Taiwan allows onshore trading of foreign derivatives

Authorities take further steps to bring $300bn of overseas traded securities onshore as it seeks to beef up the domestic financial sector

Taiwan regulators have relaxed restrictions on trading foreign derivatives onshore as part of a broader policy of what it terms "financial import substitution" – a strategy that aims to build up the domestic finance sector.

On July 30 Taiwan's Financial Supervisory Commission (FSC) introduced a new policy allowing local banks, and Taiwanese branches of foreign banks, to trade and settle offshore-issued derivatives products for institutional clients in Taiwan. Previously these services could only be done offshore.

This is the third major relaxation of the FSC's policy regarding offshore investing in 2014. In January it introduced a rule allowing local banks to sell foreign currency bonds as a broker; while in May, Taiwan's legislature passed a bill excluding locally issued foreign currency bonds from insurers' overseas investment basket, driving the amount of foreign bonds issued so far in Taiwan to hit an all-time high.

While Taiwan has the third most active onshore derivatives market in Asia, according to data from the World Federation of Exchanges, this activity is overwhelmingly retail, with institutional investors being heavy users of offshore products. However, under the new proposals foreign banks without onshore entities can now designate a local agent, which an official at the FSC in Taipei says is part of a policy to increase knowledge across the domestic industry.

"We hope there is a chance for local banks to get knowledge of derivatives through partnering with foreign peers and are finally able to design these products on their own," says the FSC official.

Additionally, Taiwan authorities are concerned at the size of the outflows of domestic institutional investor cash offshore. Figures released earlier this year by the FSC show that more than 10 trillion Taiwan dollars ($334 billion) in financial assets is currently parked overseas – a situation the regulators would like to see changed.

Local player E.Sun Commercial Bank is looking to take advantage of the rule relaxation. According to Davis Tsai, deputy chief financial officer based in Taipei, the bank's experience of managing derivatives trading both from the proprietary side and for its private banking clients give it an advantage in expanding into this area.

"We could provide value-added services like onshore marketing and being closer with clients," says Tsai. "For foreign banks that have compliance concerns, partnering with us could be a good solution."

However, while the FSC is relaxing limits on what aspects of a derivative trade can be conducted onshore – previously services such as price enquiry and negotiation, orders and settlement of offshore-issued derivatives products had to be conducted wholly outside of Taiwan, in effect banning onshore trading – it is not mandating that activities need to move to the island.

Market participants are doubtful whether there is the appetite from domestic players to enter the derivative sector or from global banks to choose an onshore partner to act as an agent, in the absence of a mandate. Andrew Fuh, Taipei-based partner at consultancy EY, says that foreign players without physical sites in Taiwan may not be interested in finding an onshore agent given how successful the current model is.

"It is unnecessary for them to find a local representative as they have already established good contacts with Taiwanese institutional clients directly and it works quite well. Nowadays communications and transactions between issuers and buyers of products can easily be done on the internet and phone, which actually diminishes the importance of physical contacts," says Fuh.

Similarly he says the lack of derivatives knowledge among local players is likely to deter them from entering the new market. "Local banks neither have the talent nor supporting function to establish derivatives structuring. It will be very hard for them to break into this area and try to compete with international peers," he says.

Eric Chan, Taipei-based head of sales at Crédit Agricole, agrees with Fuh that there will be little interest from local banks but he says instead that this is due to the limited scale of the onshore market which will always put global players at an advantage.

"By designing the same product, international investment banks can sell it to global clients but Taiwanese banks may only sell it to local investors. From a cost efficiency perspective, this is just not a profitable business for local peers," says Chan.

These views are reflective of the FSC's experience, with the official saying that so far only a handful of local banks have expressed an interest in the business. However, foreign banks that already have a local branch in Taiwan have responded positively to the new policy, with 10 foreign banks already applying for the licence for this new business, according to the official.

Crédit Agricole is positive about the potential of the reform, with Chan saying that the cost of setting up is not much for a foreign bank that already has an onshore branch. "Previously the sales team and supporting function are all based offshore, they now need to transfer them to Taiwan," says Chan.

Taiwanese authorities tightened their controls over the sales of derivatives products after the financial crisis in 2008. Currently the onshore marketing of derivatives issued by foreign banks without physical sites in Taiwan is prohibited. However, according to the new policy, the onshore agent can help promote the products for its foreign partner.

But Fuh says this is not a serious concern for foreign banks as it is very hard to define what onshore marketing is: "Most marketing is actually done in an informal way like having a casual chat. It's very convenient for foreign banks to fly their Hong Kong or Singapore-based sales people to Taiwan. They don't need an onshore agent to share the pie," he says.