The current state of play in the regulation of OTC derivatives here in Asia Pacific is still one of slow but steady change. What are the implications of developments over the last year or so for corporate treasurers? Treasury Today Asia takes a look across the regulatory landscape.
When it comes to the market for OTC derivatives, comparing the volumes and complexity of Europe, North America and Asia is perhaps unfair given the relative immaturity of the latter (it accounts only for around 8% of the current global turnover). But the market in Asia is making serious noises around expansion with new solutions being offered by a financial and vendor community hungry for growth. The corollary of expansion is, as might be expected, a moving legislative landscape.
With derivatives now assuming increased importance to treasurers here in the region as a means of risk mitigation, consideration of the changes required in the jurisdictions within which the company operates will be necessary. The key Asian derivatives markets are changing and these changes will impact corporates, not least because the regulators are on the case.
State of play
Derivatives play an important role in the economy but are associated with certain risks. Recent financial crises have highlighted that these risks are not sufficiently mitigated in the over-the-counter (OTC) part of the market, especially with regards to credit default swaps (CDS). Since the beginning of the financial crisis, regulators have been working to address these risks.
The well-developed European markets have already faced the European Market Infrastructure Regulation (EMIR) for OTC derivatives which tackles clearing, reporting and risk mitigation, and makes quite a significant demand on the gathering and collation of the right information for market participants. Progress in Asia is slow but sure.
In July 2014, four of the major jurisdictions in the region – Australia, Hong Kong, Singapore and Japan – began introducing regulations in line with the reform principles for OTC derivatives as set out by the G20 committee in 2009. The general objectives of these regulations are broadly the same as under Dodd-Frank (in the US markets) and EMIR. However, in Asia, it seems that each country is moving at its own pace and with its own priorities.
The region’s regulators have each decided to take a more phased approach with different deadlines for different types of market participants. A majority of countries seem to be leaning towards an EMIR-like reporting model in which both sides report, and most have begun with the creation of trade repositories (TRs) and reporting requirements before tackling centralised clearing. But, as we will see, that is more or less where the similarities end.
The long arm of the regulator
Asia Pacific’s corporates will almost inevitably keep taking a steer from the G20’s 2009 market reform commitments to improve transparency, mitigate systemic risk, and protect against market abuse. Is this a good thing? By 2015 the globally operating Financial Stability Board (FSB) noted that the G20 authorities were still facing a range of implementation issues, though international work-streams had been set up aiming to address most of these issues.
Of note, these were looking at steps to harmonise transaction reporting and to agree to a framework for uniform trade and product identifiers; further coordinated consideration of Central Counterparty Clearing (CCP) resilience, recovery and resolution, and central clearing interdependencies; and ongoing multilateral and bilateral discussions to address cross-border regulatory issues (with several additional steps recently taken by authorities in this regard).
For Asian players there is yet more external regulation to consider. Wherever Dodd-Frank and EMIR apply in any jurisdiction in which US and EU institutions operate, both require derivatives contracts to be cleared through CCPs approved by the US Commodity Futures Trading Commission or the European Securities and Markets Authority (ESMA) respectively. What’s more, even Asian market participants will find Dodd-Frank and EMIR rules difficult to escape from if they are dealing with US or EU counterparties, since they will also be required to comply with the respective regulations regardless of where their transactions are made.
Keeping up with the differences
Does the fact that the region is inevitably looking to learn from other regulators (as the voice of experience) mean that, somewhere down the line, we will see the same level of regulatory consistency as in Europe or the US? It seems improbable, given that it would require each jurisdiction in the region to surrender some sovereignty over their domestic markets to a pan-Asian regulatory organisation. With regulation bringing with it such great opportunities for arbitrage, it is a notion that is difficult to apprehend at this stage.
Of course, there may be a degree of harmonisation, but for some countries in Asia it is simply not in their interest. The whole point of China (in particular) launching six different exchanges is that it wants to become the centre for financial transactions. Taking a deliberately different approach may be about attracting business to the Shanghai markets and not regional market development.
