivatives that are sufficiently standardised should be moved to CCPs and be reported to trade repositories. The Dodd-Frank Act passed in the US last year mandated clearing of standardised OTC derivatives by the end of 2012. In Japan, the Amendment of the Financial Instruments and Exchange Act (FIEA) promulgated in May 2010 aims to improve the stability and transparency of the settlement of OTC derivative transactions by requiring mandatory CCP clearing of large-scale transactions, mandatory clearing at domestic CCPs for derivative transactions connected to Japanese backruptcy procedures, and storing and reporting of trade information data.
The new regulations also aim to strengthen the financial base of domestic CCPs through the introduction of a minimum capital requirement and a requirement for authorisation if a party is to hold more than 20% of voting rights. For the first time, foreign CCPs will be allowed by provide central clearing services to domestic financial institutions either in the form of a licensed foreign CCP, or through the so-called ‘link system’, which essentially involves the interoperability of two CCPs. Interoperability could be arranged between say, a licenced domestic CCP and a foreign CCP.
“The scale and scope of changes in the Japanese derivatives market since 2008 has been immense, and they are not over yet,” added Gordon.
“Keeping up with the new best practice as well as the pace of change, is driving many Japanese institutions to give serious consideration to outsourcing their derivatives collateral management processes,” he said.
BNY Mellon maintains derivatives trades and values on its systems, monitors margin parameters and calculates margin status. It also provides web-based reporting capabilities and workflow management tools designed to help clients reduce risk and enhance access control. The platform is part of DM Edge, the company’s derivatives margin management service which provides offerings for Japanese issuers and investors to support the execution and processing of derivatives. These include trading and execution, collateral management and other middle-office outsourcing services, as well as custody, accounting and consolidated reporting. To help introduce these new enhancements, BNY Mellon has partnered with Algorithmics, a provider of collateral management solutions.
The global platform has been available for several years in Japan, where BNY Mellon has a dedicated local service model for clients.
Author: Jill Wong