Asia Risk 2014 review: the five most talked-about stories

Trading errors, collateral and the potential for China's derivative market were 2014's top stories


2014-reviewIn 2013 banks partied off the back of an Abenomics-inspired Nikkei 225 surge that saw several equity derivative dealers in Japan make record profits. In 2014 the hangover kicked in: while Japan's equity benchmark eventually finished the year ahead of where it started, this was only after a random walk that saw many domestic and international experts question the efficacy of the economic reform process. Asset managers and hedge funds may have been cursing Japan's fundamentals but dealers were instead facing the impact of global trends. In particular, a secular post-crisis change in how funding costs are valued hit Japan hard. Unlike other Asian countries, Japan has pools of collateral in multiple currencies – each with their own costs. The net result was confusion over pricing of over-the-counter derivatives which drove dealers on to the listed market and proved that in a post-financial crisis world collateral is king. Given the number of moving parts in this story and the impact it had on Asia's largest derivative market, it's unsurprising that 'Cross-currency basis causes pricing headache for dealers in Japan' was the most-read Asia story on last year.

2014-reviewThe cumulative fines of less than $100,000 imposed by the Reserve Bank of India in December 2014 on ICICI Bank and the Bank of Baroda for a failure to meet their know your customer (KYC) requirements may seem like a rounding error compared with the $9 billion fine US authorities slapped on BNP Paribas for sanctions busting and anti-money laundering failures, but the principle is constant. The French bank's failings were of a different magnitude to its Indian peers but it serves to highlight the increasing focus regulators are paying to this issue. As is often the case in Asia, difficulties in managing KYC for global banks operating in the region are complicated by the diversity of regulatory frameworks among jurisdictions in the region, making 'Banks struggle to meet know-your-customer requirements' the second most read Asia story in the last 12 months.

2014-reviewderivatives-vols-ar-0215Extraterritoriality has been the key phrase as dealers in Asia face up to the impact of European and US rules on their OTC derivative businesses in the region, but 2014 saw a partial reversal of the trend as section 716 of the Dodd-Frank act, also known as the swaps push-out rule, came into play. This requires US depository institutions that use the Federal Reserve discount window to "push out" their equity, commodity derivative and non-cleared credit default swap transactions from banking entities into separate units. The upshot of which was the two largest US derivative players – JP Morgan and Goldman Sachs – setting up subsidiaries in Singapore to book trades, with Citi and Bank of America Merrill Lynch expected to follow suit soon. The high level of interest in this development made 'Goldman Sachs, JP Morgan to set up booking hubs in Asia' the third most read Asia story.

2014-reviewChanging market structures were the driver behind the fourth most read story – 'Korea clearing structure in question after HanMag trading error' – a great Asia Risk exclusive that was quickly picked up by the global media. While HanMag was just a minor Korean securities house and the total losses were less than $50 million, the impact of the failure went far beyond the peninsula with the principle of clearing houses' "skin the game" worrying dealers around the world. Credit to market-maker Optiver for handing back the profits they received from HanMag's erroneous trade.

2014-reviewWhile China has been a global economic powerhouse for some years its role in the derivative market had been more muted. The Shanghai-Hong Kong stock connect has focused global investors' attention on China's equity market – now the second largest in the world – and structural reforms mean the onshore equity derivative sector is in play. Our fifth most read story, 'China looks beyond commodity derivatives with equity options launch', looks at how the Middle Kingdom - a commodity derivatives powerhouse for some time – is looking to set up an equity derivatives market.

2014-reviewLooking forward to 2015 the biggest story is likely to be one that didn't make this year's top five: the stock connect. While initially seen as a long-only equity story, Asia Risk predicted in September that problems accessing the bridge meant that hedge funds using synthetic structures would be the biggest beneficiaries of the initiative – and not long-only asset managers. At the end of December, Reuters reported that this is indeed the case, that the link with Shanghai is driving a "derivatives boom". Japan is still the pre-eminent Asian derivative market; but 2015 will see China take firm steps towards eventually usurping it.

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