20/06/2012 (Financial Times) - As traders scour Asia for the next big trading opportunity, the sexy asset class is not equities, nor necessarily FX, but exchange-traded derivatives.

The Korean market has long been a hotspot with its Kospi futures, as has Singapore with its Nikkei-225 futures and more recently its Nifty index venture with the National Stock Exchange of India.

But a really interesting market has been quietly growing almost unnoticed: Malaysia.

Tabb Group, the US consultancy, has just produced a detailed report that sets out why.

First, even though Indonesia remains the largest palm oil exporter in the world, Malaysia has built its palm oil futures franchise into a global market centre for crude palm oil trading. This is Bursa Malaysia’s biggest derivative contract by volume.

Moreover Tabb says the market “appears more developed than emerging”.

That may be because confidence has been built both at the domestic level and with foreigners – not a feat that many emerging market exchanges manage well.

Last week Bursa Malaysia’s derivatives arm said it would ease restrictions on the setting up of branches and kiosks by futures brokers, “paving the way for greater retail participation in the derivatives market”.

Last month it launched a revamped options contract on Malaysia’s composite index futures. Investor education has been ramped up in derivatives too.

In a key move Bursa Malaysia derivatives in February launched a new clearing and settlement system, which paves the way for the introduction of new products.

But it is foreign participation that will drive the most growth.

That is already starting to happen, against an important backdrop: a 25 per cent stake in Bursa Malaysia derivatives held by CME Group of the US since 2009.

This has meant that foreign investors have been able to trade Bursa’s palm oil futures contracts through the CME’s Globex system, significantly expanding Bursa’s international customer base.

Foreign banks, hedge funds and commodity trading advisers account for 28 per cent of activity in palm oil futures, compared with 16 per cent in 2006, Tabb says.

Recent collaboration between FTSE Group and Bursa to create the FTSE Bursa Malaysia KLCI Index has also helped.

Tabb estimates that volume on Bursa Malaysia’s derivatives exchange grew by 37 per cent between 2010 and 2011.

Interestingly, all this is without US based investors being able to access Bursa Malaysia derivatives directly through “direct market access” (DMA). Permission is stuck on someone’s desk at the Commodity Futures Trading Commission, the US futures regulator.

When it comes to “sponsored access”, Tabb says that Bursa Malaysia derivatives is at least perceived as one of the few exchanges in Asia with “sufficient” pre-trade risk management tools, because its matching engine is part of CME.

All this comes amid what Tabb concedes are “lofty expectations” for the growth of Malaysia’s capital markets set by the country’s market regulator, the Securities Commission Malaysia.

It projects total Malaysian capital market size, including equities and derivatives, to grow from $667bn to $1.5tn by 2020.

Tabb says derivatives trading is expected to account for most of this growth, with notional value traded projected to increase from $213bn last year to $1.4tn by 2020.

No doubt part of that will come with the rollout of options on futures contracts for KL index futures – which happened last month – and of options on palm oil futures and palm oil options, which are set for launch in the next couple of months.

Malaysia loves targets, and the more ambitious the better. Yet Tabb throws a note of caution into its otherwise upbeat report.

It notes that the issue of DMA for US investors “remains in limbo at the CFTC”. In addition, there are only 20 brokers with the authority to clear trades onshore, with only a few having any type of international client activity.

Several market participants Tabb spoke with say there can be delays in setting up high-frequency trading customers. One foreign futures commission merchant said the Bursa had been “slow in providing the sign off for separate and distinct APIs that connect to the market”, Tabb says.

The creation of huge expectations is not always a good thing for a market that may not quite be ready to cope. The test will come this year.