* Banks may close derivative operations in some countries
* Countries reluctant to cede sovereign control of clearing
* Pan-regional clearing still a long-way off
By Rachel Armstrong
SINGAPORE, April 18 (Reuters) - Asia's derivative markets risk becoming more fragmented and significantly more expensive to trade than those in Europe and the United States due to government reluctance to cede sovereign influence over clearing and trade settlement.
That means banks may eventually stop trading derivatives in some Asian centres as the cost will no longer be worth it.
Asia's governments are in the process of responding to the Group of 20 leading economies' agreement to force as many over-the-counter (OTC) derivatives through central clearing houses as possible.
At present each country is coming up with separate plans for using their own national clearing house and setting different rules for which products should be cleared, rather than looking at some kind of pan-regional system.
The decision by Australia's government to block the Singapore Exchange's bid for the Australia Exchange on the grounds they didn't want clearing and settlement services in foreign hands highlights the reluctance to relinquish control over these operations.
But industry experts warn the increased expense and bureaucracy incurred by having to use many different clearing houses means some banks could shut down their derivative business in some countries.
"In some countries you may see banks saying 'I don't do enough business in this country to justify becoming a clearing member, I might as well shut down my business here'," said Keith Noyes, Asia-Pacific director of the International Swaps and Derivatives Association (ISDA).
The drive for reform of the $600 trillion OTC market comes from the chaos that followed the collapse of Lehman Brothers in 2008. The opaque nature of the OTC market meant widespread confusion over who was exposed to the stricken bank.
That prompted the move to push derivatives through central counterparties to ensure trades will be completed even if one side defaults.
The United States has put in place reforms under the Dodd- Frank law to force more derivatives trading onto exchanges and almost all through clearing houses. The European Union is set to approve a similar law.
LESS IS MORE
Those reforms will make it more costly to trade derivatives in those markets. But the one advantage of trading in the United States or Europe is a greater ability to put many different types of trade through a single clearing house.
Using a smaller number of clearing houses makes it easier for investors to manage the collateral needed to back their trades, reconcile all of their trading positions and lower the overall execution costs.
"If you have multiple clearing houses with different requirements the investor has to be in separate relationships with all of them so this may lead to increased capital requirements and initial margins even if they go through one general clearing member," said Pierre Mengal, Head of Collateral Management Services for Asia Pacific at Citigroup.
In Asia the likes of Hong Kong, South Korea, Tokyo, China and India have all stated their plans to meet the G20 commitments but there is little expectation for any kind of link-up between their clearing houses anytime soon.
"The Asian market is fairly fragmented, and it's hard to see certain countries linking up for historical reasons," said ISDA's Noyes.
That means that a hedge fund, for example, would not be able to use just one or two clearing houses in Asia to handle all of their derivative trades in the region.
"We may end up having several clearing facilities across different markets such as Singapore, Hong Kong, India, Korea and Japan with potentially no-interoperability between them," said Mengal at Citi.
"So a Singapore based-client may not just use the SGX's CCP (central counterparty clearing house) to access the Tokyo market because the requirements for membership will be different," he added.
HOPE FOR REGIONAL HOUSE
The first major bourse in Asia to begin offering clearing services for financial OTCs is the Singapore Exchange, despite the city-state not putting in place any mandatory requirements for derivatives to be cleared.
SGX president Muthukrishnan Ramaswami is hoping the first-mover advantage will make them a dominant clearing provider in the region. He argues moves by each country to set up separate clearers will likely prove futile.
"The cost of building this service and the expertise you need to operate these services do not support the volume of business that exists in each country," he said.
"Quite a few countries say they'll have the infrastructure but I don't think in the long-run it will pan out that way, there will be consolidation."
The hope for market participants is that this consolidation or at least some kind of link-up happens sooner rather than later.
"Failure to have a sensible degree of interoperability between the major market participants could end up being quite negative both for the sell-side and buyside," said Andrew Gordon, who oversees Bank of New York Mellon's broker-dealing and alternative investment services in Asia.
He says a lot of the fund mangers he advises in the region are waiting to see how the reforms pan out before deciding how to change their OTC trading operations.
But the big fear is that the emergence of regional clearing houses will take longer than hoped for given each country's determination to show they're meeting their G20 commitments but with a reluctance to link-up with other countries and lose a degree of control.
ISDA's Noyes says some Asian governments may force as many OTCs through their clearing houses as possible in order to recoup their costs, even though some financial products may not be traded often enough to make central clearing feasible.
"I think the potential risks are that there is political pressure to do more, and that because the volumes aren't great there is incentive to take on more products simply to get the clearing house up to break-even or profitable volume levels," he said.
The long-term vision for many banks and investors in Asia is a single pan-regional clearing house. However, as Europe's experience shows, financial market integration tends to need political integration first, something unlikely in Asia anytime soon.
"This is the journey that Europe's been on for 30 years so there's no reason to believe that Asia's going to find a magical solution," said SGX's Ramaswami.
($1 = 1.243 Singapore Dollars) (Editing by Muralikumar Anantharaman)