The Monetary Authority of Singapore (MAS) ushered in a new era for the Asian capital markets in February by issuing a consultation paper on the proposed regulation of over the counter (OTC) derivatives.
With this move, the central bank has sent a clear signal to the global capital markets that Singapore is fully committed to implementing the OTC derivatives market reforms initiated by the leaders of the G20 group of major economies and strengthening the international financial regulatory system.
MAS’s proposals also allay fears of American and European policymakers of accumulation of systemic risk and the world facing another financial crisis if derivative traders seize regulatory arbitrage opportunities in Asian financial centers known to have a more tax and regulation-friendly environment.
The proposals in the MAS consultation paper largely emulate the recommendations of the G20 which include increased standardization of derivative contracts, a move to central clearing, reporting to trade repositories and higher capital requirements for non-centrally cleared contracts to reflect their greater level of counterparty risk.
The one significant difference between the proposals of the G20 and MAS is that the Singapore central bank is not mandating that centrally cleared derivative trades be executed on electronic trading venues. This is appropriate given the small size of the market and the bespoke nature of the contracts being traded in the city-state.
These changes will certainly improve transparency, mitigate risk and protect against market abuse in Singapore. More importantly, it will have a number of other positive ramifications given some interesting characteristics of the Singapore market.
Singapore is the largest hub for trading Asian non-deliverable forwards (NDFs) – a very active, large and growing market. The Singapore Exchange (SGX) recently started offering clearing services for NDFs of the Chinese Yuan, Indonesian Rupiah, Indian Rupee, Korean Won, Malaysian Ringgit, Philippine Peso and Taiwanese Dollar.
This follows SGX’s launch of a clearing service for Singapore dollar interest rate swaps in 2010. Also, the rapid expansion and increasing international influence of the offshore renminbi (CNH) will alter the landscape of the global currency markets.
Given its close commercial relationship with China and its preeminent position in Asia as a banking and trading hub, Singapore is the next logical place for expanding CNH trading and settlement beyond Hong Kong.
If an offshore RMB center is launched in Singapore, we predict considerable growth in its currency options and swaps markets.
Given these drivers of growth in the Singaporean OTC derivatives market, MAS’s proposals are likely to result in a surge of market data, more liquidity venues, better prices and increased pre-trade and post-trade transparency. As more contracts become standardized, electronic trading venues may emerge.
Expect technology providers to play a prominent role. Clearing houses will have to upgrade their systems since the requirements of exchange traded instruments are quite different from those of OTC derivatives.
Trade repositories also need to have functionality and underlying technology capabilities for storing data and reporting to regulators. Lastly, all the different entities that play a role in the OTC derivative trade lifecycle would need to invest in networking and communications technology to connect to one another.
Even though there is varied opinion on the benefits provided by derivatives, they play a very important role in providing efficiency to the capital markets. The MAS proposals address the weaknesses in the OTC derivatives markets while preserving the benefits they offer. It will also allow Singapore to develop its own unique niche in safely and effectively trading these contracts