Magazine issues » December 2016

INSIDE VIEW: Risk management shifts east

If the shocks of 2016 offer any guide of what is in store for 2017, expect to see more and more hedging activities taking place in Asia, says Len-Yu Liu of the Taiwan Futures Exchange. Investors waking up on January 1, 2016 would not recognise the way the world looks today: President-elect Donald Trump is heading to the White House, the United Kingdom is heading out of the European Union; everywhere you look, from Asia and the Middle East, to Europe and the Americas, populist movements are rewriting the economic and political landscape. No doubt much of this uncertainty has fuelled derivative trading volumes around the world. But a quieter revolution going on behind the scenes is the shift of much of this volume to Asia. In the first half of 2016, 37% of global derivatives trading took place in the Asia-Pacific region, compared with 33% and 21% in North America and Europe respectively. POLICY CHANGE
Much of the volume shift to Asia has been due to home-grown factors. The sudden introduction and cancellation of circuit breakers in the China A-share markets and the authorities’ tightening of renminbi capital control regulations has driven risk hedging for Chinese stock and currency to offshore centres such as Taiwan and Hong Kong. A recent report by the International Monetary Fund also showed surging co-movements between Chinese and Asian equities since the global financial crisis. As a result, any policy shifts that trigger risk-on and risk-off strategies, carry trades or momentum strategies in Asia’s emerging markets will amplify derivative trading opportunities. It is no surprise therefore to see average daily trading volumes on the Taiwan Futures Exchange rising more than 30% from 622,867 to 1,083,999 contracts over the past two years as investors responded to market events. The Hong Kong and Singapore exchanges also recorded strong volume growth in derivative instruments linked to mainland benchmark indices and the renminbi. Other factors driving volume growth included the widening of daily price limits (both South Korea and Taiwan expanded their daily trading limits to 30% and 10% respectively in 2015), as well as the regional relaxation of restrictions on the ability of domestic insurance companies and pension funds to invest aboard. CROSS-BORDER
Taking advantage of these opportunities, many Asian exchanges have been actively broadening their derivatives offerings over the past few years. This includes collaborations between exchanges such as a link-up between the Taiwan Futures Exchange and Eurex (‘Eurex/TAIFEX Link’), as well as the new links between the Hong Kong, Shanghai and Shenzhen exchanges. Exchanges in Asia have also been expanding their range of cross-border offerings. In Taiwan, this included the introduction of futures linked to offshore indices such as Japan’s Topix and India’s Nifty, as well as exchange-traded fund (ETF) futures and options linked to China stock indices. The number of currency futures listed in the region has also grown. For example, the timely introduction of offshore renminbi foreign-exchange futures in Taiwan last year have proved popular with investors due to a lower trading threshold compared with products in the over-the-counter (OTC) market. THE GREAT REALLOCATION
Other shifts in global hedging activity that arose from the events of 2016 could continue to be seen in 2017. One is the growing demand for single-stock derivatives, especially for technology companies that have attracted huge followings from event-driven hedge funds. Some of the most active single-stock futures and options in Asia this year included TSMC, Nintendo, Samsung, SoftBank and Tencent, as well as companies linked to Apple’s supply chain, such as Hon Hai.    Another pronounced theme in 2016 was the turnaround of the global commodities market, an event that should continue to be supported by president-elect Trump’s pledge to boost spending on infrastructure. Commodities trading volumes should also be supported by China, which is currently the world’s biggest consumer of metals, energy and agricultural products, and home to a very large base of domestic speculators. Its domestic commodities exchanges in Shanghai, Dalian and Zhengzhou saw large spikes in trading activities during April and November 2016, which helped drive prices for thermal coal, coking coal, steel rebar, zinc, nickel, tin, iron ore and rubber to multi-year highs. Almost half of the world’s most active commodity derivatives contracts are traded on Chinese exchanges. THE WAY FORWARD
Regional derivatives markets with relatively large pools of domestic liquidity of local hedgers, such as China and Japan, should capture more share from traditional venues, such as CME [the Chicago Mercantile Exchange] and LME [the London Metal Exchange], as future liberalisations and reforms continue to be favourable for their development.  In order to enhance their competitiveness, other Asian regional exchanges will focus on strategies such as product diversification and other measures to attract more foreign flows, such as after-hours trading, in order to align with global markets.  They will also focus on bringing new derivatives products to the market, including products linked to offshore market indices, ETFs and commodities. In the case of Taiwan Futures Exchange, this will include further international co-operation with global exchanges such as CME and the launch of more offshore equity index futures. Dr Len-Yu Liu is the chairman of the Taiwan Futures Exchange ©2016 funds global asia

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