Osaka Exchange Overhauls 20-Year JGB Futures to Attract Foreign Liquidity

The Japan Exchange Group Inc. is moving to enhance liquidity in its 20-year Japanese government bond futures market, as volatility in the world's third-largest debt market surges. Osaka Exchange Inc. is considering reforms to attract more foreign participation in the long-end futures contracts. Open interest in these contracts has seen a sharp increase in recent quarters, signaling growing market interest according to Bloomberg.

The push for more liquidity comes as demand for long-end hedging tools is on the rise amid Bank of Japan policy normalization and heightened fiscal uncertainty. Akihiro Hanawa, general manager of derivatives at Osaka Exchange, emphasized the importance of building a robust ecosystem for 20-year JGB futures comparable to the 10-year contracts.

Despite recent progress, foreign participation in the 20-year futures market remains low at about 10% of total trading volume. This lags far behind the 70% foreign involvement in the more liquid 10-year contract. Hanawa noted that the existing market-maker program for 20-year JGB futures is outdated and in need of a revamp to attract more participants.

Why the Standoff Happened

The 20-year JGB futures market has long been neglected by investors, with daily turnover frequently at zero and open interest near negligible levels. Even after a relisting in 2014, the product failed to gain traction. Market participants typically used 10-year futures as the main hedging instrument, despite their shortcomings in managing duration risk at the long end of the curve according to Bloomberg.

Recent shifts, including policy normalization at the Bank of Japan and fiscal uncertainty linked to record-breaking government budgets, have reignited interest in long-end products. Investors are now seeking additional tools to hedge 20- to 40-year durations, which traditional instruments like swaps and 10-year futures have become less efficient for.

What This Means for Investors

The Osaka bourse is considering a range of reforms to boost participation in the 20-year JGB futures market. Proposed changes include adjusting maximum spread requirements, minimum quote sizes, and incentive levels for market makers. These modifications aim to make the contracts more appealing to foreign investors, who currently account for a small fraction of trading activity.

If these efforts succeed, the bourse may consider introducing even longer-term products, such as a 30-year futures contract. However, Hanawa warned that launching new products without first strengthening the 20-year market could risk cannibalizing existing ones according to Bloomberg.

The current low level of foreign involvement suggests that there is significant untapped potential in the 20-year JGB futures market. Activating this market is seen as a critical step in providing more comprehensive hedging tools for investors facing an increasingly volatile and extended yield curve according to Bloomberg.

Risks to the Outlook

Despite the renewed interest in long-end JGB futures, challenges remain. The market is still in the early stages of regaining liquidity, and there is no guarantee that proposed reforms will attract the necessary participation. The success of these measures depends heavily on coordination with stakeholders, including market makers and foreign investors according to Bloomberg.

Moreover, broader macroeconomic uncertainties, such as fiscal concerns and potential rate hikes at the Bank of Japan, could influence investor behavior. The 10-year JGB yield recently hit an 18-year high, highlighting the volatility that continues to drive demand for hedging instruments.

As the Japan Exchange Group Inc. moves forward with its plans, investors and market participants will be watching closely. The outcome could shape the future of hedging strategies in the long-end of the JGB market and influence the broader landscape of fixed-income trading in Japan.