Analysis: Asia's new clearing houses risk sitting idle

SINGAPORE (Reuters) - Money being poured into central clearing houses for derivatives in Asia may be headed down the drain, with banks and brokers unwilling to sign up due to the costs and complexities involved.

Exchanges across Asia, encouraged by the regulators, have embarked on a plan to launch clearing services for derivatives that are traded over-the-counter.

Many of those projects, however, may be doomed to fail, as it becomes apparent that the nascent state of the derivatives market in the region can only support a limited number of players and even they won't find it easy to draw clients.

"Worldwide, the view is there's room for around five or six clearing houses, the rest will struggle or have a niche market," said Laurent Cunin, Asia-Pacific head of brokerage Newedge in an interview with Reuters.

The Singapore Exchange (SGXL.SI) is already clearing interest rate swaps and some foreign exchange forwards, while Hong Kong, South Korea, Japan, China and India are all in the process of launching financial OTC derivative clearing services.

The moves follow the commitment by the Group of 20 leading economies to have all standardized OTC derivatives centrally cleared. The aim is to prevent a repeat of the aftermath of the collapse of Lehman Brothers in 2008 when a large number of its derivative trades were not completed, inflicting big losses on its counterparties.

But establishing a central clearing house is not cheap and there are doubts if all of the new entrants will be able to turn a profit.

"It comes down to cost, and if you don't have enough large players (using the service) there is going to be a disproportionate cost," said Alberto Pravettoni, managing director of commercial services for LCH.Clearnet Group, the world's largest independent clearing house for interest rate swaps, at a recent Futures Industry Association (FIA) conference in Singapore.

CONCERNS ON VOLUME

The cost of running a clearing house varies, depending on the size of the market it clears and the variety of products it handles, but at a minimum they are likely to cost tens of millions of dollars. Hong Kong Exchanges and Clearing (0388.HK) has said it will invest an initial HK$180 million ($23.13 million) in its new project.

While Asia's share of the $600 trillion global OTC market is likely to grow in the coming years, at the moment it stands at around 15 percent, according to financial services technology company Celent.

That's prompting concerns that there will not be enough volume passing through the new central clearing services to encourage the big global banks to become members of all of them.

Brokers and banks, when given the choice, would prefer to use as small a number of clearing providers as possible in order to gain the most from netting benefits - using off-setting trading positions to reduce their total margin requirements.

Joining a new clearing house also involves costs for banks in terms of stumping up money for a common default pool and installing new technology.

So banks are likely to still use, where they can, the big global players like LCH.Clearnet, CME Group Inc (CME.O) and IntercontinentalExchange Inc (ICE.N) to clear their OTC trades when the new rules kick in at the end of 2012 rather than use the new domestic clearing houses in Asia.

"I could envisage a situation where other banks that are big clearers today may decide not to join the Japan CCP (central clearing counterparty) for example," said Michelle Neal, global head of electronic markets, futures and OTC derivative clearing at Nomura.

PROTECTIONISM

Asian regulators could limit banks' ability to put all trades through a global clearing house by setting the rules such that certain products must be cleared domestically.

Japan, for example, has mandated that credit default swaps which track Japanese corporate credit indexes must be cleared at a domestic clearing house, and is mulling bringing in similar rules for yen-denominated interest rate swaps.

Hong Kong regulators have also said they will look at forcing products it considers to be of systemic importance to its economy to be cleared onshore.

But risk experts say the bulk of OTC derivative trades are cross-border so a domestic solution is tricky as it will be harder for say a Japanese bank to trade an OTC swap product with a Singapore bank.

"If governments impose those kind of rules the market will simply just shrink," said Professor Duan Jin-Chuan, director of the Risk Management Institute at the National University of Singapore.

"That would reduce the risk in the financial system but it will also lower economic activity as banks and companies will be a lot more cautious as they will not be able to hedge their risks," he said.

NICHE MARKETS

Asian exchanges are not ignorant of the challenges facing their new operations.

The Hong Kong bourse is hoping that its new service will offer specialist clearing services for the offshore renminbi products.

"We're under no illusion that we're going to be able to compete with the LCH or CME, or that we're going to be a value player in the U.S. dollar or euro currency," said Tae Seok Yoo, vice president of platform and development at the exchange during the recent FIA conference.

"But if you're interested in making money from the (offshore) renminbi come join us," he added.

Capturing a niche market may be the way to go, but there are still doubts that all of Asia's new clearing houses will survive.

"I think there is room regionally for maybe two players, but certainly no more," said Professor Duan.

He thinks it's likely regulators will eventually be forced to acknowledge this and bring in better reciprocal arrangements with each other that will make cross-border derivatives trading easier.

But banks say the reforms are making the derivative business a lot more complex, meaning some may struggle to remain global players.

"With the interest rate market, we could move from what was a fairly effective, globally cleared market to a much more fragmented market, which is introducing a lot of cost and uncertainty," said Nomura's Neal.

($1 = 1.2831 Singapore dollars)

($1 = 7.7833 Hong Kong dollars)

(Editing by Michael Flaherty and Muralikumar Anantharaman)