By Andrew Bernard, head of Asia at Tradeweb
Policymakers’ response to the global economic crisis has been to adopt a series of reforms aimed at strengthening the financial system and shielding it from future shocks. As these rules come into force in different jurisdictions, the role of technology is proving vital in facilitating compliance and enabling firms to adapt effectively to new demands.
After the onset of the financial crisis, legislators across the world looked for ways to eliminate systemic risk, promote transparency and cultivate more efficient markets. In 2009, the G20 Pittsburgh Summit declared that all standardised over-the-counter (OTC) derivative contracts should be traded on exchanges or electronic trading venues where appropriate, cleared through central counterparties, and reported to trade repositories.
Japan is the latest in line – and the first in Asia – to have implemented mandatory electronic trading for specified OTC instruments, with the new rules coming into force at the beginning of September 2015. The rules are more self-contained than many of their overseas counterparts, only affecting 5-, 7- and 10-year onshore yen-swap transactions between financial institutions with a derivatives balance of more than ¥6 trillion. These transactions must be carried out over electronic trading platforms (ETPs), which are then required to publish trade-related information.
The market had been preparing for this change for some time, having already seen its first electronically-traded yen-swap transaction cleared by the Japanese Securities Clearing Corporation (JSCC) in June 2014. The first transactions under the new mandatory electronic trading regime were completed on the same day the rules came into force. Healthy activity has continued since: financial research firm Clarus recently reported that ¥2 trillion was traded over five ETPs in September, including ¥765 billion attributed to Tradeweb alone.
The above numbers are proof that the value of e-trading in this mandated space is significant. Clients have begun transacting electronically outside the narrow terms of the mandate itself. This is a sure reflection of a developing understanding of trading efficiency and the availability of liquidity, as well as an indication of a significant shift in behaviour. The robust responses of dealers to electronic requests for quotation show that the providers– and the consumers – of liquidity are fully engaged in this market.
Elsewhere in Asia, Australia is working to produce its own rules for mandatory electronic trading, while Singapore and Hong Kong regulators are concentrating on producing rules for reporting and clearing. In February 2015, the Monetary Authority of Singapore (MAS) said that it had no plans to impose an e-trading mandate for derivatives at this stage. It proposed, however, putting in place the necessary legislative framework for implementing a trading mandate, in case it is deemed appropriate to do so in the future.
The US experience
Other regions are able to draw several useful lessons from the U.S. experience, when writing the rules for, and implementing, their own trading mandates. Electronic execution of OTC derivatives trades accelerated when swap execution facilities (SEFs), were introduced. Moreover, the phase-in approach adopted by the U.S regulators helped the market adapt more easily to the new trading landscape.
Clients in Asia had been developing their capacity for electronic trading in advance of the launch of ETPs in Japan. Since October 2013 they have been accessing U.S. liquidity via SEFs, where trades in interest rate and credit default swaps certified as “made available to trade” have to be conducted, when transacting with parties designated as “U.S. Persons”. In many cases this has been to access a pool of liquidity that is perceived to have concentrated into SEFs, and not as a result of a requirement to act through a trading platform, signifying a notable change in market behaviour.
Europe nears regulatory milestone
Europe’s major trading regulatory milestone is fast approaching. The pieces of legislation designed to reform trading in Europe – MiFID II (Markets in Financial Instruments Directive II) and MiFIR (Markets in Financial Instruments Regulation) – will cover a range of asset classes, not only equities and bonds, but also exchange-traded funds (ETFs), and derivatives.
The final draft of the technical standards for MiFID II was published in September, and will now have to be endorsed by policy-makers before being published in the official journal. The specific rules for derivatives trading come under MiFIR, which sets out requirements for using regulated trading venues, increasing pre- and post-trade transparency, and ensuring non-discriminatory access to central counterparties.
European rules are to be enacted in January 2017, and it is still unclear what their impact will be on cross-border transactions. Asia-based clients should, therefore, ensure they are fully informed on the detail of upcoming regulation, and on any potential consequences to their business, well ahead of the rules’ implementation date.
Technology easing compliance and generating efficiency
Beyond regulating market mechanisms, mandatory electronic trading rules have paved the way for new functionalities on trading platforms, designed to help market participants satisfy the new rules, while creating a more efficient trading workflow. Advanced platforms are offering investors further benefits, including greater pre- and post-trade efficiency, minimised costs, and reduced operational risks.
Compression trading, for instance, has proved highly popular with investors looking to manage their line items and minimise the number of outstanding transactions with clearing houses. In the past, this was a matter of netting or terminating individual trades – a laborious manual process. Since 2013, around $2.4 trillion in notional compression volume has been electronically executed on Tradeweb, demonstrating how innovation can help investors comply with regulations, while generating significant efficiency gains.
It is important to note that the growing adoption of e-trading doesn’t just stem from the requirements of regulatory reform. Mandatory trading rules have acted as a catalyst for behavioural change. In Japan, the volume of trades in non-mandated instruments conducted on Tradeweb has been rising steadily. This is a clear sign that clients increasingly recognise the significant operational efficiencies electronic execution venues have to offer. As firms become more comfortable performing their transactions electronically, so we will notice that there is a more broadly-based increase in liquidity across the whole marketplace.