Transcript Asian Derivative Markets

Derivatives and Securitization
Both Derivatives and Securitization represent
risk-transfer tools derived from underlying assets
Asset Securitization in East Asia
ASEAN+3 Workshop
Shanghai National Accounting Institute
Shanghai
9. November 2005
Oliver Fratzscher
World Bank
Page 1
Outline of Presentation
Hypothesis: OTC derivative markets are necessary for securitization
to be sound and efficient (not sufficient, A+B+C also necessary)
1.
2.
3.
4.
5.
6.
What are Securitization and Derivatives ?
How large are Asian derivative markets today ?
Which building blocks are necessary ?
What sequence is needed to develop derivatives ?
Which are key technical & prudential policy issues?
Conclusion and Discussion
Page 2
1. What is Securitization ?
A specialized OTC derivatives product
 Securitization is a technique to standardize financial
instruments for risk transfer from underlying assets;
it is OTC derivative product structure through SPV
 Derivative is a simple financial instrument for risk
transfer from a single underlying asset (OTC/ETD)
 MBS = package of assets linked to mortgages
 CLO = collateralized package of loan obligations
A
Governmen
t
Benchmark
Bonds
B
Banking
Intermediat
e
Products
Deposit →
Loan
C
Legal &
Collateral
Framework
D
Derivatives
Interest
Rate
OTC
→ Mortgage →
MBS
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Two perspectives
" Although the benefits and costs of derivatives remain
the subject of spirited debate, the performance of the
economy and the financial system in recent years
suggests that those benefits have materially exceeded
the costs."
Alan Greenspan
“We view them as time bombs both for the parties
that deal in them and the economic system. In our view
derivatives are financial weapons of mass destruction
(WMD), carrying dangers that, while now latent, are
potentially lethal.”
Warren Buffet
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2. Global derivative markets
rapid OTC growth and increasing ETD products
OTC Derivative Markets
2004
Exchange-Traded Derivatives
FX
12%
US: 40%
Interest
EU: 40%
Gov-Debt
Asia: 20%
75%
Equ-Index
ABS+MBS: 4%
$248 trn notional
$9 trn mkt value
26%
65%
Stocks
$53 trn notional
$10 trn mkt value
Comm
Credit
250,000
60,000
OTC (bar) and Exchange-Traded (line) Derivatives
200,000
50,000
(notional outstanding, in billions US$)
40,000
150,000
30,000
Annual growth rates exceed 30%
100,000
20,000
50,000
10,000
0
0
1991
1993
1995
1997
1999
2001
2003
Sources: BIS (Dec 2004) ; FIBV (Jan 2005)
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Asian derivative markets
banks in OTC FX and security firms in equity ETD
Daily Turnover (US$ bn)
Japan
Singapore
Hong Kong
Australia
Korea
Other Asia
% of world markets
OTC-FX
154
91
70
60
10
8
33%
OTC-INT
31
9
11
13
1
4
5%
EX-INT
63
42
1
13
13
1
2%
EX-EQU
17
3
4
4
50
8
44%
Sources: Triennial Central Bank Survey (BIS, 2005) and World Federation of Exchanges (2005)
Korea FX Futures
Korea Bond Futures
Banks
HKG Equity Options
Securities
Korea Equity Index Options
Institutions
Retail
HKG Equity Index Options
Foreign
Korea Equity Index Futures
HKG Equity Index Futures
0%
20%
40%
60%
80%
100%
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3. Building blocks for Derivatives
MBS requires similar components as derivatives
Necessary components for MBS
Product Design
Regulation
Infrastructure
 Push by originator
for risk transfer tools
 Regulatory approval,
product understanding
 Industry guide on
standardized products
 Pull by investors
for yield and duration
 Legal clarity: default,
repossession,
enforcement
 Credit ratings
industry and standards
 Risk-based pricing,
benchmark, corp bonds
 System-wide stability
without moral hazard
 Accounting rules,
transparency, disclosure
 Clear tax treatment,
level playing field
 Best practice
risk management
 Suitability criteria
for investors, SRO
Page 7
Building blocks
for derivative markets
Product Design
Regulation
Infrastructure
 Economic rationale
for hedging needs
 Lead regulator, capital
