Securities Settlement Revolution: JGB T+1 & the Dawn of a New Repo Market

  (Source: Wikipedia, Bank of Japan Head Office)

This series of reports on the so-called “securities settlement revolution” will focus on key trends and changes in Japan‘s securities settlement market while exploring legacy systems and ecosystem migration, as well as the related possibilities of innovation and emerging technologies in this context.

The first effort in the securities settlement revolution involves shortening the settlement cycle for JGBs, planned for the spring of 2018. In April 2012, the market successfully introduced a settlement cycle that was shortened to two business days (T+2) for outright JGB transactions and special collateral (SC) repurchase transactions (repos) and one business day (T+1) for general collateral (GC) repos (together collectively regarded as T+2). The upcoming “revolution” hopes to shorten this settlement cycle to T+1, one business day after a trade.

Market participants should take this event as an opportunity to modernize their business processes and systems:

  1. Initiatives to shorten the settlement cycle for JGBs and securities.
  2. Efforts to enhance the functions, and expand the use, linkages, and integration of the CCP.
  3. Enhanced functions of the central securities depository (CSD).
  4. Accelerated adoption and use of straight-through processing by market participants.
  5. Facilitating smoother cross-border securities settlement. The revolution in the works will go beyond mere cosmetic reforms to the market system.

This new market, envisioned to reach a scale of 20 trillion to 30 trillion yen, could cause structural change.

  1. The coming watershed in repo trading is an opportunity to create a new repo market.
    This is because of the shift from Japan’s unique “gentan” repo (securities-lending
    approach) to the “gensaki” approach, which is the international norm.
  2. With the advent of this new system, a same-day settlement market will emerge in
    Japan’s money market. 

Technology continues to evolve. It advances without waiting for the financial industry or its players to come to grips with it or to develop pertinent applications. The securities settlement revolution in Japan has unfolded slowly, requiring more than 15 years all told. The coming financial infrastructure revolution should not take place at such a glacial pace.

Financial institutions find themselves at a point where they should reconsider their approaches to financial infrastructure management. System reform will need to be tackled. Loosely coupling (or unbundling) connections with the financial infrastructure (exchanges, clearing houses, and settlement infrastructure) can increase the available options in business and IT sourcing models, contributing to strategic flexibility.


Related release:

Securities Settlement Revolution: JGB T+1 & the Dawn of a New Repo Market


Interoperability: Potential Game Changer for Indian CCPs

India has many stock exchanges, but trading is dominated at two main exchanges – the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). BSE is among the oldest stock exchanges in the world, while NSE was established as part of India’s economic liberalization process in the early 1990s. The NSE was quick to gain market share and now accounts for around two-third of stock trading and most of derivative trading in the country. BSE was slow to react to competition in the early days, but in the last five to six years has taken steps to up its game by making major changes in its technology. Structural issues with the Indian capital market have so far limited its ability to close the gap with NSE. The Indian CCPs that clear exchange trades are owned by the respective exchanges and at present only clear trades executed at the owner exchange. National Securities Clearing Corporation Limited (NSCCL) is the CCP for NSE while Indian Clearing Corporation Limited (ICCL) is the CCP for BSE. Interoperability among CCPs at an investor level is not allowed; i.e., investors can choose which exchange would execute their trades, but cannot choose which CCP would clear them. Therefore, in spite of having multiple players in the clearing space, there is not much competition among the CCPs. The dynamics in the Indian CCP space therefore are largely driven by the competitive developments on the exchange front. The capital market regulator SEBI allowed direct market access in India in 2008 and soon afterwards allowed colocation and smart order routing (SOR). This should ideally allow investors to execute their trades at any exchange of their choice. However, most of the liquidity is concentrated at the NSE due to its dominant position. Furthermore, since almost all of derivative trading takes place at the NSE, investors tend to prefer NSE for their equity trades as well, since that allows them cross-asset margining benefits of clearing trades in different asset classes at the same CCP. Because of this, smart order routing has not picked up in India yet. Thus algo trading reached around 15% in the cash segment in NSE in 2014, but smart order routing was only around 2%. Similarly algo trading was 70% at BSE’s cash segment, but SOR was around 1%. This shows BSE (and its CCP ICCL), with its improved technology and latency capabilities, is attracting a higher share of algo trades but is still unable to capture share in smart order routing, due to unique clearing arrangements in the market. Going forward potential allowing of interoperability promises to be a significant force of change for the Indian CCPs. It would give investors the freedom to choose their CCP, and if they get better latency and pricing from ICCL, they could choose ICCL regardless of BSE’s smaller share in trading volume. SEBI is considering this and is in consultation with a range of market participants. Eventual interoperability may be a boon for BSE and ICCL, allowing it to catch up with the dominant NSE and NSCCL.

OTC Market Reforms in Asia: Presenting New Opportunities

In another blog we discussed the issues that will have serious implications for different market participants in the OTC derivative market reform process in Asia.  Here we look at its impact on different market participants. The move towards central clearing is likely to create more demand for clearing services. Currently a small number of brokers offer clearing service in this space, and they may not be able to handle the sudden rise in demand. Some of the major international clearing firms are in the process of scaling up their operations in the region. Even though the volumes in the OTC segment are low at present, the growth prospects of the Asian economies in general, and niche areas (e.g., NDF clearing) make the region strategically important for many of these firms. However, some participants are wary about the costs of having to join many clearing houses and the issue of assuming unlimited liability in case of default. International banks have significant share in the OTC derivatives space in Asia; if these issues are not sorted out, some western banks may withdraw from some markets, or even the whole region, which would likely have an adverse impact on liquidity. Regulations mandating central clearing will create business opportunities for centralized clearing. In some markets like Singapore, the incumbent exchanges are taking a leading role in this regard. It will be interesting to see if new players will be able to enter and succeed in this business. Low volumes in the Asian markets, proliferation of CCPs and competition from international ones may result in each CCP specializing in specific niches along product lines or local currency instruments. The business models of new CCPs will come under heavy scrutiny from regulators, breaking trends from the past. As large number of OTC trades move to the CCPs, the concentration risk at some of them would be significant and national regulators would want to make sure those risks are adequately managed on a continuous basis. As CCPs replace bilateral trading, and market participants face the choice of executing trades at different CCPs, they will also need tools for managing and optimizing the use of collateral. This represents an opportunity for some market players who specialize in providing collateral management solutions. Needless to say, the kind of solutions needed and offered in this space will depend largely on the maturity of specific markets and market participants. Thus, while Credit Support Annexes (CSAs) may be sufficient for emerging countries of the region, advanced services (like collateral transformation, outsourcing of collateral management) would gain traction in the leading countries like Australia, Hong Kong and Singapore. Reporting banks would come under greater regulatory scrutiny and will have to run stress tests and ensure capital requirements on an ongoing basis.

CCP adoption in South Korea

In 2009, the G20 agreed to set up CCP (central counterparty) settlement by the end of 2012. However, as of early December 2012, adoption of CCP settlement for OTC derivatives has not been passed by South Korea’s National Assembly. In other words, South Korea yet to keep its commitment to the G20 agreement which says that G20 countries should set up a CCP by the end of 2012. The adoption of CCP settlement is crucial to improving the transparency and stability of the OTC derivatives market. In order to prevent another KIKO incident in the future, the role of CCP is essential in South Korea. This would also help support Korea’s global credit standing.