Japan regulators further relax electronic trading mandate

The Japan Financial Services Agency has further narrowed the mandate for the electronic trading of yen interest rate swaps by requiring only instruments with a tenor of five, seven and 10 years, linked to six-month Libor, to be transacted this way when the directive comes into force in September this year.

The JFSA had already sought to reduce the initial impact of its electronic trading platform (ETP) mandate – the Japanese version of the US swap execution facility (Sef) – in July last year by only requiring firms with an outstanding balance of ¥6 trillion ($59 billion) in notional derivatives to execute yen IRS in this way. This decision will capture a maximum of 30 entities, according to market sources.

On May 29 the JFSA released a further clarification in which it restricted the ETP requirements to just three tenors and one benchmark – which means the exclusion of three-month Libor, which is the other main yen IRS standard. This is in contrast to US Sef rules which include all tenors from two to 30 years.

Market sources indicate that this mandate will cover around half of the current Japan yen IRS trades.

The narrower tenors included are just one of a number of areas where the ETP rules are narrower than their Sef equivalent – particularly their focus on purely Japan traded instruments and the permitted use of single-dealer platforms which take RFQs from affiliated institutions.

My feeling is that the Japanese regulators will probably start to bring in stricter rules over the next couple of years

While both require multiple RFQs, under the Japanese approach affiliates are permitted unless the entities are substantially the same, whereas under US rules this is prohibited.

"This means dealers in Japan will be able to trade with all their affiliates via a single-dealer platform," says Tomoko Morita, head of the Tokyo office for the International Swaps and Derivatives Association.

Morita says the more measured approach in Japan is a function of the regulator's concerns about a lack of experience with electronic trading in Japan and the potential negative impact on liquidity if a mandate is imposed too quickly. Isda asked the JFSA to take into account quantitative data such as liquidity when deciding which products to include.

According to one participant in the yen IRS market who was in discussions with the regulator over the shape of the ETP mandate, parties should not misinterpret the current slow pace of the move to electronic trading; the mandate is likely to be tightened in the future.

"My feeling is that the Japanese regulators will probably start to bring in stricter rules over the next couple of years: these may be modelled more closely on the US rule. Or they could also be waiting to see what transpires in Europe with regard to this and slowly phase in some new rules that reflect that."

Currently electronic derivatives trading in Japan is linked almost entirely to non-yen denominated instruments and according to Nick Bean, UK-based global head of fixed-income trading products at Bloomberg, which is setting up one of the eight ETPs that are expected to come online with the September mandate, this is unlikely to change without an expanded mandate.

"Any increase in the adoption of ETP trading is directly correlated to the scope of mandated products. At this time that scope is relatively limited. However, it is possible that an indirect increase in electronic trading for non-mandated products may result from client familiarity with ETP solutions," says Bean.

The eight proposed ETPs in Japan are set to be launched by Totan-Icap - a JV majority owned by the Japanese broker - Tradition, Tullet Prebon, BGC, Bloomberg, Tradeweb, Dealerweb and Clear Markets.

An in-depth feature on Japan's move to electronic trading will appear on Risk.net later this week.