Compression lessons from Japan

A dealer on a renminbi swaps desk at a European bank in Hong Kong is feeling frustrated. Hitting his counterparty risk limit with his client banks in the mainland – and sometimes inadvertently breaching it – is an all too regular occurrence. The most annoying part? There’s a ready solution within reach – but his client’s just not interested.

Global lenders want their Chinese counterparties to compress the large books of renminbi swaps they’ve built up between them over the past several years in order to crush their notional exposures and free up headroom for new business. So far, they’ve failed to convince all but one lender in the world’s second-largest economy to take part, however – and with local banks not facing the same capital pressures as their global peers, things look set to stay the same for the foreseeable future.

Amid the frustration, global banks looking for succour should cast their minds back a few years to the introduction of compression to the Japanese market.

After a slow start, Japanese banks now make greater use of compression services than any other Asia-Pacific nation, accounting for roughly half of multilateral compression runs across the region, according to one vendor.

Barely a few years ago, the situation was very different. Back then, attempts by US and European banks to cajole their Japanese peers on the other side of swaps trades to compress received very short shrift.

Attitudes gradually began to change, however – thanks in no small part to external lobbying from US and European banks. Slowly but surely, the message got through to the larger Japanese banks that without the benefits of swap compression, they might not be able to trade as much as they would like with their international counterparties.

Similarly, dealers active in the booming renminbi swaps market, fuelled by a surge in onshore eurodollar bond issuance among Chinese corporates, are hoping the threat of exhausted counterparty limits will serve as a spur to local banks to engage in multilateral compression runs, too.

That threat, they hope, along with the onset of new regulation in China, could turn the tables in the next few years. Service providers also point to the looming 2019 and 2020 phases of the global non-cleared margin rules – which will force more than 1,000 counterparties to begin exchanging initial margin on derivatives trades – as likely pushing Chinese banks to act.

The other spur could be a regulatory solution that secures China’s status as a clean-netting jurisdiction, for example, precipitating greater interest in the onshore market on the benefits of portfolio compression, according to a rates trader.

If the eventual embrace of trade compression by Japanese banks shows anything, though, international banks would be well served to keep up the pressure.