Opportunities Within the Japanese Fixed Income Market

While acknowledging a recent slow-down, the fixed income market continues to provide opportunities. With the clear incentives of a new source of alpha and better returns, particularly in comparison to the traditional equities markets, the fixed income range is seeing a notable increase in interest. This is resulting from both numerous new entrants and an expansion of business from existing participants as firms look to bonds, commodities and rates to beat the current difficult financial conditions and to benefit from the increase in corporate and government debt that has been issued.

Changes in the regulatory structure that intend to push standardised products on exchange and increase electronic trading are also factors in the resurgence of fixed income as a product. According to the Association for Financial Markets in Europe’s (AFME) annual survey, some 51% of respondents expect to see an increase in their fixed income electronic trading during 2011.

While this shift towards fixed income is being seen on an international basis, it is more prevalent in some regions than others. Many US and European firms are looking to expand their presence in Asia, for example, both to grow their business and leverage global and emerging opportunities as economic growth continues to outpace many of the developed and emerging markets. Firms are also looking to extend their range of client services as competition becomes ever-more difficult and revenues continue to fall.

Japanese and Other Asian Fixed Income Market Expected to Grow

Despite the short-term market turbulence caused by the aftermath of the Japanese earthquake in March, the outlook for the region is still positive. The Japanese and other Asian fixed income markets are expected to continue to grow this year on the back of the monetary stimulus provided by the Japanese government.

However, despite the clear opportunities, many firms looking to move into fixed income as new entrants, or develop their existing fixed income businesses into larger scale operations that span multiple regions, are finding that they are faced with certain challenges. The issue of technology is one that impacts many firms looking to either enter or expand their presence in the fixed income markets, as investment in the middle and back office to support this area of the business has fallen behind that of equities. At a time of significant regulatory and market change, the ‘poor cousin’ approach to fixed income IT investment will no longer be viable. Unfortunately, simply leveraging firms’ current equities-specific processing solutions to support fixed income products is not an option as debt instruments are far too complex to be processed in the same way.

Many firms are also faced with the problems that the fragmentation of the Asia-Pacific region can bring. Those companies considering a move into the Asian markets are finding that the benefits of cross-border trading are being militated against by both the cost and difficulties of the associated processing. The costs of entering a new market can be prohibitively high, particularly in a fragmented region such as Asia, and while the option of establishing local partnerships can be helpful, it can also considerably increase the costs of trading.

Even those companies that have taken the multi-entity approach, by establishing legal trading entities across multiple jurisdictions, have found a duplication of certain functions, such as custodial relationships with agent banks and internal processing operations, which can result in ongoing issues such as additional costs and inefficiencies, and more potential points of failure. This puts banks in a difficult position when they need to support a rise in volumes.

One solution to this issue is that of affiliate matching and settlement, where banks set up a single, centralised clearing entity which is responsible for clearing trades for all entities and managing the custodian relationship in a particular market or region. It is suitable for an entity with a high volume of cross-border trades with a custodian relationship and a presence in the local market themselves; and potentially a number of legal entities across a region, each with its own relationships and clearing and settlement arrangements.

Affiliate matching and settlement allows banks to reap substantial benefits within their cross-border operations, including the promotion of best practices and a stronger position within the cross-border field. A fully-scalable affiliate clearing strategy will continue to provide cost reductions and operational efficiencies as a company moves into new markets and its volumes continue to expand.

Technology Needs Within the Asian Markets

Affiliate matching and settlement is not the only way in which firms need to consider their technology needs when considering a move into the Asian markets. In Japan, for example, the Bank of Japan (BOJ) has announced plans to redevelop its BOJ-Net System, utilising XML-based messaging, which is expected to go live in early 2016 for BOJ market operation transactions. The main reason for this is to improve system accessibility and extendability in the future, while this will also offer extended operational hours for certain settlement functions, to prevent financial system shocks such as seen during the global financial crisis. The system will be able to run over a longer business day, meaning that means that global financial institutions can access JPY funding in a wider variety of time zones.

Firms intending to become active in the Japanese market would therefore be well advised to seek a technology partner that can offer a full-function, multi-language, post-execution clearing and settlement solution not only for equities, but for fixed income and related instruments with interfaces to both Japan Securities Depository Centre (JASDEC) and the BOJ, together with comprehensive regulatory and legal reporting for Japan.

Those firms looking at other Asian markets can also benefit from a partner that has considerable experience in these markets. They should also look for a trusted, client-centric partner with a good service reputation, a strong balance sheet and the willingness to invest substantially to ensure ongoing product innovation and responsiveness to market change. Time to market is also a critical factor, as is a low risk implementation path; an experienced and specialist supplier is therefore essential.

In such an extended period of economic and market difficulties, firms would be wise to leverage any opportunities, such as the trend towards fixed income and extending to new markets, to enhance their business and increase their competitive profile. However, only a full-ranging evaluation of the challenges and the employment of the necessary technology will result in success.

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