Asia swaps trading stumbles amid confusion over margin rules

[SINGAPORE] Trading in Asia's over-the-counter (OTC) swaps market has ground to a near halt as dealers seek clarity over new derivatives trading rules that could ramp up global funding costs by more than US$500 billion.

The rules, effective on Thursday, directly affect US and Japanese banks, major players in the region, which will be required to post and collect collateral or 'margin' against OTC trades - a development set to dramatically raise the cost of trading in the US$500 trillion global swaps market.

Traders and market insiders told Reuters some major banks in the region had halted dealing in a range of OTC derivatives products, including foreign exchange non-deliverable forwards (NDFs) and interest rate swaps, as they are not yet able to comply with the rules, first proposed by global regulators following the 2008-2009 financial crisis.

"There is a lot of confusion," said one interest rates trader in Singapore. "The margining is an issue. The big banks are covered under that rule, and some of them don't yet have systems and the back-end documentation processes in place."

The markets for Asian currency NDFs and interest rate swaps are "frozen at the moment" due to the new margining requirements said Jeffrey Halley, senior market analyst for foreign exchange broker OANDA in Singapore.

"Some counterparties don't want to face US and Japanese names, because they don't want to have to be obliged to post initial margin...so the whole market's a bit fragmented. As a result, it's just come to a complete halt basically," Mr Halley said.

The new rules will not be enforced in Europe until mid-2017, as the European Commission announced earlier this year that it would delay implementation.

But in practice European banks have also been working towards the Sept 1 date, according to the International Swaps and Derivatives Association (ISDA), a global trade association for OTC derivatives.

"On the face of it, the delay in European rules would appear to mean a phase 1 European entity can trade with another European phase 1 entity and not be subject to US or Japanese margin requirements from September 1," said Scott O'Malia, ISDA's chief executive.

European banks may need or want to trade with US or Japanese counterparties for certain products for pricing or liquidity reasons, he said. "As such, European phase 1 firms have been working towards the September 1 start date too," he said.

Following the financial crisis, global regulators drew up rules to increase transparency and reduce risks in the OTC derivatives market, which was largely responsible for the collapse of Lehman Brothers and bringing insurance giant AIG to its knees.

These included pushing some OTC trades onto exchange-like platforms and through clearing houses, which guarantee payment in the event either party defaults.

The margin rules aim to secure trades that are too complex or illiquid for exchanges and clearing houses to handle, but the global cost of funding the margin rules is likely to ultimately exceed $500 billion, according to U.S and European regulators.

Large US and Japanese banks have been scrambling to prepare for the first phase of the margin rules - which require changes to risk models, legal documents, and custody arrangements - but some were not able to do so by Thursday.

"We've been working on fixing documentations for a month but we couldn't finish everything in time," said one trader at a Japanese bank, who added that liquidity in NDFS had been low on Thursday.

Regulators in Europe, Singapore, Hong Kong and Australia recently delayed the implementation of the margin rules amid fears their banks were not ready - in a move some experts say has created an uneven playing field. India said it was delaying its margin rules on Thursday.

Many banks from these markets have stopped trading OTC products with US and Japanese banks, lest they are forced to post collateral to trade with them, said Kishore Ramakrishnan, a director at PricewaterhouseCoopers Consulting in Hong Kong.

"It's D-Day today and we're seeing the market segment. Not all the rules globally are in harmony, so many banks in the region have been revising their contracts so as not to deal with US banks," Mr Ramakrishnan said. "This regulatory arbitrage won't change until we have a level regulatory playing field next summer."

REUTERS