Throughout 2014, western exchange operators began to look east and were not afraid to shout about their growing presence in the region. Deutsche Boerse was perhaps the most vocal, alongside its derivatives subsidiary Eurex.
Its listed and options in EUR-denominated products and European benchmarks have been available to and traded by Asian investors for years, but more recently Eurex has looked to grow its strategic partnerships in the region.
It’s not just about easing the access to Eurex products in the Asia-Pacific region, it works both ways. In 2010, a link with Korean exchange KRX gave customers in Europe the chance to trade KOSPI 200 options outside of Korean core trading hours to make them easier to access for European and American investors.
More recently, a 2013 deal with the Taiwan Future Exchange sought to bring similar benefits to trade derivatives from its blue chip index TAIEX.
Another western firm that has looked to make its mark in the region is Intercontinental Exchange (ICE).
As this issue of The TRADE Derivatives goes to press, the exchange is launching its new Singapore-based exchange and clearing house, a development facilitated by its acquisition of the Singapore Mercantile Exchange for $150 million in November 2013.
The move marks the first direct attempt to setup an exchange in Asia by a western group, with most relying on local sales offices and partnerships with local exchanges up until now.
“The key for new entrants to the market is they need to make sure they create derivatives products that are friendly to the Asian market,” said John Warren, senior vice president at SunGard Asia.
“Clearing is also driving a lot of the investment because we need to make sure we have clearing capacity in Asia. ICE has been at the forefront in this, recognising there is a need and role for more clearing in Singapore.”
Being ‘Asia-friendly’ is perhaps the most difficult challenge for foreign market operators looking to break into the region. Compared to the US and Europe where derivatives markets are primarily institutional in nature, in Asia the retail component is equally important.
“In many ways, Asian derivatives markets are more advanced than in Europe and the US. Asset managers are very sophisticated in their use of derivatives and they are used frequently further downstream in the retail market,” explained Warren.
A product that fits
When it comes to product design, considering the potential to make them appealing for retail investors as well as the institutional market will be key to breaking into Asia with a bang. Smaller contract sizes and contracts focused on commodities are likely to be winners in the region, Warren says, because they appeal to retail investors and corporates, which he believes are generally less risk averse than in other parts of the world and more willing to use derivatives contracts on a day-to-day basis.
That said, Asia’s relatively fragmented nature compared to the more homogenous markets of Europe and Asia are likely to continue to be a major challenge for both local and foreign derivatives market operators.
“The problem with Asia is there’s not a country called Asia,” Warren adds, “It’s fragmented and there’s also a concentration on fewer a better venues, with Singapore and Hong Kong being the dominant centers.”
Singapore and Hong Kong are likely to become even stronger in the future as increased regulation across the region reduced the advantages of regulatory arbitrage that some of the smaller markets have relied upon to attract business in the past.
Another trend which could be significant for new players in the Asian region is the growing demand for local brokers among investors. The collapse of MF Global has led to fears that a similar event could happen in the future and reduce trust in brokers from outside the region.
However, many regional brokers face hurdles. Firstly it can be challenging to become a clearing member on European or US exchanges, though firms are dedicating themselves to achieving this, with one local broker, Singapore-based UOB, becoming a clearing member of CME in October last year, and Warren expects more to follow.
“There is demand for local brokers to become clearing members of the US and European exchanges so I think we will see more this year,” he explains, “Investors want flow to go via their local brokers and using a third party clearer just isn’t economically viable anymore.”
While the listed space has at the forefront for exchanges in the region, the OTC derivatives market is also undergoing significant change, largely due to the same global regulatory factors affecting the US and Europe since the G20’s Pittsburg meeting in 2009, which set out a roadmap to central clearing of derivatives trades globally. However, the way in which regulation is being implemented in these markets has created some very different results.
Rebecca Terner Lentchner, head of policy and regulatory affairs for the Asia Securities Industry & Financial Markets Association, says that differing policy priorities, legal frameworks and implementation timelines in Europe and the US have made it hard both for global market participants and other less-developed jurisdictions to comply with the principles laid out by the G20 in 2009. “Different experiences of the crisis have led to serious divergences between Europe and the US in the implementation of those reforms, which may create an unequal playing field for large globally active banks and asset managers,” she says.
The G20 plan for reducing systemic risk in the global derivatives markets centres on the migration of standardisable instruments to central reporting and clearing and trading on exchange-like platforms.
Non-standardisable instruments face higher margins and capital charges. Necessarily, the largest jurisdictions were the first to pass and implement new legislation.
Asia’s OTC markets are smaller, less diverse and built on different legal frameworks than those in Europe and the US. This has influenced the pace and detail of regulatory reform, as have other local factors, such as currency controls in some jurisdictions and the varying volumes of trading in particular instruments across the region.
While interest rate swaps (IRS) are the biggest class of OTC derivatives globally, FX derivatives dominate the Asian landscape. Hong Kong is the biggest single equity-linked OTC derivatives market in Asia ex-Japan, but does very little trading in IRS, a market dominated by Australia and Singapore.
Reporting from Asia
The G20 requirement to report OTC derivatives trades to a trade repository is still being rolled out in Asia. In Japan – which accounts for roughly half the region’s OTC derivatives trading volumes – reporting rules came into force in parallel with those imposed by the US Dodd-Frank Act. And while the European market infrastructure regulation (EMIR) went for a big bang approach in February 2014, requiring both buy- and sell-side firms to report OTC and listed derivatives transactions, Australia, Hong Kong and Singapore are taking a more gradual approach.
Although there remains much work to do in terms of completing the reporting mandate, the attention of many Asian OTC derivatives traders will focus on clearing in 2015.
While Japan is widening the range of instruments that must be cleared centrally, Singapore could still launch mandatory clearing before the end of the year, but Hong Kong and Australia are still consulting the market.
With voluntary volumes residing largely in LCH.Clearnet’s SwapClear, at least for IRS, the proxy battle for OTC derivatives clearing market share is most evident in the international positioning of central counterparties (CCPs) in Asia’s major hubs.
The CCPs of the incumbent exchange groups of Australia, Hong Kong and Singapore have invested to gain qualified CCP (QCCP) status under the principles for financial market infrastructures (PFMI) laid out by the Committee on Payment and Settlement Systems and the International Organization of Securities, but that doesn’t guarantee the right to compete globally.
“EMIR legislation is very prescriptive about some of the risk management practices of CCPs,” explains Keith Noyes, regional director, Asia Pacific at ISDA. “To be recognised in Europe as a QCCP, foreign CCPs must apply for recognition to the European Securities and Markets Authority (ESMA), which involves determining country equivalence by the European Commission, an assessment of compliance with regulations and law that are ‘equivalent’ to EMIR, and the signing of a MoU between ESMA and the local competent regulatory authority. If they cannot be recognised as a QCCP, they will be subject to a higher set of capital charges under Capital Requirements Directive IV.”
These extra costs of compliance with different jurisdictions’ legislative routes to the same global goal are a source of frustration, but progress has been made in recent months. EMSA has adopted equivalence decisions for the regulatory regimes of CCPs in Australia, Hong Kong, Japan and Singapore.