Derivatives trading isn’t what it used to be. In the U.S. and Europe, wide ranging regulatory changes and advances in technology over the past decade have resulted in a dramatic shift away from the traditional, voice dominated over-the-counter (OTC) trading, towards more transparent electronic markets. The Dodd-Frank Act in the U.S. and the Markets in Financial Instruments Regulation (MiFIR) reforms in Europe were put in place to reduce systemic risk by imposing standardisation and central clearing in markets after the global financial crisis.
Asia, however, has largely not experienced such regulatory shifts, and OTC trading is still common across the region. As a ‘later mover’ when it comes to electronic swaps trading, Asia has opportunities to learn from its counterparts in America and Europe, to realise the benefits of electronic execution in ways that suit the unique markets that make up the region.
Hong Kong, Singapore and Tokyo are major derivatives hubs, however trading remains very much OTC. Personal relationships between clients and liquidity providers, which were historically at the core of derivatives trading globally, remain extremely important in Asia, where personal connections are fundamental to doing business. Many traders still believe the only way they can maintain this relationship-driven workflow is by picking up the phone and discussing pricing with a couple of trusted brokers, rather than taking advantage of an electronic alternative.
The development of the Asian swaps market is of global interest, as its importance grows in line with its strong economic growth. Last year, a survey by the International Swaps and Derivatives Association found that 74% of respondents expected that the proportion of global foreign exchange derivatives taking place on Asia ex-Japan trading desks will grow over the next three to five years. The same survey found that nearly three-quarters of respondents expect derivatives trading activity of Asian banks to increase over the same period, compared with just 35% for U.S. and European banks in Asia.
Following the launch of our Asia emerging markets interest rate swaps platform in January 2020, our offering now covers 12 markets including Singapore, Hong Kong, Korea and China. So far, we have seen nearly USD20 billion notional traded by the end of August, supported by 8 liquidity providers.
Our experience suggests that electronic trading will take hold in Asia, but that its rise will be different to what has been seen in Europe and the U.S. As markets grow in the region, electronic tools give traders the ability to scale up their operations efficiently and automate the more routine tasks, so time is given back to focus on key relationships. As an adjunct to voice trading, electronic execution builds on the capabilities of human traders to deliver benefits in terms of straight-through-processing efficiencies, enhanced liquidity access and best execution.
Another source of demand for electronic trading is from global accounts. These large clients are typically subject to either European or U.S. regulations that mandate their activity to trade and/or clear on a regulated electronic venue. As these accounts become more active trading swaps in Asia, we expect it will boost the demand for electronic trading.
The leading banks and institutions that dominate each of the region’s local markets are starting to modify their voice driven business models, building more technology solutions into their trading workflows. This gives firms a considerable advantage: being able to service both global clients trading into their local markets, as well as more traditional local clients. One notable example of this working in practice is when participants are actively using USD to hedge trades in domestic markets, and taking advantage of the associated benefits that electronification brings.
Additionally, we have witnessed a marked acceleration where clients in Asia are embracing new tools and processes that help them to automate certain parts of their workflow. As asset managers face increasing pressures to optimise their trading operations and ensure cost-effectiveness, the accuracy and scalability of trade automation are required to boost competitiveness in a fast-evolving and challenging landscape.
Asia’s forward-thinking institutions realise that these changes are not a threat to the longstanding relationships they have with their clients. Instead, a more efficient trading solution keeps relationships central to the process, since it allows brokers to focus more on maintaining the connections with their clients. So as both traders and brokers better understand the win-win situation that comes from electronic trading, it is our view that swaps in Asia are more and more likely to be traded on a digital platform.