The Japanese derivatives market is really two distinct
markets – financial derivatives, with three exchanges,
and commodities, with four. But the apparent strength of these
forces is not reflected in powerful results. Trading volumes
for most of the exchanges, in fact, have been dire. Now both
sectors have begun to grapple with the need for fundamental
The financial derivatives market, with its own regulator and
individual rules, is serviced by the Osaka Securities Exchange,
the Tokyo Stock Exchange and the Tokyo Financial Exchange. This
market is globally significant – though without
Separately, there is commodity derivatives –
peopled by the Tokyo Commodity Exchange, the Tokyo Grain
Exchange, Kansai Commodity Exchange and the Central Japan
Commodity Exchange. This market has shrunk at an alarming
The OSE leads trading volumes in Japan, with 166m contracts
traded last year, making it the world’s 19th
largest exchange according to Futures and Options Intelligence.
OSE has outstripped the TSE – Japan’s
dominant stockmarket – through its suite of Nikkei 225
Index Futures, Options and Mini Futures, which account for
virtually all its volume.
The TSE has been concentrating on winning the share trading
race. Its volume of 26.2m contracts in 2009 was a sixth as much
as OSE’s – its biggest product, Topix
Index Futures, is just not as popular as the Nikkei contracts.
TSE’s Ten Year Japanese Government Bond Futures
also declined in volume last year, though the related options
held up well.
The Tokyo Financial Exchange’s derivatives
offering has virtually dwindled away. Trading of its Three
Month Euroyen Futures on Japanese short term interest rates has
shrunk from 39m contracts in 2007 to 13m last year. Only 3.15m
contracts were made in the first four months of 2010. The
bourse has had some success with its new spot FX service.
Japan’s commodity markets also have a tale of
woe to tell. Tocom is the strongest exchange, though its volume
has declined fairly steadily from 87m contracts in 2003 to
28.9m last year. The slide appears to have bottomed out,
however, with 9.9m bargains in the first four months of
The pain is much worse at Tokyo Grain Exchange, where there
were just 4.83m contracts in 2009, a quarter of
The decline of Japan’s commodity futures
markets is no accident. An amendment to the Commodity Exchange
Law, implemented in 2005, made soliciting individual investors
difficult by putting curbs on aggressive sales techniques such
as phone marketing or cold calling.
Brokerages, which represented retail investors, were forced
to deposit their clients’ margin funds with the
new Japan Commodity Clearing House, which led to a clearer
separation between the accounts of customers and
To make life even harder, the government recently passed new
requirements that from 2011 will ban marketing commodities
products to retail customers except through newspaper
advertisements or specialist seminars – draining the
once dominant retail sector from Japan’s commodity
These legal changes hit some exchanges harder than others,
especially the TGE, which had a large retail customer base.
So bad has the performance of the Central Japan Commodity
Exchange been that news reports even suggested that it would
cease trading – though a spokesperson for the exchange
However, while the commodity exchanges have been handicapped
by changes in the law, they did little to help themselves.
New products, longer hours
The Japanese exchanges know they have a problem with falling
volumes, and that they need to act before they are left further
behind by global competitors. They have announced a string of
initiatives to attract more trading.
The TSE has ambitious plans to double derivatives trading
from 2007 by the end of the 2011 financial year next March.
Because of the decline since then, that means it will have to
raise volume by 153% from 2009 levels.
However, the exchange insists that by expanding its product
portfolio, it can still meet the target.
On July 26, the TSE will introduce three dividend futures,
hoping to capture trade that previously went on over the
counter. They will be linked to the Nikkei Stock Average
Dividend Point Index, the Topix Dividend Index and the Topix
Core 30 Dividend Index.
Dividend futures are this year’s trendy
contract for exchanges to launch, from Chicago to Frankfurt to
Julien Le Noble, chief executive officer of futures broker
Newedge Japan, says there is no reason why the
product’s success elsewhere cannot be replicated
Perhaps the busiest exchange, in terms of new measures to
boost volume, is Tocom. The exchange will extend its trading
hours to 4.30am from October, in the hope of luring trading
firms that play the London and New York commodity markets. In
March it introduced Nikkei-Tocom Commodity Index Futures.
The OTC sunrise
Besides new products and longer trading hours, perhaps the
most intriguing development for the Japanese exchanges is the
prospect of clearing over the counter derivatives.
The idea has been important to European and US exchanges
such as NYSE Liffe and CME Group in recent years.
Japan is the first and so far only major nation to pass a
new law since the financial crisis that mandates clearing of
some derivatives. In Japan, standard yen interest rate swaps
and credit default swaps linked to the iTraxx Japan index will
have to be cleared by regulated clearing houses, probably from
TSE and TFX had both already begun work on creating OTC
clearing houses, and are eager for the new opportunities
created by the law.
