Settlement and clearing in Asia: an evolving landscape
11 February 2015
The regulatory and market landscape in Asia continues to evolve, with implications for clearing and settlement across the region. Nicholas Bone and Stephen Pemberton of Standard Chartered Bank take a look
Image: Shutterstock
In recent years, efforts to integrate Asia’s capital markets have gathered pace. The (ASEAN) Association of Southeast Asian Nations trading link, which allows investors to more easily trade cross-border, was established by Malaysia, Thailand and Singapore in 2012, and subsequently joined by Indonesia, the Philippines and Vietnam. For market participants, the ASEAN trading link should, in theory, offer greater opportunities to increase investment choice, improve liquidity and lower costs.
To date, however, the ASEAN trading link has failed to fulfill its promise. It has struggled, largely due to a lack of unified regulation. Local regulators are understandably reluctant to cede oversight over domestic trades, and limited regulatory middle ground has been found. Meanwhile, there seems little chance of an external, third-party (non-domestic) exchange emerging as an alternative to exchange integration, given the fate of Chi-East’s multilateral trading facility, which ceased operation in 2012.
One of the key success criteria to successful exchange consolidation is the delivery of a scalable, cost efficient post-trade platform, which typically accounts for a significant proportion of the front-to-back cost base of market participants. Last year, a new post-trade services regime was established as part of the ASEAN trading link to allow investors to trade cross-border and settle with their domestic central securities depository (CSD). However, while this development is welcome, CSD settlement processes are unlikely to change and uncertainties around deadlines, fees and taxes remain.
Like its exchanges, Asia’s central counterparties (CCPs) remain largely focused on their home markets. Some non-Asian CCPs, such as Eurex and ICE, are now setting up in the region. However, to date their impact has been limited and brokers remain unable to realise the operational and financial benefits of concentrating their activities with fewer CCPs.
Some signs of progress
While the pace of regional exchange integration may not have lived up to prior expectations, other regional initiatives offer grounds for optimism. The Asian funds passport was set up to reduce the dynamic of the ‘suitcase’ sales of (predominantly European-domiciled) mutual funds into markets. This complements some regulatory aspirations to build up the local industry by requiring that foreign managers have a local presence.
It seems, however, that the industry might be viewing the idea of a full Asian funds passport as unattainable, at least in the near term. As a result, mutual recognition or sub-regional passporting is a first step. In 2009, the ASEAN Capital Markets Forum (ACMF) created a framework for the mutual recognition of cross-border offerings of collective investment scheme products (CIS) within the ASEAN to non-retail investors, with the intention of making such products available to retail investors once adequate protective measures have been established. This may be the roadmap to the future developments of passporting schemes in the region.
Another encouraging sign is that the adoption of ISO15022 or ISO20022 standards for post-trade market infrastructures across the region is accelerating. For instance, the Singapore Stock Exchange (SGX) plans to introduce a new post-trade market infrastructure. The first phase will allow market participants to communicate with SGX using an application programming interface (API). For clearing processes (such as allocations), FIXML messages will be used, while ISO20022 SWIFT messages are for settlement. The current client accounting system will be de-commissioned by early 2016.
The second phase of the project, which is expected in the second half of 2016, will enable depository members to send ISO20022 messages for settlement instructions as an alternative to file uploads. In addition, the simultaneous movement of securities and cash will be facilitated (currently there is a lag) and two-tier bank guarantees will be removed.
Similarly, the Thailand Securities Depository is planning to introduce a new post-trade matching system by mid-2015, which will allow local custodians to use SWIFT MT messages for settlement purposes. Kustodian Sentral Efek Indonesia, the domestic CSD, is also planning to upgrade its post-trade infrastructure using ISO 15022 and/or 20022 standards for settlements, corporate actions and funds execution, while the Vietnam Securities Depository is considering the use of ISO15022 for both settlement and corporate actions processing.
Connecting countries
While some pan-regional initiatives may be nascent, other ambitious initiatives are underway to connect markets at a country level. Perhaps the best publicised of these is the Shanghai-Hong Kong Stock Connect, which allows certain investors in each location to access stocks in the other. After the initial launch excitement in November 2014, volumes have remained around 20 percent of quota utilisation on a daily basis, partly due to practical issues, including beneficial ownership and pre-delivery that have prevented many regulated funds in Europe and the US from utilising the link. However, reassuringly, the Hong Kong Stock Exchange is engaging the market to resolve many of these challenges and an ID solution, for example, should be introduced by April this year.
More generally, in the longer term the Shanghai-Hong Kong Stock Connect should be seen as a positive development as it is easier for foreign investors to access the A share market. Equally, the positive reaction and keen interest in the link demonstrates that a unified regulatory view that takes into account practical impediments is key to driving multi-exchange links.