The perceived lack of regional harmony could undermine the G20 push for transparency within these markets which was, after all, the fundamental goal of the reforms in the first place. With myriad regulations cropping up across the region – self-interested or otherwise – without one body having oversight of the ‘big picture’ this certainly has the potential to undermine the G20 goal.
In practice, market fragmentation could also pose a challenge for corporate treasurers and other end users too. There will be some jurisdictions in Asia where both corporates and banks will be required to report, but also some where only the bank has to, and some where all asset classes are subject to reporting requirements. Interpreting these rules will require time and diligence. For corporates, the need is to ensure they have read, interpreted and understood the laws and regulations correctly across every country in which they intend to operate. This effort hardly plays well to the desire for market accessibility.
Listen and learn
Despite these macro-issues, the journey to match G20 objectives has been smoother, relative to the disruption seen in the US and EU where the introduction of Dodd-Frank and EMIR proved quite demanding. The better ride for Asian players might be accounted for, on the one hand, by the fact that derivative markets in the region are comparatively small. But some credit must also be given to the phased approach taken by the region’s national regulatory authorities who, having carefully scrutinised how the G20 commitments were carried out elsewhere, opted not to take the ‘big bang’ approach.
Since implementation began several years ago, Asian regulators have moved step-by-step bringing trade reporting across different markets segments and asset classes. Last year, trade reporting was live for interest rates and credit only in Singapore. Five asset classes were live in Australia, meanwhile, but only for large institutions. Since then, the asset classes and market participants subject to trade reporting have slowly expanded. Singapore went live, for example, with FX products in May of this year. In Australia, the regulators changed their OTC derivatives requirements to include a much larger community of reporters.
So while banks, corporates and institutions faced a steep challenge in becoming compliant across all of their OTC derivatives activities in Europe, market participants in Asia have been somewhat less encumbered by the changes taking place, lessons having been learnt from the stress caused by ESMA’s big bang. But ESMA has its purposes as far as Asian regulatory progress in concerned.
With respect to data needs, the Asian regulators have been very careful to adopt any measure that looks like it is evolving as a global standard. Already, DTCC estimates that, across the nine jurisdictions they are live in, there are some 40m open positions in its database, accounting for around 70% of the global OTC derivatives market. This provides a strong incentive for Asia’s national regulators to look at the data standards being developed by the likes of ESMA.
In fact, Asia’s regulators appear to realise that a lot of what they want to see has probably already been reported somewhere in some shape or form. They are seeing what they can leverage, looking at the fields reported by ESMA, these representing a large share of the reported volume.
The regulatory burden may well, as many financial services professionals believe (anecdotal evidence accepted), continue to increase in Asia over the coming years. Yet the traditional characterisation of Asia as a strictly regulated region, relative to that of liberally managed economies in the US and Europe, has shown some real progress.
A matter of note, say industry experts, is that regulators in Asia have been more considered and thoughtful in the way they have planned and implemented their reforms. Unlike in the US or Europe where financial institutions and corporates alike have lamented time and time again that regulatory bodies have pressed ahead with regulatory changes with little consideration to the ‘unintended consequences’ those in the industry believe may emerge as a consequence of reform, Asia’s regulators have paused, and listened carefully to the views of all affected parties.
Even when specific regulations – like the Basel Accord’s capital ratios – have been set at a high level, they have, consciously, not been set so high as to be out of reach of those subjected to them. Likewise, the recent amendments to Singapore’s AML legislation was only implemented after the Monetary Authority of Singapore went through a ten-month consultation phase. Financial services professionals in other regions could be forgiven, perhaps, for looking at how things have unfolded with a degree of envy.
Indeed, there seems to be an increasingly collaborative approach where regulators are very keen to have an open conversation with the market to understand the challenges and what can be done to address these without exposing the financial markets to regulatory uncertainty.
