SINGAPORE (Reuters) - Asian banks are reviewing relationships with their U.S. counterparts to avoid being caught by tough new American rules on derivatives trading that are about to come into force.
From the start of next year, non-U.S. banks that annually deal in at least $8 billion worth of products such as interest rate swaps with American counterparties are expected to be subject to new derivatives rules in the Dodd-Frank Act.
In practice that means they will need to register as swap dealers with U.S. regulators and abide by their rules on capital requirements and risk management, all of which adds to costs.
“If I have the choice, I just don’t want to deal with a ‘U.S. person’,” said a treasury manager at a regional Asian bank.
“We’re still looking at our compliance situation, but it may mean that in future I need to ask all my U.S. counterparties if there’s a way they can change where they book their trades with us”.
A “U.S. person” as defined by the regulation is a relatively broad term, intended by regulators to apply to any person or entity that will have an effect on American commerce.
The Dodd-Frank Act was spurred by the 2008 financial crisis and aims to impose tighter supervision of cross-border derivatives trade following incidents such as the loss-making trades by the so-called “London Whale” at JPMorgan’s UK office.
But some lawyers say even entities that deal in a relatively small amount of derivatives could be forced to execute trades on an electronic platform and put them through a central clearing house acceptable to American regulators.
That has prompted a knee-jerk reaction from some Asian institutions to consider cutting all their derivative trading relationships with U.S. counterparties, anxious to avoid higher trading costs and the spotlight of American regulators.
“For some players the approach now is, ‘do we just bring up the drawbridge to U.S. institutions’?,” said Paget Dare Bryan, a partner for law firm Clifford Chance in Hong Kong.
In reality, few banks are likely in the long-term to cut all trading with U.S. banks given that they provide a lot of liquidity to the market, and it would be hard to remain active in the global markets without them he added.
In Hong Kong, Singapore and Japan combined, around $143.1 billion of interest rate derivatives were traded every day in April 2010, according to the most recent figures from the Bank of International Settlements.
While still small compared with the $1.2 trillion traded in the UK and the $642 billion in the U.S., the turnover has almost tripled from the $50.8 billion recorded in 2004.
American banks are big players in global over-the-counter derivatives markets, with JPMorgan Chase & Co (JPM.N), Citigroup Inc (C.N), Goldman Sachs Group Inc (GS.N), Morgan Stanley (MS.N) and Bank of America Corp (BAC.N) accounting for about 37 percent of all outstanding contracts, according to the International Swaps and Derivatives Association.
Asian players have a smaller share, although Singapore banks DBS Group Holdings (DBSM.SI), Oversea-Chinese Banking Corp (OCBC.SI) and United Overseas Bank Ltd (UOBH.SI) account for a large part of the S$282 billion ($225.57 billion) of interest rate swaps cleared at the Singapore Exchange since it launched its clearing service in November 2010, analysts estimate.
Lawyers say U.S. banks operating in Asia are now re-thinking how they structure themselves and handle their trades.
“U.S. groups that want to remain competitive in the non-U.S. market will need to develop a structure that enables them to trade in a way that does not scare their counterparties away,” said Theodore Paradise, a partner at law firm Davis Polk & Wardwell in Tokyo.
“So the central booking model, where the home office in the U.S. is the counterparty to the trade with the Hong Kong or Singapore hedge fund or bank may be less viable,” he added.
The key criteria for Asian banks is to review which of their trades will be classed as being with a “U.S. person”, a task more complicated than it sounds. For example, a trade between an Asian bank and the Singapore branch of an American bank will be classed as a trade with a U.S. person. A trade with a subsidiary of an American bank in Singapore will not be.
Currently most banks tend to operate overseas operations as branches, since subsidiaries are more expensive to run as they need to be capitalized separately from their parent.
U.S. regulators have indicated that foreign banks can be exempt from some of the rules if the regulatory regime in their home country is viewed to be relatively similar to the American one — a principle known as ‘substituted compliance’.
In Europe, regulators are drafting regulations similar to Dodd-Frank, meaning those exemptions are more likely to apply.
The picture is less clear in Asia. While regulators in major financial centers such as Hong Kong and Singapore are proposing new rules mandating the central clearing of some over-the-counter derivatives, they are opting not to adopt proposals such as forcing trades to be executed on electronic platforms.
“In some ways the general rule is it’s bad to do business with U.S. firms, even U.S. firms located outside the United States, because once an Asian firm does business with a U.S. firm, the Asian firm runs the risk of being subject to U.S. regulation,” said Steven Lofchie, a partner at law firm Cadwalader in New York.
Reporting by Rachel Armstrong; Editing by Denny Thomas and Ken Wills