In January, it emerged that Hong Kong and Shenzhen will also create a link, allowing access to more A shares and potentially providing a further boost to liquidity. Future developments could include a bond connect offering.
In September 2014, SGX and the Taiwan Stock Exchange announced a link enabling investors to trade on the other bourse without the need to place an overseas order via a domestic broker. This connection—and a proposed connection between Taiwan and Japan—should lower transaction costs and improve efficiency. However, there is a risk that such links could be difficult to manage: multi-jurisdiction governance and a lack of post-trade efficiency could hamper liquidity, as some perceive it has done with the ASEAN trading link.
Regulatory and market changes
While Asia remains slow to embrace pan-regional solutions—and links between Hong Kong and Shanghai or SGX and Taiwan are still at an early stage—its markets are nevertheless undergoing change as a result of new international and local regulatory reforms and market developments.
For example, many Asian financial institutions are considering the impact of derivatives clearing regulation on their European or US counterparties. Meanwhile, brokers are focused on capital requirements that have arisen from Basel III and other international regulations. They are also adapting to changing clearing requirements for those G20 markets in Asia, which is further exacerbated by the introduction of margin requirements for over-the-counter non-cleared derivatives.
These changes are spurring considerable debate. For example, changes to collateral requirements associated with external regulatory change (rather than simply a desire to manage counterparty risk) are prompting growing awareness of the need to use forms of collateral other than cash, which predominates in Asia. One potential hurdle is the relative illiquidity of Asian bonds, which reduces their attractiveness as collateral. Local corporates and financial institutions are consequently interested in solutions that allow them to use such pools of collateral effectively.
Working with the right provider
The failure to progress faster with regional exchange integration means that Asia remains an extremely diverse and, fragmented region. International and local regulatory change—aimed at making markets safer for investors—reinforces this plurality of market environments. Ultimately, there is a risk that uncoordinated regulatory and market changes, however well intentioned, could restrict investor choice, resulting in outcomes contrary to those intended.
All too often, service providers and other market participants are forced to address change at a single country level, resulting in higher costs and increased complexity. To help make sense of this challenging environment it is important for market participants to work with a service provider that has a pan-regional view and presence, especially at a time when many service providers are reconsidering their commitment on what they want to offer to the region.
In addition, market participants should select a service provider that takes an open-minded view of market and regulatory change. Service providers must be proactive in working with third parties in order to bridge markets and address regulatory challenges. For example, by working with international CSDs it is possible for them to take a more holistic approach to collateral management while providing a differentiated value proposition to clients.
In a complex and rapidly evolving regulatory and market environment, service providers must constantly seek new ways to help their clients to access opportunities in the region as efficiently and effectively as possible.
To date, however, the ASEAN trading link has failed to fulfill its promise. It has struggled, largely due to a lack of unified regulation. Local regulators are understandably reluctant to cede oversight over domestic trades, and limited regulatory middle ground has been found. Meanwhile, there seems little chance of an external, third-party (non-domestic) exchange emerging as an alternative to exchange integration, given the fate of Chi-East’s multilateral trading facility, which ceased operation in 2012.
One of the key success criteria to successful exchange consolidation is the delivery of a scalable, cost efficient post-trade platform, which typically accounts for a significant proportion of the front-to-back cost base of market participants. Last year, a new post-trade services regime was established as part of the ASEAN trading link to allow investors to trade cross-border and settle with their domestic central securities depository (CSD). However, while this development is welcome, CSD settlement processes are unlikely to change and uncertainties around deadlines, fees and taxes remain.
Like its exchanges, Asia’s central counterparties (CCPs) remain largely focused on their home markets. Some non-Asian CCPs, such as Eurex and ICE, are now setting up in the region. However, to date their impact has been limited and brokers remain unable to realise the operational and financial benefits of concentrating their activities with fewer CCPs.
Some signs of progress
While the pace of regional exchange integration may not have lived up to prior expectations, other regional initiatives offer grounds for optimism. The Asian funds passport was set up to reduce the dynamic of the ‘suitcase’ sales of (predominantly European-domiciled) mutual funds into markets. This complements some regulatory aspirations to build up the local industry by requiring that foreign managers have a local presence.
It seems, however, that the industry might be viewing the idea of a full Asian funds passport as unattainable, at least in the near term. As a result, mutual recognition or sub-regional passporting is a first step. In 2009, the ASEAN Capital Markets Forum (ACMF) created a framework for the mutual recognition of cross-border offerings of collective investment scheme products (CIS) within the ASEAN to non-retail investors, with the intention of making such products available to retail investors once adequate protective measures have been established. This may be the roadmap to the future developments of passporting schemes in the region.
