Starting in mid-2018, global investors will have access to a large slice of China’s US$7 trillion market following MSCI’s decision last year to add 222 China A Large Cap stocks to its Emerging Markets Index. In December, Hong Kong’s stock exchange announced major changes to its listing rules and procedures, in a bid to gain a bigger share of the global IPO market. And in March 2018, Bloomberg announced that Chinese bonds would be added to one of its global indices.
These and other developments present a significant opportunity to investors keen on diversifying their portfolios in Asia-Pacific and capitalising on the region’s growth story. At the same time, it’s vital to recognise that these changes add new layers of complexity in a part of the world where each market is characterised by its own set of regulations, trading infrastructure and risks.
In addition, many Asia-Pacific markets are transforming their clearing and settlement practices, with the help of regulatory changes, new products and advances in technology.
For instance, exchanges in Hong Kong, Singapore and Japan are each considering their own approach to following Australia’s lead in using blockchain technology. Meanwhile, India and Malaysia, among other Asia-Pacific markets, are considering adopting SWIFT’s ISO 20022 messaging format, which could replace legacy systems connecting to central counterparty clearing houses (CCPs) and central securities depositories (CSDs). And at a time when local regulators are reassessing capital requirements, risk reduction is driving markets towards shorter settlement periods, which can prove especially challenging for European and US investors trading in the region unless they have a regional presence.
In such a dynamic environment sound custodial, clearing and settlement services are crucial. Non-compliance with these new standards is not an option, therefore the burden on a self-clearing broker to invest and adapt to these new infrastructure changes can be substantial and a significant distraction.
Of the various options available to brokers, third-party clearing (TPC) offers the most benefits and flexibility. While self-clearing may sometimes be seen as cost-effective for those managing large trading volumes, TPC can reduce capital outlay such as investing in a back-office system and hiring staff to manage the operation. TPC also makes for a better choice in many markets over the legacy account-operator model, which helps cut down on most costs but leaves the responsibility and the expenses associated with regulatory compliance to be borne by the broker.
Flexibility and efficiency
First, there’s the perennial issue of liquidity which is a very different proposition in Asia than in Europe and the US. Different markets in Asia-Pacific use different currencies, with different funding available in each. As such, investors selling one security in one market are required to go through an FX transaction to cover a trade settling in another market, unlike in the EU or US. This extra step can cause a delay in funding, affecting intraday liquidity requirements. Similarly, brokers that operate regional hubs in Asia-Pacific may need to move funds from market to market to effect the timely settlement of transactions with their clients. One solution is for brokers to seek intraday liquidity solutions from their banking partners. These solutions need to be flexible enough to cover any peak activity that can come from rebalancing periods from their clients, whilst not creating significant fixed costs that can hit profitability. The banking partner may request collateral or some other form of assurance from the broker to provide the necessary credit line and this can impact on the brokers’ overall asset structure.
An alternative solution can be provided through TPC: the clearing party could, for instance, provide intraday liquidity solutions to the broker on an uncommitted, undisclosed basis to assist in the coverage of their daily activity. Or they could do so on a committed or overnight basis to add more certainty and flexibility (at an additional cost). These solutions allow brokers to feel more comfortable meeting the needs of new clients with cross-border liquidity requirements and the clearing agent can use the assurance gained from their operation of the clearing and settlement flow to reduce the additional collateral requirement.
Consider also that securities service providers are typically at the forefront of anticipating new regulations and the impact on their clients. Brokers can count on TPC to reduce their compliance burden and help them navigate the constantly shifting maze of regulations across Asia-Pacific markets. A TPC model also helps streamline the clearing and settlement process, taking care of ongoing project expenditure on operations and IT, freeing up the broker to focus on its core business, winning new clients or on expanding into new markets and asset classes.
TPC can deliver significant cost savings. Costs such as capital requirements, payments of margin calls and contributions to the default fund are passed to a TPC partner, who also takes on the responsibility of preparing for future changes to market infrastructure. Added to which, TPC does away with the need to maintain a separate relationship with a local bank for cash settlements and liquidity requirements. In the account operator model, the broker is responsible for all of the above except infrastructure upgrades.
Even large international brokers, who might typically opt for self-clearing to handle high trading volumes, would be best served by outsourcing to a TPC partner. Compared to self-clearing’s high fixed costs such as capital for collateral, staffing and compliance, outsourcing the service can lead to lower and more manageable variable costs and avoids the international broker needing to keep a very close eye on the ongoing changes in each local market.
Access to technology
A TPC operator can also provide clients access to its technological expertise, saving them the effort of developing, maintaining and upgrading in-house technology, or the hassle of finding a vendor to outsource their technology needs.
This can be especially useful in managing changes to market infrastructure. Adapting to the digitisation of post-trade systems -either through new technology like blockchain or the introduction of new messaging standards - can be a challenge. This is especially so for smaller brokers, both in terms of the prohibitive costs involved and the need to re-evaluate current operating models. Outsourcing to specialist firms helps as they are better equipped to manage current and future changes to market infrastructure.
As an example, BNP Paribas Securities Services owns a stake in US-based fintech company, Digital Asset, that is building a clearing and settlement system, potentially the first industrial-scale platform using blockchain, to replace the Australian Securities Exchange’s Clearing House Electronic Sub-register System, or CHESS.
International and local expertise
In essence, a TPC partner combines the services of custodian, settlement agent, netting provider, liquidity provider, and settlement and cash bank, not to mention a technology provider with guaranteed operational support. On top of which, TPC gives brokers the confidence that a committed, focused partner is helping them meet their regulatory and client needs.
Even large global players with established self-clearing infrastructures in their home markets would be better served by partnering with established local or regional custodians in Asia-Pacific, to help with the challenges of entering and succeeding in such a dynamic and rapidly evolving market.
A regional expert such as BNP Paribas Securities Services, one of the largest third-party clearers in the region, can bring a consultative approach and dedicated teams of local experts to help manage new regulatory environments and minimise their impact. As the region moves to implement wide-ranging changes to its market infrastructure, many of which are expected to be along the lines of those in practice in European markets, BNP Paribas Securities Services is well positioned to assist investors to make the most of the immense opportunities offered by the Asia Pacific markets.
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