Central clearing of OTC derivatives is keeping the regulators and market participants busy around the globe. Considering the original G20 deadline on January 1st, 2013, it is interesting to tackle the question, how much progress the individual jurisdictions have made.
The implementation of the OTC derivatives reform in the largest OTC trading jurisdictions has been initiated a long time ago. However, it is obvious that there is still plenty of catch up to do and that most jurisdictions and players need to push ahead aggressively in order to reach full implementation of the required changes. A lot remains to be done.
Since the global OTC market reform is currently one of the hottest topics, there are numerous publications that aim to provide transparency with regard to the progress of implementation. However, most of these publications focus on Europe and the US and therefore the actual situation for these markets seems “relatively” clear. This relative advantage in transparency is also due to one big difference in comparison to the Asian markets: While the OTC derivate markets in Europe and the US are regulated by one single initiative each (EMIR and Dodd-Frank respectively), Asia shows a highly fragmented structure, where each country has its own approach towards the market reform. This makes the assessment of the reform progress in the Asian jurisdictions more complex than in the EU and US ones and might lead to a certain ambiguity within market participants. Where do the Asian markets actually stand? What are their specifications? When will they achieve compliance?
Each and every financial institution that wants to engage in worldwide transactions with international counterparties needs to be able to answer these questions since non-compliance can have significant effects on the profitability due to enhanced capital and margin requirements.
The Asian markets are getting ready and this market commentary aims to shed some light on the topic of cross-border transactions and provide a brief introduction into the current status of the OTC market reforms of the key Asian OTC players.
The Australian market is still in a relatively early phase with regard to the reform of the OTC derivatives market since the government introduced the legislation into the parliament in September 2012. Currently, the negotiations are ongoing, headed by the Australian Securities and Investments Commission (ASIC), with the deadline for the consultation phase being the 15th of February 2013. Consequently, Australia has neither central clearing nor reporting requirements for OTC derivative transactions at the current state.
In fact, Australian authorities hold off on clearing or execution requirements providing no specific timeline for the implementation of those. So, from the regulatory perspective, there is no immediate need to compel central clearing of OTC derivatives. However, there are significant commercial drivers for central clearing stemming from tightened requirements for non-cleared transactions in form of pricing, capital and margin implications that will incentivize players to obtain access to clearing before the obligation arises.
The market perception is, that the Australian authorities in general apply a more “laissez faire” approach and are in no hurry to rush with the OTC markets reform in form of mandatory clearing requirements.
Nevertheless, the Australian Stock Exchange (ASX) is eager to enable clearing of IRS since it is working on this plan since mid-2012. It is expected, that the central clearing service for Australian dollar denominated IRS will be active halfway through 2013. However, the ASX is going to face competition in the swaps clearing business since the Anglo-French clearer LCH.Clearnet is planning to penetrate the Australian market by offering central clearing for IRS in 2013.
For Australian regulators not the mandatory central clearing, but the trade reporting of derivatives is the initial focus since a phase in trade reporting requirement for OTC derivatives is planned to start this year. The trade reporting regime is estimated to be in place in mid-2013 and major financial institutions are expected to commence reporting at the end of 2013.
Similar to Australia, Hong Kong is at a relatively premature state with regard to the progress of its OTC market reform ambitions since the consultation on mandatory central clearing is still ongoing. The Hong Kong Monetary Authority (HKMA) and the Securities Futures Commission (SFC) lead the consultation and are also in charge of the legislative drafting of the finalized version of the OTC markets reform. It can be expected that the complete bill will be introduced early in 2013. Once introduced, mandatory central clearing is said to initially only apply to certain IRS products and non-deliverable forwards (NDF). The scope will be extended to cover credit derivatives over time.
At the moment, the Hong Kong Exchanges and Clearing Ltd. (HKEx) operates three domestic clearinghouses, which are in charge of integrated clearing, settlement and depository for the Hong Kong market. But until now, Hong Kong does not offer a domestic solution for the central clearing of OTC derivatives yet. Recognizing the need for a local, in-country solution, the HKEx has announced to launch a CCP to allow eligible OTC transactions to be centrally cleared.
The HKMA announced that it will establish a trade repository under the name HKTR, which will provide an electronic system for collecting, keeping and maintaining details of OTC derivative transactions. This system is expected to be launched in mid-2013. OTC derivative transactions will have to be reported to the HKTR, however, initially the mandatory reporting obligation only applies to certain IRS and NDF.
