Starting from 25 July 2022 and in parallel with global regulatory norms, Taiwan Futures Exchange (TAIFEX) offers central clearing services of OTC derivatives for market participants to lower capital requirements and improve capital efficiency. The launch is a response to the urgent needs for market participants such as commercial banks to manage their interest rate swap (IRS) and non-deliverable currency forwards (NDFs) exposures, amid a time when central bankers across the world have begun the quantitative tightening program and raised interest rates to combat inflationary pressures as well as further implementation of uncleared margin rules (UMR) and Basel III requirements.
Continuous growth of Taiwan’s OTC derivatives market
Taiwan’s OTC derivatives market has grown significantly in recent years, with a combined turnover of NT$ 107.7 trillion (US$ 3.6 trillion) in the first half of the year, up 5.01% year-over-year, according to the data from the OTC Trade Repository (TR) of Taipei Exchange (TPEx). The outstanding notional amount of OTC derivatives has reached NT$ 77.8 trillion (US$ 2.6 trillion) as of the end of June 2022, and is continuing to rise.
Currently, the main participants of OTC derivatives are primarily commercial banks and insurance companies. OTC currency and interest rate derivatives account for predominantly 66.6% and 32.7% of total outstanding transactions used by financial institutions to hedge market fluctuation risk.
With a proven track record for trading and clearing derivative products built up over the last few decades, TAIFEX has recently been granted Qualifying Central Counterparty (QCCP) recognition for its OTC derivatives clearing services by the Financial Supervisory Commission (FSC) in June 2022. This recognition ensures that clearing members and customers benefit from lower capital risk weighting for their exposure settled through TAIFEX.
Optimising collateral management & lower costs
In line with the international best practices, the introduction of central clearing of OTC derivatives in Taiwan in 2022 incorporates the essence of Principles for Financial Market Infrastructures (PFMI) framework, margin control, valuation modeling, and default management. Moreover, this ensures high transparency in clearing, settlement and risk management procedures. These widely adopted standards will facilitate all investors, including the overseas banks which deal in Taiwan’s onshore interest rate swap market, with collateral optimisation and lower costs.
The risk weight assigned to financial institutions undertaking centralised clearing for their OTC transactions could be dramatically reduced from 20% to 100% of their uncleared transactions to as little as 2% to 4%. This significantly reduces the costs of maintaining their swap positions, boosting capital utilisation and liquidity of their balance sheet.
Implementation of Taiwan’s CCP
With TAIFEX’s OTC derivatives clearing system built in-house, the first phase of the launch incorporates voluntary central clearing services for inter-bank dealers. Proprietary transactions of TWD-denominated IRS submitted through approved trade affirmation platforms, including MarkitWire and TPEx OTC TR, can now be centrally clear domestically in Taiwan. In the next implementation phase, the Exchange plans to extend the product range for central clearing services to include USD/TWD NDF for the end customers of banks in the coming year, upon regulatory approval.
Currently, 11 financial institutions have signed up as clearing members, granting them a wide range of benefits such as operational efficiency, collateral and position management, and a more comprehensive risk management. TAIFEX is also applying for overseas clearing house recognition, including the US, the UK and Canada, as essential steps to promote its OTC derivatives clearing services.
With these plans in place, TAIFEX will spare no effort to promote the development of the central clearing of OTC derivatives, ensuring efficient collateral management and risk management to support different types of OTC derivatives transactions. Financial institutions, with imminent deadlines to cope with the collateral challenge and potential counterparty risks for OTC transactions, can now find the support they need.