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December 9, 2013

Will the CFTC disrupt Japan domestic IRS liquidity? | Japan update

There are two Japan-related CFTC no action relief (NAR) deadlines approaching:

  • December 21st 2013: the NAR expires which temporarily allows US banks' guaranteed non-US affiliates to trade with Japanese domestic / other non-US banks in Japan without CFTC substituted compliance approval. Japan is on the list of regimes looking for substituted compliance approval by CFTC.
  • December 31st 2103: the NAR expires which allows US banks and guaranteed non-US affiliates to clear at JSCC without its CFTC DCO approval. JSCC's application is with CFTC for foreign DCO approval.

Approving the JSCC foreign DCO application and Japan substituted compliance may be a stretch given CFTC workload and priorities. If nothing is done, this may result in worse complaints from Asian than we heard already on the curtailment of some cross-border trades.  We could see a material reduction in Japanese domestic swap market liquidity through temporary withdrawal of some US banks from trading JPY swaps in Japan with Japanese domestic banks. Unless the CFTC can pull an approval rabbit from a hat in the remaining days, there seems little alternative to extending the exemptive reliefs to avoid distraction from its focus on domestic and trans-atlantic. For more on why, please read on.

Brief background on Japan developments

  • November 2012: Dealer-to-Dealer-only clearing mandate went live on JSCC
  • October 1st 2013: JSCC's merger with JGBCC took effect (in discussion: portfolio margining IRS vs IR futures vs JGB)
  • Feb 14th 2014: JSCC IRS / CDS client clearing launch
  • Later in 2014: JSCC aims to go live with JPY swaptions and non-JPY IRS (in discussion: cross-currency swaps)
  • April 1st 2014: Japanese trade reporting / repositories go-live
  • Later in 2014: (date TBC) JFSA mandated client clearing

Wait…isn't CFTC a touch busy on the rule-making front?

Not sure – off the top of my head the following seems like a lot to land in around the turn of the year:

  • By December 21st, finalise extra-territoriality substituted compliance for the EU, Switzerland, Canada, Japan, Australia, Hong Kong
  • By December 31st, approve JSCC as a foreign Derivatives Clearing Organisation (DCO)
  • Finalize SEF Made Available to Trade (MAT) determinations
  • Dialogue on multiple late-term guidances pushed out by Chairman Gensler
  • The extra-territoriality lawsuit from bank trade associations

Do the regulators themselves believe the deadlines can be met?

Not good signs. Both Japanese and Australian regulators have requested an extension on the substituted compliance deadline – see eFinancial News article (subs) and even some at CFTC have publicly doubted the substituted compliance deadline – see Commissioner O'Malia quotes in this Risk article (subs).

How do US banks trade in the local market?

Judging by the JSCC clearing members / entrustors list, GS and Citi appear to have standalone trading and clearing entities, while JP, BofA, MS appear to trade in US and other entities and "entrust" clearing to local subsidiary members.

What if neither substituted compliance nor JSCC DCO recognition get done?

As the Japanese domestic banks are inhibited by Japanese regulations from clearing at any CCP other than JSCC, US banks can only trade JPY IRS/CDS with them via EITHER guaranteed non-US affiliates which are CFTC registered / compliant OR via non-guaranteed non-US affiliates. For US banks, this may imply:

  • At minimum, limiting trading to appropriate entities
  • Possibly, registering Japanese trading affiliates as SDs
  • At worst, injecting additional scarce capital into local Japanese trading affiliates or other activities to remove guarantees of non-US affiliates by their US SD

Depending on capital available and how many contingency compliance efforts a given bank has ready to go live, we could see temporary or even permanent withdrawals of US banks from the Japanese domestic market.


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