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What's the right regulatory recipe for Asia?

Wednesday 7 September 2011 - by Keith Noyes

 Asian regulators are struggling with how they might recognise third country central clearing counterparties, conscious that impeding cross-border trading could drain liquidity from markets and increase hedging costs, says Keith Noyes, Asia Pacific regional director for the International Swaps and Derivatives Association.

Perhaps due to lessons learned during the 1998 Asian Financial Crisis, Asian financial institutions and markets came through the 2008 Global Financial Crisis in robust shape.

Over the counter derivative markets suffered minimal dislocation and counterparty trading losses on OTC derivative transactions were small.

Problems with Asian derivative transactions centered on mis-selling of structured products (e.g. Lehman "mini bonds") to retail investors and misuse of hedging products for speculative purposes by corporate end users (e.g. KIKO in Korea or leveraged FX forwards in India).

Some adjustment of regulations to address these problems could be expected, and indeed have taken place across many Asian jurisdictions, including China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Taiwan.

Some regulatory reforms that Asia has signed up to, however, address problems that Asia didn't and doesn't have (they perhaps don't address the causes of the financial crisis in the US and Europe either, but that is a different can of worms) and will likely bring unintended consequences that in the worst case could dramatically reduce liquidity and increase hedging costs.


The Proliferation of Asian CCPs

Following the September 2009 G20 summit commitment deadline to clear and report OTC derivative trades by the end of 2012, clearing houses have already been built in India, Japan and Singapore, are in the planning stages in China, Hong Kong and Korea and are also being considered by regulators in Australia, Taiwan and Thailand.

CCPs are expensive to build and operate, with conservative estimates running to tens of millions of US dollars each for building and annual operation, meaning that large clearing volumes are required to defray costs.

However, according to the June 2010 BIS Triennial Survey, the entire Asia Pacific interest rate derivatives market only accounted for about 8 per cent of global volume as of June 30, 2010, with Japan accounting for roughly half of this total.


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