Mifid speeds drive towards regional swaps-booking models

Brexit adds impetus for decentralisation of booking hubs to Asia

Banks are stepping up their efforts to establish regional hubs in Asia for booking derivatives in response to the European Union's new Markets in Financial Instruments Directive (Mifid II). The recent referendum decision to pull Britain out of the EU has also refocused attention on banks' booking models, according to industry sources.

"Up until now, the Dodd-Frank regulations were actually more onerous and made life far harder for US banks in Asia than European rules did, but now I think we're getting to the business end of the developments, and even European banks are finding there is a significant advantage to regionalisation and have started exploring these options as well," says Terry Yang, a lawyer at Clifford Chance in Hong Kong.

Many European and US banks have been reviewing their booking models for years, but efforts to decentralise their portfolios have so far been limited. Only a few European and US banks have started migrating their trades to regional entities, mainly for over-the-counter derivatives. Sources indicate increasing numbers of banks are edging closer to portfolio migration, which is likely to include listed derivatives, as well as OTC.

In the US, banks initially looked at decentralising their booking models because of a particular provision in the Dodd-Frank Act, known as the swaps push-out rule, which would have required certain more speculative derivatives contracts to be ring-fenced and placed in separate affiliates. However, this rule was repealed at the end of 2014, removing the incentive for many of these banks to continue down this route.

It is now European legislators that are forcing banks to review their booking models – not only European firms but also their US counterparts, which book their trades through London. Yang also thinks the countdown to the British exit from the EU is likely to push them down this path more quickly. Banks will want to make sure they can still offer the same level of service to their clients, regardless of the outcome of Brexit.

"As a rule of thumb, it takes at least two years for banks to address the licensing, operational and personnel issues associated with establishing a new booking centre," says Yang. "As a result [of Brexit], financial institutions may find themselves under pressure to make important decisions around booking models without clear visibility of the future financial landscape due to the lead time required for establishing booking centres."

As a result [of Brexit], financial institutions may find themselves under pressure to make important decisions around booking models without clear visibility of the future financial landscape
Terry Yang, Clifford Chance

HSBC is understood to have already started migrating some of its interest rate derivatives trades from London to Hong Kong, while Standard Chartered is locked in close discussions with the Hong Kong Monetary Authority (HKMA) about setting up a licensed entity in order to book many of its Asian trades in the jurisdiction.

Standard Chartered already has a subsidiary in Hong Kong, but needs to obtain a separate licence before it can use it to start booking trades. Standard Chartered is also believed to be investigating the possibility of setting up a separate booking hub in Singapore, which would serve its south-east Asian business, but this is likely to be quite a bit further down the line.

"Given their Asia-facing business, it is no surprise they are looking at this," says a Hong Kong regulatory expert at a US bank.

Standard Chartered declined to comment on its business plans, while a spokesman for HSBC said: "We review our booking model and how we can best serve our clients on a regular basis."

The HKMA declined to comment on what specific banks are doing, but a spokesperson for the regulator said it often receives new proposals from such firms. "We will work together with the banks to ensure any such new business proposals are implemented in a prudent manner, with the associated risks properly managed," she said.

Mifid transparency burden

Mifid II will enter into force in January 2018. Among other things, it will increase the amount of information that derivatives counterparties must report. For Asian counterparties, which are not used to grappling with the intricacies of something as complex as Mifid, this could be a little overwhelming.

"Mifid can be very penalising for Asian counterparties. It subjects them to all the risk mitigation and documentation requirements pertaining to pre-trade price transparency, post-trade reporting and post-trade margining. And this isn't just for one asset class – it's all-encompassing. Why would I, as an Asian client, want to face Mifid rules when I could go to an Asian institution that is not subject to them?" asks Kishore Ramakrishnan, a director in the financial services risk department of PwC.

Ramakrishnan, who has been advising several banks on setting up booking hubs in Asia, says Mifid is accelerating efforts to regionalise them.

Ben Hammond, Hong Kong-based partner at law firm Ashurst, confirms banks are thinking quite closely about the effect that European regulation will have on their booking models, but he does not think it will be the deciding factor in determining whether to set up a regional hub.

"Mifid may very well nudge banks along the path they are already heading down, but I don't think that on its own it will force institutions to create a change in their booking model. There are other things to consider, too, such as additional capital requirements, the need to obtain a local licence and having to repaper existing agreements with counterparties," says Hammond.

You can't rely on the mother ship posting endless amounts of cash into offshore subsidiaries
Senior director, international bank

Banks that have been reviewing their booking model approach tell Risk.net that the number-one consideration when setting up a regional hub is how it should be capitalised.

"To start booking derivatives into a regional hub, you need a proper subsidiary – it has to be rated, it has to be well capitalised and it has to be liquid. You can't rely on the mother ship posting endless amounts of cash into offshore subsidiaries," says a senior director in the treasury department of one international bank.

Ramakrishnan of PwC says he has seen banks forced to set aside significant amounts of additional capital to support a regional booking hub. One of the reasons the additional charge can be so high is that regulators in the region tend to be fairly cautious when it comes to approving internal models, forcing many banks to use the standardised approach.

One way of solving this, says Ramakrishnan, is to book trades locally, but back the risk out to the central hub sitting in Europe or the US, which will usually have model approval from regulators.

"This allows banks to book trades with a local entity whilst keeping credit and market risk on an advanced-model approach, and netting positions between counterparties and within asset classes," he says.

This approach is favoured by some large global players, including Standard Chartered and HSBC. But one Hong Kong-based lawyer thinks the capital choices may be more complicated as the precise approaches vary for each jurisdiction.

Different scopes

"It can be capital-efficient to have [the] main capital activity in a central location rather than distributing it into different pockets, but it is not always as straightforward as this," says the lawyer. "If you look at a group on a global basis, the capital cost of some activity can differ between jurisdictions and, depending on location, capital can contribute differently to the overall group capital position, so things might not be so expensive to decentralise."

For example, a US bank placing its Asian booking vehicle under a European holding company would subject itself to European rules (as well as US regulations at group level). But if it moved this booking hub over to Asia, then European rules would no longer apply.

"This could be advantageous, depending on how Europe versus the US recognises capital sitting in the relevant subsidiaries," says the lawyer.

Much will depend on how the margining of non-cleared derivatives eventually turns out, says the lawyer. Although the margining regimes are supposed to be aligned, the scope may not be quite the same in the different jurisdictions, he says.

But the deciding factor in whether a bank chooses to decentralise its booking model is likely to be the shape and nature of its business.

"For a bank such as Standard Chartered, it makes perfect sense to decentralise their booking hub to Asia. Even though they call themselves a global bank, their book is very Asia-centric," says a senior business development manager in the structuring department of one European bank, who has looked at some of these issues. "But it might not make sense for everyone. There's a lot of effort in changing your booking model, in terms of obtaining a licence and capitalising the local entity, so you have to make sure it's worth it."