It is also evident, as we have seen above, that the regulators have learned from the mistakes – and successes – of their global peers. They are interested in gaining knowledge from the other regions as to what is best practice and what is not. Generally, the approach taken has been a sophisticated one; it’s not about mirroring what has been done in Europe or America, but looking at all the issues and considering what makes sense for the local markets and what is economically proportionate. It is, to all intents and purposes, a highly researched approach to doing the right thing, rather than being overly political.
Renewing the spirit of cooperation
Despite the efficacy of this more consultative model, as growth accelerates, it is natural that the emerging markets will continue to draw upon the know-how of more experienced players. In the spirit of cooperation, ESMA and the Securities and Futures Commission (SFC) of Hong Kong concluded a Memorandum of Understanding (MoU) in November 2015 allowing the exchange of information on derivative contracts held in TRs. The MoU allows ESMA and SFC to have indirect access to TRs established in the European Union and Hong Kong respectively. It became effective on November 19th 2015.
In November 2014 and February 2015, ESMA had already concluded MoUs with the Australian Securities & Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) providing for a direct access to TR data. However, the ESMA-SFC MoU was cited as the first cooperation arrangement among authorities to establish an indirect access to TRs through exchanges of information. It followed the recommendation of the FSB to enter into this type of agreement to overcome legal barriers to accessing data on derivatives trades, for example when direct access by foreign authorities to TR data is not currently possible.
Emerging markets, and particularly those with weaker fundamentals like Vietnam, Malaysia and Indonesia, have experienced a fair degree of volatility lately. The derivatives market in Vietnam, for example, is seen as an important step in creating qualitative change for the Vietnamese securities market after a long era of quantitative development. Technology has a role to play here and in March 2016 the GMEX Group entered into a joint venture agreement with FPT Information System (FPT) based in Hanoi, Vietnam to provide technology, global business and local operational expertise to launch the first derivatives market and fully integrated clearing house in the country.
Vietnam’s Ministry of Finance (MOF) called upon the Hanoi Stock Exchange (HNX) (formerly the Hanoi Securities Trading Centre) and the Vietnam Securities Depository (VSD) to operate the derivative market’s transaction activities. The project aims to provide a multi-asset, multi-language exchange trading system suite and market surveillance solution to HNX, which will operate the derivatives exchange. The project is expected to deliver a real-time clearing system to VSD, which will operate the clearing house.
The new market is intended to facilitate transactions based on stock accounts such as stock indexes, Government bonds and shares. Indeed, the first traded instruments will be share indexes (HNX30 and VN30) and Government bonds with five-year terms. The target go live date is Q416.
Time to act
With the extraterritorial reach of regulations from elsewhere adding an extra layer of complexity to the web of new rules now emerging in the region, corporates really have no time to lose. The first step should be to perform a careful examination of the company’s treasury technology and its capabilities when it comes to types of data that might need to be reported. As mentioned above, comfort may be taken in the knowledge that the scale of the problem will not be the same as that experienced by firms reporting under EMIR; this required a major effort in gathering all the right information and collating it.
Treasurers here in Asia won’t have to climb that same, steep learning curve if they begin their preparations in good time, as the regulatory landscape unfurls. The progressive regional roll-out model will buy time but it will have to be tackled at some point. This might involve taking a report from one of the swap data repositories and then figuring out what, if any, gaps there exist. This should help in the understanding of what needs to be reported and in preparing for any future requirements.
Whilst Singapore is ahead of the Asian curve in this respect, for many countries, the necessary format to report in is still under discussion. For this reason, such a project is something that should be on any future project list for treasurers.
It is already known that International Swaps and Derivatives Association’s (ISDA’) work across Asia Pacific focuses on certain core topics such as documentation, public policy, market structure, market practice and research – so opening up the discussion now within treasury makes sense. Regardless of how the markets develop globally, it is clear that the Asian derivatives markets are changing and that there is an opportunity to increase scale and availability, guided by intelligent and considered regulation. Treasurers must familiarise themselves with the changes as they happen. Of course, this is not as easy as it sounds but help from banks, vendors, industry bodies, and other treasury professionals is out there.