Another encouraging sign is that the adoption of ISO15022 or ISO20022 standards for post-trade market infrastructures across the region is accelerating. For instance, the Singapore Stock Exchange (SGX) plans to introduce a new post-trade market infrastructure. The first phase will allow market participants to communicate with SGX using an application programming interface (API). For clearing processes (such as allocations), FIXML messages will be used, while ISO20022 SWIFT messages are for settlement. The current client accounting system will be de-commissioned by early 2016.
The second phase of the project, which is expected in the second half of 2016, will enable depository members to send ISO20022 messages for settlement instructions as an alternative to file uploads. In addition, the simultaneous movement of securities and cash will be facilitated (currently there is a lag) and two-tier bank guarantees will be removed.
Similarly, the Thailand Securities Depository is planning to introduce a new post-trade matching system by mid-2015, which will allow local custodians to use SWIFT MT messages for settlement purposes. Kustodian Sentral Efek Indonesia, the domestic CSD, is also planning to upgrade its post-trade infrastructure using ISO 15022 and/or 20022 standards for settlements, corporate actions and funds execution, while the Vietnam Securities Depository is considering the use of ISO15022 for both settlement and corporate actions processing.
Connecting countries
While some pan-regional initiatives may be nascent, other ambitious initiatives are underway to connect markets at a country level. Perhaps the best publicised of these is the Shanghai-Hong Kong Stock Connect, which allows certain investors in each location to access stocks in the other. After the initial launch excitement in November 2014, volumes have remained around 20 percent of quota utilisation on a daily basis, partly due to practical issues, including beneficial ownership and pre-delivery that have prevented many regulated funds in Europe and the US from utilising the link. However, reassuringly, the Hong Kong Stock Exchange is engaging the market to resolve many of these challenges and an ID solution, for example, should be introduced by April this year.
More generally, in the longer term the Shanghai-Hong Kong Stock Connect should be seen as a positive development as it is easier for foreign investors to access the A share market. Equally, the positive reaction and keen interest in the link demonstrates that a unified regulatory view that takes into account practical impediments is key to driving multi-exchange links.
In January, it emerged that Hong Kong and Shenzhen will also create a link, allowing access to more A shares and potentially providing a further boost to liquidity. Future developments could include a bond connect offering.
In September 2014, SGX and the Taiwan Stock Exchange announced a link enabling investors to trade on the other bourse without the need to place an overseas order via a domestic broker. This connection—and a proposed connection between Taiwan and Japan—should lower transaction costs and improve efficiency. However, there is a risk that such links could be difficult to manage: multi-jurisdiction governance and a lack of post-trade efficiency could hamper liquidity, as some perceive it has done with the ASEAN trading link.
Regulatory and market changes
While Asia remains slow to embrace pan-regional solutions—and links between Hong Kong and Shanghai or SGX and Taiwan are still at an early stage—its markets are nevertheless undergoing change as a result of new international and local regulatory reforms and market developments.
For example, many Asian financial institutions are considering the impact of derivatives clearing regulation on their European or US counterparties. Meanwhile, brokers are focused on capital requirements that have arisen from Basel III and other international regulations. They are also adapting to changing clearing requirements for those G20 markets in Asia, which is further exacerbated by the introduction of margin requirements for over-the-counter non-cleared derivatives.
These changes are spurring considerable debate. For example, changes to collateral requirements associated with external regulatory change (rather than simply a desire to manage counterparty risk) are prompting growing awareness of the need to use forms of collateral other than cash, which predominates in Asia. One potential hurdle is the relative illiquidity of Asian bonds, which reduces their attractiveness as collateral. Local corporates and financial institutions are consequently interested in solutions that allow them to use such pools of collateral effectively.
Working with the right provider
The failure to progress faster with regional exchange integration means that Asia remains an extremely diverse and, fragmented region. International and local regulatory change—aimed at making markets safer for investors—reinforces this plurality of market environments. Ultimately, there is a risk that uncoordinated regulatory and market changes, however well intentioned, could restrict investor choice, resulting in outcomes contrary to those intended.
All too often, service providers and other market participants are forced to address change at a single country level, resulting in higher costs and increased complexity. To help make sense of this challenging environment it is important for market participants to work with a service provider that has a pan-regional view and presence, especially at a time when many service providers are reconsidering their commitment on what they want to offer to the region.
In addition, market participants should select a service provider that takes an open-minded view of market and regulatory change. Service providers must be proactive in working with third parties in order to bridge markets and address regulatory challenges. For example, by working with international CSDs it is possible for them to take a more holistic approach to collateral management while providing a differentiated value proposition to clients.
In a complex and rapidly evolving regulatory and market environment, service providers must constantly seek new ways to help their clients to access opportunities in the region as efficiently and effectively as possible.
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