Mitch Fulscher, a consultant with Melamed & Associates
in Tokyo and chairman of the Futures Industry Association
Japan, says that unlike the US, the Japanese have taken a
measured approach to regulation since the global financial
He believes the market will benefit from more central
counterparty clearing, though two exchanges offering the same
service could be one too many, when the Japanese OTC market is
not that large.
TFX seems to be thinking along the same lines. Masayuki
Nakajima, executive officer at TFX, says that while no formal
agreement is in place with TSE, one possibility might be that
TFX offers OTC clearing for the interest rate swaps, while the
stock exchange handles CDS.
Tocom is also examining the feasibility of an OTC clearing
house, encouraged by CME Group’s success with
ClearPort for commodities, says Mitsuhiro Onosato, executive
officer for business planning.
Tech is the key
For an exchange, good technology can be a game changer. One
reason why the OSE has been more successful than the other
Japanese exchanges is that it listened to its clients by
implementing Span, give-ups and colocation services.
Not content to rest on its laurels, the OSE has agreed a
deal with Nasdaq OMX to upgrade its platform from the second
quarter of 2011.
Several of the other exchanges have now embarked on
TSE introduced a new options trading platform, Tdex+, in
October last year, and will move its futures to it in the next
TFX, which struck a deal with Liffe to license its exchange
platform in 2005, will upgrade its technology in 2013. Nakajima
says the exchange is "presently in the process of selecting"
which firm will supply the new system.
In the commodities sector, too, the exchanges have finally
begun to address their technical weaknesses, something Fulscher
says is long overdue. They have continued to use archaic
practices, such as an Itayose system, which prevented any
direct market access orders.
In May 2009, Tocom finally went live with a new Nasdaq OMX
trading system, which includes circuit breakers and allows the
exchange to offer colocation.
TGE has also belatedly realised that good technology is
important, striking a deal with Tocom to share its Nasdaq OMX
trading and clearing platform from January 2011.
Fulscher says the IT upgrades show the exchanges have
"finally" realised their technological offering was hindering
"For a long time the leaders of the exchanges just
didn’t get it, just didn’t understand
the importance of providing technology that is demanded for
getting the international participants to join and bring the
liquidity that makes even the domestic markets more
successful," Fulscher says.
Le Noble says these measures have borne fruit: "The influx
of prop trading shops and market makers in the last four years
is a positive reflection of how much more conducive the market
For Fulscher, all the exchanges deserve credit for the
efforts they have made to address this need, but Tocom has
perhaps made the greatest strides. "Tocom has taken long-needed
action to position itself to attract international players," he
One way of seeking trading volume from overseas is a remote
membership scheme – something that the OSE, TFX, Tocom
and TSE have done. These allow overseas investors with no
offices in Japan to become members.
Each scheme is slightly different. At the TSE, firms must
establish some relationships physically in Japan, which
includes having a designated clearing participant and a
resident compliance representative.
With the TFX programme, remote members are only permitted to
trade its Three Month Euroyen Futures and Options.
For its part, Tocom is hoping to capitalise on its upgraded
technology by seeking approval from overseas regulators to
offer direct market access internationally.
Several international firms have taken advantage of this new
service. Fulscher says he himself has noticed an increase in
the number of foreign firms now looking at Japan, though he
advises them that there are still several issues that need to
be addressed. As he puts it:"High frequency traders call upon
me and ask, 'Is now the right time to get into this
market?’ I say 'Almost’."
Fulscher says that while Japan is making huge strides
forward, it must still address problems with the tax position
of international remote members. Firms that have any trading
infrastructure in Japan are taxable, and the tax levels are
much higher than those in other countries.
"Tax is already complicated enough – especially in
Japan. Who wants to put servers close to the Japanese
derivatives exchanges and then be hit by the Japanese tax
authority?" asks one executive at a futures commission merchant
The TSE has worked hard to address this issue. Earlier this
year, it reached an agreement with the National Tax Agency
whereby overseas investors without a presence in Japan will be
considered, on a case-by-case basis, for exemption from the
country’s 40% 'permanent entity’
It is not clear whether the other exchanges offering remote
membership have secured similar agreements. Fulscher says FIA
Japan is in the process of putting a working group together to
tackle this issue with regulators.
A hotline to London’s
While international trading in Japan can be troublesome,
that is not the case in London. NYSE Liffe plans to introduce
Topix futures in the fourth quarter of this year, which will be
fully fungible with the TSE’s contracts. Both
exchanges hope to profit from the deal.
