Korea Exchange, which operates the nation’s stock market, will first mandate clearing interest-rate swaps between financial firms operating in South Korea, Kim Jingyu, the president of the exchange’s derivatives market division, said in an interview at his Seoul office on Jan. 10. The clearing house will expand to other over-the-counter products such as credit- default swaps and cross-border trades, Kim said, without giving a time frame.

Regulators worldwide are increasing scrutiny of over-the- counter derivatives after they were blamed in part for masking risk in the lead up to the 2008 credit crisis and the collapse of Lehman Brothers Holdings Inc. Governments globally are working to move the trades on to exchanges and through central clearing houses, which manage risk. The market reached $708 trillion at the end of June 2011, according to Bank for International Settlements data.

“We’re making preparations to establish and operate a central counterparty for OTC derivatives transactions, in line with global moves,” Kim said. “It’s aimed at securing more stability in the financial system.”

Interest-rate and credit-default swaps may be subject to mandatory clearing first, according to South Korea’s Financial Services Commission.

Clearing houses operate as central counterparties for every buy and sell order executed by their members. Each party posts collateral to the clearing house, which is the intermediary in the trade, reducing the risk in the event a trader defaults on a deal as the counterparties would spread the open positions to the remaining members.

Global Efforts

The Group of 20, comprised of the biggest industrialized and emerging economies, has promised to implement derivative reforms by the end of 2012.

Hong Kong last year started consultations on proposals for regulation of the city’s over-the-counter derivatives market in a bid to reduce systemic risk. Singapore Exchange Ltd. (GSX) began clearing non-deliverable forwards and standardized interest rate swaps in Singapore dollars and U.S. dollars. The Japan Securities Clearing Corporation began clearing over-the-counter credit defaults swaps on the iTraxx Japan Index in July. Regulators are drafting rules for an interest-rate swap clearing house.

Korea Exchange is studying ways to list one-year bond futures after having introduced three-, five- and 10-year futures, and to introduce Chinese yuan futures “sometime in the future,” Kim said.

Volatility Futures

The exchange plans to list futures for the Kospi 200 Volatility Index “as soon as possible” after consultations with the nation’s regulators, Kim said. The gauge measures the volatility of options tied to the Kospi 200 Index. The Korean bourse, whose Kospi 200 futures contracts are currently being traded on CME Group Inc.’s Globex electronic network, is in discussions to start after-hours trading for U.S. dollar futures this year, Kim said.

A derivative is a contract between two parties linked to the future value or status of the underlying asset to which it refers, including the development of interest rates or price of commodities such as oil or wheat. An over-the-counter derivative is one privately negotiated between two parties, rather than being traded on an exchange.

-- With assistance from Jiyeun Lee in Seoul. Editors: Allen Wan, Ravil Shirodkar

To contact the reporters on this story: Saeromi Shin in Seoul at sshin15@bloomberg.net Eleni Himaras in Hong Kong at ehimaras@bloomberg.net

To contact the editors responsible for this story: Darren Boey at dboey@bloomberg.net Nick Gentle at ngentle2@bloomberg.net

http://www.bloomberg.com/news/2012-01-12/south-korea-to-start-otc-derivatives-clearinghoue-to-reduce-global-risks.html

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