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Japan: The Land of Rising Sun and IRS Electronification

| Derivatives
Taichi Shibuya thumbnail
Taichi Shibuya
Head of Japan, Tradeweb

This article originally appeared in FOW here.

 

As Tradeweb prepares to celebrate the 20-year anniversary of its interest rate swaps (IRS) marketplace, Taichi Shibuya, Head of Japan, looks back at one more milestone that marked the firm’s international business expansion. In 2005, Tradeweb ventured into pastures new with the establishment of its first APAC office in Tokyo. Twenty years on, local market participants are slowly but surely embracing e-trading workflows, driven by a combination of regulatory impetus and technological innovation.

What is the status quo for IRS electronification in Japan?

Taichi Shibuya (TS): The Japanese Yen IRS ecosystem is an interesting one. Compared to other developed rates markets, it is still behind the curve in terms of leveraging technology to improve the execution process. Interdealer 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.

A good example is Japanese Government Bond (JGB) asset swaps. 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. 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.

What tipped the scales in favour of more digital trading workflows?

TS: For Yen swaps, it was a combination of regulatory change and technological efficiencies. Japan was the first country in Asia – and the second worldwide after the U.S. – to introduce mandatory electronic trading for specified over-the-counter derivatives contracts on September 1, 2015. Many Japanese institutions started preparing for the new regime by executing IRS trades on digital marketplaces well ahead of the implementation date. 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 to execute 5-, 7- 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.

Instead, the higher uptake of digital workflows is due to the operational efficiencies they offer, such as solving the time zone issue affecting liquidity in Yen rates. Let me explain what I mean by that. 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. 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.

Electronic trading also helps combat one more market-specific challenge causing liquidity fragmentation, which is the language barrier. The majority of global sell-side firms recruit English-speaking salespeople to support international investors, but some dealers may not have sufficient resources. Digital marketplaces provide a universal trading environment, where both domestic and global participants can connect to each other without having to worry about that barrier.

It sounds like trade automation is making headway in Japan. Are there any other e-trading tools or protocols that are popular with clients?

TS: Automated trading via AiEX is a breakthrough technology that has helped clients not only achieve time- and cost-efficiencies, but also reduce compliance and operational risks. In IRS, automation can also be considered as an enabler of new and different types of trading activity.

However, we must not leave out our two-way pricing protocol Request-for-Market (RFM), another Tradeweb first in the IRS space, enabling buy-side clients to search for liquidity without revealing their trading strategy. It is the execution method of choice for Emerging Markets swaps, but is also gaining in popularity among our Yen IRS clients. At the moment, approximately a quarter of the volume we see in Yen swaps is done via RFM. Trade sizes are also increasing, as clients are becoming increasing comfortable using it. It is easy to understand why, if you look at how volatile markets have been in recent years. By preventing sensitive or strategic trading information from being disclosed, RFM delivers pricing transparency while ensuring that clients can preserve their intent.

I have to also mention an innovation that is of particular interest to the Japanese IRS market. Major Japanese institutions can only clear at the Japan Securities Clearing Corporation (JSCC), but U.S. 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). 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 Swap Execution Facility (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.

Next year, Tradeweb will be celebrating 20 years of IRS trading and the establishment of its Tokyo office. What does the future hold for the firm in Japan?

TS: Our inaugural office outside the U.S. and Europe was in Tokyo, which opened its doors in 2005. This is something the Tradeweb team in Japan feels very proud of and we look forward to celebrating both milestones with our employees, but also with our buy- and sell-side clients too. We are very grateful for their trust, support and partnership through both good and bad times for financial markets. We are committed to continuing to make their lives easier by doing what we do best, which is to take their feedback and make it the basis of our future technology build. With that in mind, we will be focusing on making it easier for international accounts to access the domestic IRS market. We believe we can achieve that by collaborating with other infrastructure providers, such as the JSCC, and the dealer community.