Singapore is Asia’s second largest Over-the-Counter (OTC) derivatives market, making its introduction of central clearing for OTC trades a potentially lucrative business opportunity. According to analyst firm Celent, financial institutions account for around 94% of total OTC trading volume in the city-state, the majority of which is in FX derivatives, a characteristic typical of the Asian derivatives market.
In that FX derivatives market, foreign firms account for 86% of trading by value. In the interest rate derivatives market – the second largest by volume – they account for 94% of value traded.
These proportions are significant for the local exchange and clearing house operator Singapore Exchange (SGX). At present a large amount of trading in Singapore is cleared via overseas clearing houses. With overseas firms trading OTC and clearing with international central counterparties (CCPs) it may be difficult to gain a significant advantage from the regulations that are coming into play. However, an increase of OTC in business within Asia could provide a natural boost for local players.
Michael Syn, head of derivatives at SGX, says, “Today many Asian markets are priced as a spread to Western benchmarks, such as Brent crude, or US Treasuries, but increasingly Asian assets are uncoupling from the West and developing independent price formation. These assets will clear in Asia because the clearing liquidity will then be in Asia.”
Singapore’s rules for centralised clearing and reporting of derivatives trades stem from the mandate agreed by the G20 in 2009, with OTC trades centrally cleared or subject to a higher capital charge, standardised contracts to be traded on electronic markets and all trades to be reported to trade repositories. Although Singapore is not a member, it places a great deal of value on its position as a financial hub in Asia and is therefore required to maintain or surpass the standards set in other global financial centres. However it is not enforcing the G20 commitment to push standardised contracts onto electronic platforms, and that decision removes one potential revenue stream from trading venue operators, both current and potential.
The original timeframe set for all G20 countries in 2009 fell by the wayside; larger derivatives markets like Europe, Japan and the US have been the most active in delivering change, but even they have missed targets.
The legislation providing for the reporting of OTC derivative trades and central clearing mandate in Singapore was passed by Parliament in November 2012. The Monetary Authority of Singapore (MAS), the city state’s regulator, has since published subsidiary legislation for implementing the reporting mandates, which commenced on 31 October 2013.
“We are currently developing the subsidiary legislation for the central clearing mandate and expect to have it in place later this year,” confirmed an MAS spokesperson.
Local versus global
The gap in implementation between the larger European and US markets and smaller markets means that Singapore’s introduction of central clearing and trade reporting has already somewhat been overtaken by overseas regulation. The local regulation established a requirement for trade reporting at the end of 2013, and once clearing rules are established, they will create a demand for local market participants to clear trades. Despite this, there are concerns amongst local players that the change to the existing business model will prove challenging to implement.
Thair Hussain, director of sales at Phillip Futures, says, “While there is no central clearing regulation, MAS is trying to push for banks to do this as soon as possible, but this is a new model within Singapore and so I think this will take some time.”
On the other hand, international sell-side firms are already clearing local derivatives trades using international CCPs. These firms – SwapClear, the derivatives arm of London-based clearing house LCH.Clearnet; CME Clearport, part of market operator CME Group; and ICE Clear Europe, which is used to clear Asian trades for exchange giant ICE – are being encouraged by Singapore to compete for business with each other and with the local CCP, AsiaClear, run by SGX.
They have been spurred to action by the financial costs of Basel III, the capital adequacy rules put into place by the Bank of International Settlements (BIS), and the frameworks of new US and European derivatives trading regulations. Local firms are not moving at the same pace, and harbour concerns about the challenge ahead.
“Some customers look at what happened with firms like MF Global and see those problems as something that happen in the US and Europe,” explains Hussain. “It may be difficult for them to see the value and increased security that things like account segregation at a CCP provides, and therefore it may be hard for them to appreciate the changes.”
On 7 April 2014 GreySpark, a capital markets consultancy which released a report assessment of buy-side priorities for selecting a clearing brokers in Asia-Pacific, which indicated a lack of movement towards clearing in the region.
Russell Dinnage, senior analyst at Greyspark, says, “There are a number of large, medium and small buy-side firms across the region that are looking at EU and US clearing mandates coming through, and in terms of reaching the rest of the world they are looking to comply with mandates in those regions; however outside of that they are very focussed on trying to maintain existing operations in Asia Pacific until local regimes force them to do otherwise.”
Reporting requirements for Singapore
Only specific contracts – currently interest rate and credit derivatives – which are both traded and put on the book of a firm that operates in Singapore have to be reported. At present the only trade repository (TR) service for reporting trades is provided by the Depositary Trust and Clearing Corporation (DTCC), the US post-trade giant; MAS says that it will not discuss whether further repositories are on the cards.
