New U.S. derivative rules leave Asia markets vulnerable

Sun Nov 24, 2013 4:09pm EST
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By Saikat Chatterjee and Rachel Armstrong

HONG KONG/SINGAPORE (Reuters) - Several Asian and U.S. banks are working around new U.S. regulations on derivatives trading aimed at preventing a repeat of the 2008 financial crisis - moves that are legal but leave markets in the region exposed to a risky liquidity shortage, traders and bankers say.

U.S. regulators are pushing to move much of the $693 trillion over-the-counter derivatives market to new electronic platforms known as Swap Execution Facilities (SEF), which will increase transparency and help prevent the recurrence of the 2008 crisis. The SEFs started trading on Oct 2.

But dealers estimate only 10 to 20 percent of Asia's daily market turnover in currency and interest rate derivatives - estimated by derivatives traders in the region at about $20 billion - has moved to the SEFs with the rest being settled in the wider market or bilaterally. The fragmentation of liquidity has made it difficult for investors to hedge portfolio risk, especially for large trades.

Asian participants say they are not legally bound by the rules drawn up by the Commodities Futures Trading Commission (CFTC), the main U.S. derivatives regulator. But any trades with U.S. counterparties will have to be on SEFs if their deals with American entities exceed $8 billion over the preceding 12 months.

"We have shifted away from dealing with U.S. persons although we have not forbidden our staff to trade with them altogether - if you have to do it you have to do it, but if you have an alternative then go for that as we would like to keep under the CFTC minimum threshold," said Frederick Shen, head of global treasury business management at Oversea-Chinese Banking Corp Ltd (OCBC) in Singapore.

Trading on the SEFs will mean more disclosure and other regulatory requirements in addition to more costs. So many Asian banks now prefer to trade derivatives with non-U.S. counterparties, or look to settle trades bilaterally.

"One of the issues with SEFs is because you are going through a broker, they are likely going to charge you more on a SEF because they've got additional reporting requirements. They typically have to outsource that work, so they pass on the additional cost," Shen said.

U.S. banks, worried they may be shut out of the growing Asian swaps and derivatives market, are employing methods that will avoid the rules but are legal.   Continued...