David Strachan, UBS, October 06, 2014

A renewed focus on consolidation and collaboration across Asia Pacific (APAC) exchanges and central counterparties (CCPs) has characterised 2014. While the APAC OTC market represents just 8% of global turnover in OTC derivatives, it is nevertheless, a $56 trillion market and global exchanges are seeking to extend their presence in the region by acquisition, establishing new clearing houses and developing partnerships with regional exchanges.

In part, these moves are underpinned by a growing appetite for derivative products based on APAC markets but the ramifications of structural market reforms have also acted as a powerful catalyst for consolidation among exchanges and CCPs. This remains a focal point for APAC market participants as OTC activity shifts gradually towards being cleared on CCPs. While the harmonisation of rules across exchanges, CCPs and regions remains some way off, the potential benefits of gaining critical mass as the clearing house of choice for specific asset classes and currencies, is widely recognised.

Regulation is already being enacted. Transaction reporting requirements for dealers and derivatives mandates for dealer clearing now exist in Japan, and are set to be introduced in Australia, Singapore and Hong Kong. Typically, regulators have adopted a phased approach to mandatory clearing with an initial focus on credit default and interest rate swaps later being extended to capture NDF and other products. The first phase of mandatory client clearing in APAC will begin in Japan in December 2014, beyond that, mandates are not expected until 2015.

Asia's smaller clearing houses - in China, India and Korea - have also been mandated to introduce dealer clearing. On 2 June, India permitted forward foreign exchange clearing at the Clearing Corporation of India while on 30 June, the Korea Exchange launched clearing for won interest rate swaps and, on 1 July the Shanghai Clearing House began clearing of Renminbi IRS. In addition to proliferating local rules, Asian banks dealing with US or European counterparties must adhere to the transaction reporting and clearing requirements laid down by Dodd-Frank and EMIR.

However, infrastructure is struggling to keep pace with investor demand and regulatory change. While trading derivatives in some countries is relatively straightforward, in others the process can be complex and time-consuming. Liquidity across the region remains fragmented as disparate regulatory regimes and diverse cultures resist attempts to create fully multi-jurisdictional facilities. Although seven local and four international CCPs could soon be operational, many of them will only clear a single asset class or group of asset classes. Issues relating to collateral, settlement and regulatory supervision across borders are, as yet, far from being resolved.

In response to what they perceive as onerous transaction reporting, clearing and collateral requirements associated with OTC derivatives, some clients have turned to futurised options. US exchanges such as Eris have responded by offering products such as interest rate swap futures which, they say have similar risk characteristics as the OTC interest rate swaps but can trade on futures exchanges and so attract lower amounts of collateral without the complexity that comes with SEF execution. The success of Eris Flex Swap Futures paves the way for APAC CCPs to consider similar alternatives.

However, there are signs of political will to foster greater integration in markets, as regulators give the go-ahead to a raft of consolidation between APAC exchanges and clearing houses. Since the blocked bid for the ASX by the SGX, a number of moves have started to sew together the patchwork of diverse Asian clearing houses.

In December 2012, the HKEx completed a $2.2Bn acquisition of the London Metal Exchange (LME) and outlined plans to expand the commodity exchange’s reach into China. Since then, the Intercontinental Exchange (ICE) announced the purchase of the Singapore Mercantile Exchange. Eurex, Deutsche Borse's derivatives arm, has moved to establish a clearing house in Singapore and the ASX and CME are in talks to develop a mutual offset system which would enable trades to be cleared on either exchange.

In December 2013, HKEx and SGX announced a Memorandum of Understanding (MOU) to co-operate on technology development. In March this year, the TSE and OSE integrated their derivatives markets under the JPX umbrella. The combined volumes of derivatives trading on both markets had hit a record high for the second consecutive year in 2013. The merged exchange also has listed futures on the Indian stock index and a super long term JGB future. All contracts will be consolidated onto the group’s derivatives trading platform – J-GATE.

However, consolidation is not the only game in town: APAC entities are also vying to attract greater liquidity and build critical mass in a rapidly-evolving environment with some extending trading hours for the benefit of investors in different timezones. Korea has launched overnight contract sessions on the CME and Eurex while Taiwan has taken similar steps via Eurex, and TFEX has recently announced an MOU with EUREX to do the same for the Thailand index futures. The LCH has plans to extend operating hours to include the APAC time zone in Q4 2014 and local settlement capability by Q1 2015.

Investors who wish to trade APAC instruments already have a range of options at their disposal. A number of liquidity pools exist either on-exchange or through synthetic structures that provide investors with exposure mapped to their specific requirements. While trading directly on some local exchanges can be challenging, synthetic access can ease the way. Synthetic derivatives provide the same economic exposure as a listed derivative without the need to acquire an investor ID - a prerequisite in many Asian markets. A user-friendly solution for clients who wish to access restricted markets as the bank will be responsible for settling and funding trades.

As APAC markets stabilise after a volatile 2013, demand for direct and synthetic investment can be expected to increase, and lead to further improvements to market structures. Given stable markets, derivatives volumes in Asia Pacific should grow substantially. Investors will have increasing access to consolidated liquidity, new markets, standardised processes and enhanced technology. Considerable advances have already been made and planned improvements promise near-term benefits to both the buy and sell-side.

David Strachan is Managing Director, Head of APAC Clearing, UBS

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