Listing the futures at Liffe will lengthen the trading day
from the present seven hours to 19.5 hours. When trading
finishes in London, open interest will be transferred to
Jonathan Seymour, director of equity derivatives at Liffe in
London, says the new products will complement the
exchange’s existing index futures and options,
while also satisfying demand from clients for access to this
"Topix is very much an institutional benchmark product,"
says Seymour. "It is used globally by institutions that have
exposure to Japanese equities. Many of those institutions are
based in Europe. Our listing of the Topix futures contract will
provide the ability to trade that market in European and US
One country, seven exchanges
Choice is often a competitive driver. However, in Japan it
may be hindering the development of derivatives trading. For a
modest-sized market, Japan’s seven exchanges is a
surprisingly large number.
Le Noble says the effect is to increase costs and barriers
to entry for trading firms. "It’s hard to
understand – when the government and the regulators
are passing into law the possibility for exchanges to list all
types of products, and even to merge or acquire one another
– why so little is happening in this area."
As a result, any firm interested in trading, say, long and
short term Japanese interest rate contracts and the most liquid
equity index contracts would have to connect to three
exchanges. It would have to undertake due diligence three
times, find brokers – not many connect to all the
exchanges – establish relationships and so on.
"It’s very costly for Japan, not only in terms
of higher trading and operating costs, but also the opportunity
loss when participants shy away from such a fragmented and
complex marketplace," Le Noble concludes.
However, the exchanges have steadfastly refused to consider
merging – even though the Commodity Futures Industry
Association of Japan declared in February 2009 that the TGE
should combine with Tocom. It said 80% of brokers surveyed by
the association favoured a merger. The TGE rejected the
An analyst at a Japanese trading firm in Tokyo says he
believes the stubborn approach – particularly from TGE
– is derived from its ownership structure.
While tax may deter bigger international players from
entering Japan’s derivatives markets, there are a
few other problems unique to the commodity sector.
Perhaps not surprisingly, since Japan has been a
domestically focused market until now, its commodities
exchanges have not been that attractive to international
"The products were not really designed for international
customers," says Emmanuel Faure, head of business development
and sales for futures at HSBC, and the issue is complicated by
the large number of commodity exchanges.
For example, the TGE and Kansai Commodity Exchange have a
very similar range of products, and many of the commodities,
such as sugar, silk, coffee and soybeans, can be traded with
much greater liquidity at exchanges elsewhere in the world.
Fulscher highlights another problem: what he calls the
"desperate need" to upgrade the Japan Commodity Clearing House
The FIA Japan published a report on this point in February
2009, saying urgent action was needed in four areas: risk
management, IT infrastructure, overall management, and a new
"The JCCH is far behind international standards," agrees Le
Noble, "and far behind with regard to its ability to serve
The trade association even said that with things the way
they are at the JCCH, a more radical approach may be
"It would be very difficult to expect the existing clearing
house to deal with the changes that we believe are required,
due to its existing structure and the current financial status
of the commodities futures industry in Japan," the FIA Japan
It recommended that Tocom, as the largest commodities
exchange, should head the clearing house. However, it also
offered a more radical suggestion: to create a single clearing
house for both financial and commodity derivatives.
"Internationally, it is recognised that users need and
demand a way to better manage their clearing funds and margin
money, as well as to have transparency and to be able to
measure the risk between each clearing participant as well as
its offsetting positions and arbitrage," the FIA Japan report
Le Noble says creating a single, multi-asset clearing house
would be a great help for the Japanese market. "It would be as
beneficial as if there was one single exchange in Japan," he
Faure agrees: "Anything that makes trading cheaper and
easier for the clients is a good thing for the margin. If they
were to merge the clearing house, at least you could pool
One chance left
With Japan still the world’s second largest
economy – if only a whisker ahead of China now
– it is natural to expect that its derivatives market
should be a global force. However, that view is too easy.
The Japanese market is in danger of being sidelined, as
regional superpowers such as China and India emerge.
"For years and years, Japan was the only way to invest in
Asia," says Faure. "Over recent years other markets have
opened, and now it looks as if other markets have more
Fulscher concludes that Japan should have taken its rightful
place as the financial centre for Asia many years ago, but that
inaction by the exchanges on a series of issues had let the
country fall behind.
But market participants also agree that all is not lost. "I
don’t see Japan as a dead market," says Faure.
Le Noble stresses that Japan continues to be a force in the
world’s markets, and still has all the really
important ingredients to regain a leading role.
"Right now is probably the last chance for Japan to make a
comeback and be a firmly established dominant marketplace in
the Asia Pacific region," says Le Noble. "Japan runs the risk
of being left behind once other regional exchanges have
developed and opened up. But that being said, there is still
huge potential as the problems are more about cultural customs
and domestic policies, rather than real expertise or a lack of