Samuel Riding, Regulation Asia, March 18, 2016

OTC Derivatives Summit 2016 panellists discuss the operational challenges of clearing services and infrastructure in Asia.

Asia Pacific banks and international players operating in the region are facing a huge variety of regulatory requirements in areas such as capital, leverage limits, risk management and derivatives.

In OTC derivatives, they are dealing with requirements such as mandatory clearing, margining of non-cleared instruments and – in a sign of one set of regulations informing another – changing portfolio dynamics as a result of increased capital requirements.

The opening panels of the inaugural Regulation Asia OTC Derivatives Summit in Singapore discussed the circuitous routes banks providing intermediary services including clearing must travel to succeed in this landscape.

The first panel of the day, moderated by Sam Ahmed, managing director of technical consultancy Deriv Asia, discussed intermediary business in the OTC space, touching on the difficulties of existing market participants and the potential opportunities for Asian service providers and institutions to take market share.

On the first front, Conor Cunningham, chief executive officer of collateral and capital management service provider ACUO Financial Solutions, noted a mismatch between different regulatory requirements. He said: “Market regulators are pushing towards central clearing, but on the other side prudential regulators are giving very little relief.”

From a buy-side perspective, funds too are becoming ever more highly regulated. This is leading them to seek “transparency, best execution, and choice of [trading] venue” which in turn is prompting support for “a more disintermediated model” according to Philippa Allen, chief executive and managing director of Compliance Asia.

Global vs. Local

Overall, increased regulation has made the business difficult for incumbent global providers, according to Luke Brereton, co-head of ECLiPSE (Execution, Clearing, Liquidity and Portfolio Services) at Standard Chartered.

“Universal banks have legacy clients and management structures which are not absolutely in tune with regulators. It is very hard to turn an oil tanker, like the big clearers,” he said. “It has come home to roost just how unprofitable these businesses are.”

It can be easier just to start from the beginning, he noted, as “if you don’t have a legacy client base you can price it right from the get-go.”

The requirement in Asia for institutions to access CCPs creates a rationale for larger players to “take the technology and the know-how from their own book and make that available to clients”, he added.

Regional banks, meanwhile, take a cautious approach to offering clearing services, according to Frederick Shen, head of business management for global treasury at OCBC Bank

“Our model has been we are not necessarily offering every service to every client,” he said. “Even though it is not a volume game, you have to be driven by that as you have fixed costs to cover.”

Being selective markets is not only important for regional banks, however, according to Cunningham. Some global names are feeling the pressure of offering too wide a range of services and covering too many markets.

“It becomes a question of when markets start to penalise them for their global ubiquity. Are they [trading] at a discount because of various exposures that aren’t necessarily to their core market?” he explained. “They are slimming down, cutting off marginal geographies and trimming down businesses they cannot lead in.”

Allen noted regulators were concerned by banks using higher regulatory requirements to cut off certain sections of the market:

“HKMA (the Hong Kong Monetary Authority) brought up the point that they are in discussions around Asia to say it is not an appropriate response to de-risk by cutting people off, as that is not how regulations were intended to work.”

Again here, de-risking could present an opportunity for local players, Cunningham believed.

“For some of the major banks the top 20 percent of clients contribute about 80 percent of revenue so aggressively cutting your tail is necessary,” he said. “In China there are securities firms carrying thousands of clients who have no economic benefit. You will find a fragmentation of providers throughout the world, and Asian banks have an opportunity to become the dominant players in this region.”

This prompted Shen to re-stress the need for regional banks to be selective about which services they offer:

“We tend to outsource in areas where we don’t have a competitive advantage. The cost of building infrastructure just to manage in-house flows, plus compete for external flows where there are established service providers, is prohibitive.”

Are Asian Markets Ready for Domestic CCPs?

In the second panel of the day, moderated by Phuong Trinh, general counsel of FIA Asia, participants discussed the viability of creating Asian CCPs.

Asad Merchant, Deutsche Bank’s APAC director and product head for listed derivatives, noted some institutions could be caught between regulations requiring CCP members provide clearing services

“Clearing members can shy away from offering a clearing service, mainly because the economics have not been appropriately balanced. The cost of holding capital is not commensurate with the fees that have been returned,” he said.

However, according to Thomas McMahon, chief executive officer and director, Pan Asia Clearing Enterprise, strong clearing houses have emerged from challenging circumstances, and generally provided a useful risk-management function.

“A Hong Kong clearing house failed in 1987 on the back of a member’s inability to figure out what margins it owed. This is how HKEx, one of the best clearing organisations in the world, came about,” he said. “At best guess, Lehman Brothers had an exposure of USD2.2 trillion the day it failed, yet its final loss was very much within its capability to pay. Innovation can come out of these constraints.”

One solution for less established jurisdictions could be to form multi-market CCPs, believed Merchant.

“The ASEAN region is large with many different jurisdictions. Liquidity and the sheer breadth of product are not there, so there is not enough traction to start a CCP.

“What do we do when un-cleared margining rules come in for countries that do not have a viable platform for launching a CCP? Other than a pan-ASEAN CCP, I can’t come up with a solution.”

Shane Worner, senior economist with the International Organization of Securities Commissions, who also gave a keynote speech at the event, acknowledged the application of global regulation could be difficult for some jurisdictions.

“The theory of having overarching international standards or rules is a really sound one. The reality is more complex. We come up with best practices, but ultimately it is up to people to adhere to them on a best-efforts basis,” he concluded.


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