rules, reporting standards
 CCP, ISDA master,
close-out netting
 Liquid cash market,
long and short positions
 Legal clarity: ISDA
standards, enforceability
 Demut. exchanges,
strong capital, margins
 Market determined
prices, interest/FX rates
 Accounting rules,
transparency, disclosure
 SRO rules enforced
with limits, monitoring
 System stability,
no moral hazard risks
 Level playing field, tax
harmonized, integration
 Certified investors,
code of conduct
Page 8
Derivatives enhance financial development
win-win instruments for banks, corporations, investors
 … beyond rice trading in Tokyo and tulip trading in Amsterdam
 Commodity producers lock in future prices and reduce uncertainty
 Corporations can close mismatch between assets and liabilities
 Firms can hedge export receipts and seek cheapest funding abroad
 Banks can share excessive or lumpy risks in capital markets
 Investors gain access to new markets and broader asset classes
 Pension funds can diversify exposure and enhance risk management
 Retail receives better pricing for mortgages and securitized products
 Foreign investment is facilitated by higher liquidity and hedging tools
 Financial system enhances stability through new “spare tire”
Page 9
Rewards and risks of derivatives
market development combined with prudential issues
Market efficiency
Risk sharing and transfer
Low transaction costs
Capital intermediation
Liquidity enhancement
Price discovery
Cash market development
Hedging tools
Regulatory savings
 More leverage
 Less transparency
 Dubious accounting
 Regulatory arbitrage
 Hidden systemic risk
 Counter-party risk
 Tail-risk future exposure
 Weak capital requirements
 Zero-sum transfer tools
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4. Schematic development of D markets
cash liquidity+sound regulation+solid CCP infrastructure
Investor Base
hedging needs,
products, IT,
lower costs
Accounting
adopt IFRS,
MTM, IAS39,
full disclosure
Design CCP
close-out net,
ISDA master,
enforcement
Cash
Derivative
Market
Building
Blocks
ETD
Exchange
platform, links,
capital,margins,
first futures
Regul & Legal
Framework
derivatives law,
SRO function
Repo
OTC
OTC License
reg approval,
CP credit risk,
swaps IR & FX
Cash Markets
liquid,efficient,
integrated;
benchmarks
Repo Markets
effective short,
margin trading;
secur. lending
Intermediary
Licensing
qual. investors,
training
Taxes level
playing field
cash=repo=D,
avoid trans tax
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Link between cash and D turnover
liquidity corridor for emerging and developed markets
Derivatives Turnover
100,000
5:1
USA
GER
10,000
KOR
1,000 SIN
JAP
UK
HKG
AUS
IND
100
100
1:1
ESP
1,000
10,000
100,000
Cash Turnover
Source: World Federation of Exchanges (Dec 2004)
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Derivative products in Asia
three tiers of exchanges offer six product categories
Australia
Index
Futures
Options
Options on futures
Stock
Futures
Options
Currency
Futures
Options
Interest rate
Futures
Options on futures
Bonds
Futures
Options on futures
Commodities
Futures
Options on futures
# of products traded
China Hong Kong India
Indonesia
Japan
Korea
MalaysiaPhilippinesSingapore Thailand
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0
Notes: Australia: Australian Stock Exchange (ASX) and Sydney Futures Exchange (SFE)
China: Zhengzhou & Dalian Commodity Exchange, Shanghai Futures Exchange Hong Kong: HKEx
India: National Stock Exchange of India (NSE) and Bombay Stock Exchange (BSE)
Indonesia: Jakarta Futures Exchange (JFX), and Surabaya Stock Exchange
Japan: TIFFE, Tokyo Stock Exchange (TSE), Osaka Securities Exchange, Tokyo Commodity Exchange
Korea: Korea Stock Exchange (KSE) and Korea Futures Exchange (KOFEX)
Malaysia: Malaysia Derivatives Exchange Philippines: Manila International Futures Exchange was closed
Singapore: SGX-DT Thailand: Thailand Futures Exchange plans to open in 2006
Sources: Websites of regional exchanges, WFE, Futures Industry Association, and HK-SFC (2004).
