ISDA Survey Highlights Close Out Netting as Crucial Factor in Derivatives Growth

Trading volumes in Asia’s derivatives markets are expected to increase, but achieving certainty on close-out netting is identified as an important factor in driving further development of local markets, according to a new survey of derivatives market participants active in Asia-Pacific, published by ISDA to coincide with the start of its Annual General Meeting (AGM) in Hong Kong.

Nearly three quarters of survey respondents expect the proportion of foreign exchange derivatives trading executed in Asia ex-Japan to increase over the next three to five years, while 63% predict an increase in the share of interest rate derivatives traded in the region. Overall, 74% of survey participants expect derivatives trading activity by Asian banks to increase over the next three to five years, while only 35% expect growth in derivatives trading by US and European banks in Asia.

Unsurprisingly, Singapore and Hong Kong are expected to be the most important centres for derivatives trading in the region, followed by Tokyo, Shanghai and Sydney. Among the factors determining the location of their trading activities, market participants point to a sound legal and regulatory framework, the depth and breadth of market infrastructure, access to customers and counterparties, and netting certainty.

Achieving certainty on close-out netting is considered essential to the further development of robust, liquid and efficient derivatives markets in Asia, with 47% of survey respondents citing this as very important. More than half pointed to the enforceability of close-out netting as having the greatest impact on their firm’s derivatives and risk management activities in Asia. To that end, despite the importance of close-out netting, just 11% of survey participants believe it is very likely that legal certainty on close-out netting is achievable in China over the next three years, and 12% think it is very likely in India. Expectations for Indonesia and Vietnam remain lower at 3% in both countries.

“Close-out netting is the single most important tool for reducing credit risk between counterparties,” says Scott O’Malia, chief executive of ISDA. “While good progress has been made in parts of the region, there is still ambiguity over how close-out netting will be treated in China, India and Indonesia – three of the biggest economies in the region. As these economies continue to grow and demand for financing and hedging increases, having strong, liquid and robust derivatives markets will become even more important.”

ISDA has worked with authorities across the globe to help draft legislation on the enforceability of close-out netting and last October, it published the 2018 update to its Model Netting Act, which is designed to provide a template than can be used by jurisdictions considering close-out netting legislation.

“Without close-out netting, firms need to manage their credit risk on a gross basis, significantly reducing liquidity and credit capacity,” says Eric Litvack, chairman of ISDA. “We believe having certainty on the enforceability of close-out netting encourages more participation from globally active firms, which adds to liquidity and creates the conditions for local derivatives markets to prosper.”

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Colin Lambert

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