ANALYSIS: International clients boosting electronic rates trading in Japan

An influx of international firms is helping the Japanese rates market catch up with peers in terms of the electronic trading of interest rate swaps (IRS), according to a leading over-the-counter platform.

Taichi Shibuya, head of Japan at electronic trading pioneer Tradeweb, said there are signs of movement fifteen years after the venue - which is majority owned by LSE Group - opened its first Asia Pacific office in Tokyo.

“The Japanese Yen interest rate swap (IRS) ecosystem is an interesting one,” Shibuya said. “Compared to other developed rates markets, it is still behind the curve in terms of leveraging technology to improve the execution process.

“Inter-dealer activity accounts for an estimated 50% of the traded volume. The rest is attributed to the dealer-to-client space, where international institutions are becoming major players. This can influence how Yen swaps are executed, as it allows us to adapt functionalities we offer in other markets to suit the needs of local market participants.”

Tradeweb on Friday reported a record month in September, with a 55% year-on-year increase in average daily notional volume of $2.21 trillion (£1.7tn). The firm is dominant among US registered swap execution facilities (SEFs), with 63% of the interest rate swap market, according to the FIA. As global rates volumes have ballooned, the venue is focusing on its Japanese market, particularly asset swaps for government bonds (JGB).

“These used to be predominantly traded over voice or chat, but we are helping to electronify this market by allowing the JGB and IRS legs of the transaction to be executed separately,” Shibuya added. “This way clients can select the best dealer combination that provides them with the best possible price, and this is something they cannot easily achieve when trading manually.”

Japan was the first country in Asia and the second after the US to introduce a mandatory electronic trading obligation for liquid over-the-counter derivatives, rolled out in September 2015. The lack of expansion of that regime has hindered further development, according to Shibuya.

“Many Japanese institutions started preparing for the new regime by executing IRS trades on digital marketplaces well ahead of the implementation date,” he said. “However, many felt that the scope of the trading obligation was limited, as it only requires domestic institutions with derivatives positions greater than JPY 6 trillion (£30.1 million) to execute five, seven and 10-year Yen swaps on Electronic Trading Platforms (ETPs). Not expanding the in-scope instruments since ETPs went live has resulted in a failure to sustain momentum in ETP volume growth.”

Nevertheless, drives to increase trading efficiency has helped adoption.

“Our data shows that clients can achieve the best performance in these products if they send enquiries inside core market hours, which span 8:45am to 3:02pm, Tokyo time,” he said. “It is easy to see how that can pose a problem for global traders, who either need to wake up early or work night shifts. This is where automated trading solutions available on electronic platforms like Tradeweb come in handy.

“We were, in fact, the first to develop a tool called AiEX Time Release, which allows clients to time their trade enquiries to be sent during core market hours. It is a feature of our rules-based Automated Intelligent Execution tool, and works a bit like a leave order, but rather uses the request-for-quote (RFQ) protocol.”

Another feature gaining traction is Tradeweb’s two-way request for market (RFM) protocol, which has been embraced by emerging market swap users and is increasingly popular in Japanese yen interest rate swap market where it now accounts for a quarter of the market, according to Tradeweb.

Japanese infrastructure providers like the Japan Securities Clearing Corporation (JSCC) have also taken steps to promote access to the market.

“Major Japanese institutions can only clear at the JSCC, but US clients are not able to clear at JSCC. This creates differences in depth of liquidity at certain curve points, leading to a clearing basis between JSCC and other central clearing counterparties (CCPs),” Shibuya said. “Clearing at the JSCC versus other CCPs comes with its operational differences, which causes complexity for clients who can clear at both.

"So, we recently worked with the JSCC and clearing brokers to introduce SEF/Multilateral Trading Facility (MTF) trading, allowing global investors to trade, process, and then clear Yen swaps in the same way they would do with other currencies cleared at other CCPs, and we are witnessing a continued growth in both interest and usage.”

ISDA chief executive Scott O’Malia said last month regulatory reforms of Japan's fund management industry have created a “strong case for the broader use” of derivatives.