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Derivatives infrastructure in Asia
liquidity indicators improve but regulation still evolving
Australia
China
Hong Kong
India
Indonesia
Japan
Korea
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# best practice components
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Liquidity
Fixed income benchmarks
Fixed income liquidity
Equity market liquidity
Regulation
Derivatives law
Securities lending
Accounting standards
Exchanges
Clearing and settlement CCP
ISDA netting opinion
Demutualized exchange
Taxes
Tax harmonization
Transaction costs and IT
Malaysia Philippines Singapore Thailand
Notes:  denotes best practice ; q denotes progress on existing deficiencies ; and  denotes major problems.
1./ Fixed income liquidity indicators and benchmarks are obtained from asianbondsonline.adb.org, which shows weaknesses in China (segmented markets), Hong
Kong (small local currency issuance), Indonesia, Philippines, and Thailand (limited medium to long-term benchmark issues). 2./ Turnover ratios for fixed income
instruments have also been obtained from HSBC (2004). 3./ Equity market liquidity indicators have been obtained from World Federation of Exchanges (2004), which
revealed thin markets in Philippines, Indonesia, and Thailand. 4./ Information about laws on derivatives was obtained from individual country, with only Australia,
Hong Kong, and India currently having distinct laws on derivatives. 5./ Securities lending data were obtained from Endo and Rhee (2005), showing restrictions in
Malaysia and Philippines on short selling, with very little activity in Indonesia and Thailand. 6./ World Bank public documents on accounting standards (ROSC) and
professional publications reveal adequate accounting standards aligned to IFRS standards only in Australia, Hong Kong, Indonesia, Malaysia, and Singapore, but major
gaps exist in the Philippines. 7./ CCP information was obtained from industry sources and ADB, showing adequate functioning only in Hong Kong, Korea, and
Singapore. 8./ ISDA netting opinions have been issued for all countries mentioned with the exception of China, but many countries have issues to resolve. 9./ Data
from individual exchanges show their progress towards demutualization (2004). 10./ Data on taxation were obtained from PWC "Taxation on financial derivatives in
Asia" (2003), which showed small stamp duties in effect in Hong Kong and Malaysia, and VAT being applied in China, Philippines and Thailand. 11./ Transaction
costs for bond markets were obtained from ADB (2004) and additional market information on taxation. 12./ Institutional investor base and NBFI indicators are
obtained from ADB, which shows weaknesses especially in Indonesia and Philippines.
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5. Technical issues
critical tools to increase netting and enhance cushions
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Basics first: liquid and efficient cash markets allowing short positions
Legal framework: D law, SRO rules, licensing, ISDA documentation
Equal taxation: D may enhance volatility and substitute cash markets
Governance issues: accounting standards (IAS39), disclosure rules
Netting is critical: 85% risk reduction through close-out netting
Manage CP risk: Central clearing counterparty (CCP) is best practice
Modern exchange: demutualized, effective margins, strong buffers
Risk tools: dynamic margins, pos limits, reserves, capital, insurance
Product sequence: corporate hedging (interest rate futures)
are more important than retail speculation (equity options)
 Investor education: suitability, disclosure, monitoring, non-savings
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Policy issues
transparency + monitoring + oversight enhance stability
 ETD vs OTC: Investors prefer Exchanges – Banks prefer OTC Markets
shifting OTC products (interest futures) onto exchange enhances stability
 Regulation: level playing field for ETD and OTC markets plus disclosure
 Caution: D can undermine fixed prices, pegged FX regimes, credit policies
 Monitoring: highly leveraged institutions, cross-border, FX and credit D
 Capital: D require risk-based capital plus add-on cushions, beyond Basel-I
 Public banks: bridge market failures but subsidies can create warehouses
 Oversight: exchanges, SROs, rating agencies provide critical infrastructure
 Enforcement: market surveillance, transparency, legal clarity, ISDA standards
 Investor protection: rationale for new D products, standards for suitability
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6. Conclusion – main messages
1. Derivatives can enhance financial intermediation
and economic growth but require efficient
underlying cash markets and sound infrastructure
2. Modern exchanges with leading risk systems (CCP,
dynamic margins, buffer) can enhance transparency,
safety, and competitiveness of a financial system
3. Prudential supervision is critical for FX and credit
derivatives which could undermine fixed prices,
pegged FX regimes, and credit policies
4. Securitization products should be grounded on
sound OTC derivative market structures.
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Discussion
谢 谢
Thank You
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