Today marks an important milestone for HKEx, as we have officially launched our over-the-counter (OTC) derivatives clearing house, OTC Clear. The launch may not attract much attention locally or internationally, but it does represent an important step for us in fulfilling our long-term strategy to diversify into more asset classes and develop Hong Kong as a comprehensive financial centre.
We launched OTC Clear in response to changes in both the regulatory and business landscape. From a regulatory perspective, the financial tsunami in 2008 revealed some serious problems in the growing OTC market, such as counterparty risk, a lack of transparency, and uncertainty about the exact size of OTC losses and their distribution. In the aftermath of the crisis, the Group of 20 industrialised nations decided that considering the size of the OTC market, greater oversight was needed. The G20 mandated that all standardised OTC derivative contracts be cleared by central counterparties in order to reduce systemic risk to the financial system. This presents significant opportunities for exchanges and market infrastructure players such as HKEx.
From the business perspective, OTC Clear fits strategically into our long-term vision of building a leading horizontally complete and vertically integrated exchange in the Asia-time zone. We already have our own clearing houses for our exchange-traded equity and equity derivatives markets, which means all parts of the trading ecosystem – products, trading and settlement – are under one roof. But we are now moving into new markets and new asset classes, like fixed income and currencies. In these markets, a lot of the trading is OTC. Therefore establishing OTC clearing is necessary if we want to serve these markets well.
More importantly, we are positioning ourselves to be the leading exchange and Central Counterparty Clearing House in handling the growing use of the RMB as an investment and settlement currency. Hong Kong has already established itself as the most important offshore RMB centre in the world. OTC Clear will leverage this advantage by clearing RMB-denominated derivatives contracts, a tremendous growth area, further enhancing our status and differentiating us from many of our competitors.
That being said, it's important to understand that OTC clearing remains a relatively new market and, as I mentioned, there are a number of global regulatory issues that still need to be worked out. Therefore we will start small, testing the water with interest rate swaps covering the Hong Kong Dollar (HKD), RMB, US Dollar (USD) and Euro, and non-deliverable forwards with currency pairs of USD/RMB, USD/Taiwan Dollar, USD/Korean Won and USD/Indian Rupee.
We are proud to have 12 founding shareholders as part of the business, most of which are leading banks in China and globally. They will also be the first clearing members of OTC Clear. While it is not a public utility given its highly customised products and services, the business is not a "club" either; the shareholders are key members of the trading community for these products, and we hope more members of the community will join as well. We expect OTC Clear to be competitive because it provides international risk management measures and capital efficiency, all based on Hong Kong’s sound regulatory environment and market structure.
What is the benefit for Hong Kong? In the short term we are able to fulfill our G20 mandate; over the long-term we will grow this business and begin clearing a broader range of OTC products. That helps keep some business in Hong Kong that might otherwise go elsewhere, and it contributes to making the capital markets and the banking system safer for everyone.
Initiatives like OTC Clear sometimes fly under the radar. But as it turns out, some of the most important work at the exchange is behind the scenes to make sure we're competitive over the long term. OTC Clear is a good example of an initiative being launched as a piece of a much larger puzzle. It is not a standalone item, but a project that completes our vertically integrated business model in the fixed income and currency markets, and serves Hong Kong by bringing transparency and centralised risk management to the important OTC space. While it will take some time to get going, we’re optimistic about its long-term potential.
