Singapore proposes central clearing for OTC derivatives

In a consultation paper (11-page / 293KB PDF), MAS says that OTC derivatives contracts should be assessed on factors including the level of systemic risk posed by the product and the depth and liquidity of the product.

A derivative is a type of financial contract linked to the underlying value of the asset to which it refers, such as the movement of interest rates or currency value, or the possible bankruptcy of a debtor. OTC derivatives are those not traded on a regulated stock exchange but instead privately negotiated between two parties.

A clearing house is an entity which acts as the central counterparty (CCP) between the buyer and seller to a particular trade, effectively acting as the buyer to every seller and the seller to every buyer. As a result neither the seller nor the buyer is exposed to the risk of the other defaulting because the credit risk has been shifted to the CCP.

MAS plans to introduce mandatory clearing by asset class, beginning with Singapore dollar and US dollar interest rate swaps, it said.

Interest rate derivative contracts account for about 50% of all derivatives booked in Singapore, and interest rate swaps (IRS) make up 90% of these. In turn, around half of interest rate swaps are Singapore and US dollar contracts. Forcing these to be managed through clearing houses would "significantly reduce systemic risk in the Singapore financial system", MAS said.

IRS are also highly standardised contracts, which pose minimal operational concerns for clearing, unlike more complex and exotic products, MAS said. 

MAS has also taken into account the availability of approved clearing houses (ACH) and recognised clearing houses (RCH) in Singapore, it said. The Singapore Exchange Derivatives Clearing is an ACH and currently offers the clearing of Singapore and US dollar interest rate swaps, and MAS would aim to approve or recognise more central clearing parties as ACHs or RCHs able to clear interest rate swaps before the rules come into play, it said.

Clearing obligations may be extended to interest rate swaps in euros, sterling and Japanese yen, MAS said.

MAS is also seeking feedback on whether extending the clearing obligations to a wider range of products in Singapore dollars, US dollars, euros, sterling and Japanese yen, such as basis swaps, forward rate agreements or overnight index swaps, will help market participants to achieve greater margin efficiencies, it said.

It is proposed that central clearing will initially only be needed for transactions booked in Singapore-based operations of both parties, and the requirements will only apply to banks that have booked at least SIN$20 billion (US$15) in contracts in Singapore for the past four quarters, MAS said.

The SIN$20bn threshold is "calibrated to subject the most active major global banks, regional or domestic banks trading OTC derivatives, to clearing obligations. All other specified persons that are not banks will also be initially exempted from clearing obligations", MAS said.

The contracts may be cleared through domestic or foreign central counterparties, as long as they are regulated by MAS, it said.

The consultation period ends on 31 July 2015.