Yuan Drop Shakes Taiwan Into Tighter Scrutiny of Its Derivatives

  • Yuan-tied products impacted by $1.5 billion unrealized losses
  • Regulator ``will be able to gather warning signals''

Taiwan has stepped up its scrutiny of derivatives after the yuan devaluation battered trades tied to the currency.

The island’s regulator is requiring more details to be disclosed as derivatives get ever more complex and entwined between financial institutions, said Jean Chiu, the deputy director general of the Financial Supervisory Commission’s banking bureau. Yuan-linked derivatives have unrealized losses of about NT$50 billion ($1.5 billion) after China’s surprise currency devaluations last month.

“With this new information, we will be able to gather warning signals and ask the market to do something before it’s being pushed to the limits,” said Chiu. “Without more detailed data, when there’s a big move in the market, we don’t know the detailed information of the exposure.”

Watchdogs across Asia are targeting derivatives after the 2008 collapse of Lehman Brothers Holdings Inc. prompted leaders of G-20 nations to improve their markets’ transparency. Australia and Singapore signed a world-first agreement last September allowing cross-border information access on such securities, while Japan now requires electronic trading platforms for some over-the-counter derivatives. Hong Kong is introducing mandatory reporting.

Since July 1, Taiwan’s banks, brokerages and insurers have been required to include information such as counterparty type and mark-to-market values of new transactions. Following the yuan drop in August, the regulator now plans to ask for even more detailed reporting.

‘Wait and See’

The notional amount of the island’s so-called yuan target redemption forward and discrete knock outs, derivatives that cease to exist after certain profit or exchange rate conditions are met, was NT$135 billion as of mid-August, said Chiu. Smaller derivatives markets tend to adopt a “wait-and-see” approach on reporting, with policy makers prioritizing other reforms, according to Graham Lim, a partner at law firm Jones Day.

“While the goal is the same, the paths taken are different,” said Lim, whose focus includes banking and finance. “Conversely, the likes of Australia, Hong Kong, Japan and Singapore are well on their way to incorporating G-20 equivalent standards on reporting and central clearing to maintain the viability of their financial hubs.”

Both investors and banks will benefit from greater transparency of over-the-counter derivatives, through better identification and risk management, according to Tom Jenkins, a partner at KPMG China.

“As regulators obtain a more complete picture of OTC derivative activities through the trade reporting requirements, they will be able to focus their efforts on regulating those areas of the market that present systemic risks,” said Jenkins. That will avoid “over regulation of less risky areas."

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