Andy Sterry, London-based co-head of Standard Chartered’s execution, clearing, liquidity and portfolio services business (Eclipse), says, “Reporting is more or less there; the mandate represents a certain operational hurdle and a good line in the sand for those financial institutions and corporate that will be impacted by that requirements.”
Voluntary reporting by selected banks began on 3 February 2014, and all banks began reporting on 1 April 2014. Reporting for other financial entities will begin on 1 July 2014 and for all other ‘significant derivatives holders’ from 1 October 2014.
The latter category is determined as any person based in Singapore whose “aggregate gross notional amount, for the year ending on the last day of that quarter, of the specified derivatives contracts to which he is a party” exceeds the threshold of S$8 billion.
Ahead of the game
Despite the current lack of a mandate to support clearing, many global brokers are already taking up the gauntlet in Singapore. Their motivation is the Basel III capital adequacy rules.
Luke Brereton, the Singapore-based co-head of Eclipse at Standard Chartered says, “The other piece of regulation that we focus on more than the clearing mandate is Basel III. Banks have been voluntarily clearing OTC derivatives on CCPs, such as the LCH, ICE and CME for many years prior to any regulatory mandate. Under Basel III cleared trades attract preferential risk weighting compared with un-cleared trades. Wherever we see increases in risk-weighted assets (RWA) we are naturally looking to find ways to reduce that.”
Clearing brokers have to add a 2% RWA charge to trade exposures for the purpose of calculating the bank’s own counterparty credit risk capital charge, and a CCP’s default fund contributions have to be reflected in any collateral posted. If the bank is not able to clear a derivatives trade through a CCP, an additional 2% RWA charge is applied to the buy-side client for listed derivatives; for OTC trades that are not cleared the additional costs can be so high as to make trading uneconomic. In its Quantitative Impact Study published in 2013, the Bank of International Settlements (BIS) found that the 33 banks surveyed, which made up 75% of global non-centrally cleared derivatives activity, had around in non-cleared €216 trillion notional outstanding, and would therefore require €558 billion for initial margin. Those margining requirements would “increase significantly if the standardised schedule is used by a significant number of firms” the BIS warned.
When brokers are deciding which CCP they should join as members, in order to provide clearing for their clients, these charges have to be considered. Sterry notes that, if a local Asian CCP has not been qualified by the European and Securities Markets Authority (ESMA), pan-European regulatory body, then a European bank will not be able to utilise the local CCP for clearing.
“We will have to go via a local subsidiary of the entity,” he says. “Connecting to CCP’s via multiple legal entities is inefficient for the clearing member and increases costs. The international versus local CCP is an interesting issue. How much international risk should a CCP take on outside of its jurisdiction before it becomes an issue of the home regulator? Conversely could this dilute the international regulators influence when dealing with a local default cleared through an international CCP?”
Selecting a CCP
Standard Chartered cleared its first Singapore trade via SwapClear on 11 December 2013, but also plans to use AsiaClear.
Brereton says that any bank trading in Asia has to examine the costs involved in becoming a member of a local clearing house compared to the international houses and make decisions based upon efficiency.
“As an institution we are assessing which CCPs attract, or likely attract, liquidity, our preference would be for this to be spread across few [CCPs] if possible,” he says.
As the impact of US and European regulations will not be felt by many banks in Asia, who concentrate on local clients and business a situation may develop in which firms like Asiaclear are able to generate membership the local markets, while international players use the bigger CCPs.
“There is a precedent for a local CCP to be effective,” says Brereton. “In the Nordics, local banks servicing their local client base may prefer to use the Nasdaq OMX solution that allows clearing in local currency and euros and dollars. Asian CCPs might look at the same kind of model targeting the different local banks and hedge funds as a good local solution. There is a market for it, the knock on effect is that the big global players have to maintain access to multiple CCPs.”
Syn believes that one possible partition between CCP choice will be based upon where a particular client prefers to hold their counterparty credit risk, such as if a jurisdiction is more familiar to a client, more trusted, or has a better reputation. The second possible partition is where greater liquidity exists, with a growing proportion in Asia.
“Both factors indicate that Asian jurisdiction OTC clearing will see greater usage,” he says. “The CCP in question can be run be either a local exchange or an international exchange.”
Market Infrastructure in Singapore
*Note: There is no current requirement to trade OTC on exchange. The exchanges listed below support listed derivatives.
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Exchanges |
Clearing Houses |
Trade Repositories |
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CME |
Asiaclear (SGX) |
The Depository Trust & Clearing Corp |
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ICE |
CME |
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SGX |
Eurex |
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Singapore Mercantile Exchange |
ICE Clear Europe |
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Swapclear |
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