The Japanese OTC derivative market is by far the largest of the Asian market. Therefore, it might come as no surprise that Japan has, in some respect, made the most progress of all the countries in the Asian-Pacific region. In fact, Japan can be considered a pioneer since it became the very first G20 country to begin the mandatory clearing of OTC derivatives.
Since the 1st of November 2012 compulsory central clearing is in effect and provided by the Japan Securities Clearing Corporation (JSCC) for index-based CDS and plain-vanilla JPY denominated IRS with reference to LIBOR. However, the scope of the products subject to mandatory clearing will grow over time and include foreign currency denominated IRS and CDS with a reference to Japanese companies. At the first phase of implementation the obligation only applies to transactions between large domestic financial institutions that are members of the JSCC.
Those companies are also obliged to report OTC transactions for which trade repository services are available. However, it is planned to allow for centrally cleared deals between such financial institutions and foreign ones. The specifications for such cross-border deals still have to be defined and implemented.
It is of particular interest that Japan (together with China) requires partial or full local clearing while Hong Kong, Singapore and Australia leave it up to the counterparty whether to clear locally or in a third country. In fact, Japanese authorities dictate that CDS are required to be cleared through the JSCC (currently the only licensed domestic CCP) and IRS trades on JPY Libor are required to either be through the JSCC or a linked foreign CCP.
Japan may be the first country that started the implementation of the G20 reforms, however, Singapore has made the most significant progress with respect to actual clearing activity. Since 2006 the Singapore Exchange (SGX) started clearing commodity derivatives and expanded its scope to IRS denominated in Singapore and US Dollars (2010) and NDF (2011). With its CCP AsiaClear, the SGX positioned itself early as the Asian OTC clearing hub.
From a regulatory perspective, the Monetary Authority of Singapore (MAS) is working on the implementation of mandatory central clearing and reporting provisions defined by G20. Since its introduction in October 2001, the Securities and Futures Act (SFA) regulates the derivative markets in Singapore. The Act has undergone a variety of amendments in order to adapt to certain market circumstances. Consultations with regard to the last amendment are still ongoing and have passed its second reading.
It is widely expected that the derivative markets in Singapore will start mandatory reporting and clearing regimes over the course of 2013.
Concerning reporting it is interesting to note that the Depository Trust & Clearing Corporation (DTCC), the world’s largest post-trade financial service company headquartered in the US, has opened an Asia-Pacific data headquarter in Singapore on December, 19th 2012. In addition, it has set up operations and client support in Singapore and Japan. This step can be considered as a milestone in helping the Asian markets to comply with actual and future regulatory requirements with regard to OTC derivatives trade reporting.
In general we get the impression that, with the exception of Japan, the Asian jurisdictions are still waiting for the European and US OTC market regulations to be fully implemented before they push their own mandatory central clearing and reporting requirements. However, now that we briefly described the current status of Australia, Hong Kong, Japan and Singapore, the important question that needs to be answered is, how does this all effect cross-border transactions? How are financial institutions going to conduct global OTC deals in the future?
In order to answer this essential question, we first need to understand that the regulation of a global market is a highly complex and demanding task. In fact, it is impossible to create one single rulebook that applies to all countries around the globe. The way that countries or players approach this issue is based on the trading pattern and the counterparty they wish to engage in deals with.
It seems obvious that the US, as a key player in the OTC derivatives market, play a significant role in setting the rules of the game. This is due to the simple fact that parties that wish to conduct OTC business with US firms are required to achieve recognition by US regulators under the Dodd-Frank Act. The usual procedure is that an Asian CCP needs to register with the Commodity Futures Trading Commission (CFTC) as a Derivative Clearing Organization (DCO), which makes it a direct subject to the regulatory oversight of US authorities. This can result in a delicate situation for the CCP if there are certain conflicts with the domestic requirements.
Under the European Market Infrastructure Regulation (EMIR) on the other hand, there is a mechanism that allows for recognition of equivalent regimes in other jurisdictions. This recognition is tied to certain specified conditions and enables EU counterparties to transact with foreign counterparties under the conditions of the foreign jurisdiction.
In any case, it can be summarized that the entire development is far from ready and market participants are well advised to follow the developments carefully since 2013 is going to be a year of significant importance for the OTC markets reform on a global scale.