When you ask a bank or securities company to trade derivatives, the party that bears the gain or loss depends on whether the other side trades for its own account or passes your order on. This holds whether you enter into an OTC interest rate swap with a bank or buy and sell exchange-traded futures through a securities company.

Who the profit or loss belongs to

The difference between a dealer and a broker is whether the profit or loss on a trade belongs to the firm itself or to its customer. Consider a hypothetical example in which F Securities buys 1 unit of Nikkei 225 Futures, an exchange-traded derivative, at 30,000 and sells it at 31,000. One unit is the Nikkei 225 value multiplied by 1,000 yen1, so the difference is 1 million yen. If F Securities bought on its own judgment and with its own funds, the 1 million yen gain belongs to F Securities. If it placed the order on the exchange for a customer, the 1 million yen gain belongs to the customer. Had the sale been at 29,000, the customer would also bear the 1 million yen loss.

Teaching material from the Japan Financial Literacy and Education Corporation (J-FLEC) covers the businesses of a securities company. It calls the business of passing investors' orders for stocks and bonds on to the market "commissioned trading" (the broker business). It calls the business of buying and selling stocks, bonds and other securities with the company's own funds "proprietary trading" (the dealer business)2. A securities company or similar firm that can trade directly on an exchange market is called a trading participant3. The exchange's business regulations require a trading participant to indicate, when it places an order on the market, whether the order is on a customer's behalf or for its own account4. The table below sets the two roles side by side.

Item Dealer Broker
Whose account (who the profit or loss belongs to) Its own account (belongs to the dealer) The customer's account (belongs to the customer)
Role in OTC derivatives Becomes the counterparty to customers and other dealers Arranges trades between the parties (interdealer brokers and others)
Risk carried Market moves on positions taken on with customers until the hedge is in place Does not carry the risk of market moves (the profit or loss belongs to the customer)
Role on an exchange Keeps quoting buy and sell prices as a market maker and trades for its own account Passes customers' orders on to the exchange as a trading participant
Category under Japanese law Derivatives transactions themselves (Financial Instruments and Exchange Act, Article 2, paragraph 8, items 1 and 4) Intermediation, brokerage and agency for derivatives transactions (items 2 to 4 of the same paragraph)

Role in OTC derivatives

In OTC derivatives, a dealer typically becomes the customer's counterparty to make the trade happen5. Consider a hypothetical example in which Company C, which has borrowed at a floating rate, enters into an interest rate swap with Bank G with a notional amount of 10 billion yen and a term of 5 years. Company C pays a fixed rate of 1.02% a year, and Bank G pays the floating rate. Company C can in effect turn the floating-rate interest on its borrowing into fixed-rate interest. Bank G receives the fixed rate and pays the floating rate, so it loses out if rates rise6.

In the Bank of Japan's analysis, dealers such as banks take the other side of both pay-fixed and receive-fixed yen interest rate swaps at the request of customers such as corporations, institutional investors and banks. The dealers act as market makers (firms that stand ready to take either side of a trade)6.

The Bank of Japan analyzes yen interest rate swaps using trade-by-trade data collected by the Financial Services Agency. The data covers trades in which at least one party is a Japanese financial institution or a foreign financial institution located in Japan7. In that analysis, trades by dealers such as foreign banks and securities companies, Japanese securities companies and major banks made up about 90% of all trading (as of 2020). This high share reflects the dealers doing large volumes of both receive-fixed and pay-fixed trades8.

In OTC trading, a broker brings the parties together and does not become a counterparty itself. A broker that arranges trades between dealers is called an interdealer broker. The US Commodity Futures Trading Commission (CFTC) describes interdealer brokers in a proposed rule from November 2018 as firms that operate systems for arranging swap trades mainly between dealers9. Consider a hypothetical example in which Bank G is looking for a counterparty for a swap in which it pays a fixed rate of around 1.00% a year. The interdealer broker looks for another dealer that wants to receive the fixed rate on the same terms and puts together the price and terms.

In the United States, interdealer brokers put trades together through voice-based systems, or through systems that combine voice with electronic systems such as order books (lists of orders). Dealers use these systems to get a sense of market conditions and to keep their names hidden from the other side before trading10. Some interdealer brokers have registered parts of their systems as swap execution facilities (SEFs), a type of trading venue11.

Risk carried and hedging

Dealers usually adjust the positions they take on with customers through opposite trades with other dealers and similar means, and so hedge their interest rate risk12. In the swap between Bank G and Company C, suppose Bank G enters into an opposite interest rate swap with H Securities on the same day. The swap has the same notional amount of 10 billion yen and the same 5-year term. Bank G pays a fixed rate of 1.00% a year and receives the floating rate. If the floating-rate payments on the two trades are on the same terms, they offset each other. Bank G is left with the 0.02% a year difference between the fixed rates, or 2 million yen a year on 10 billion yen.

Company CCustomerBank GDealerH SecuritiesDealerFixed 1.02%FloatingFixed 1.00%Floating
Figure 1A dealer hedging an interest rate swap with a customer through an opposite trade
Figure description

Payments on two interest rate swaps. The customer, Company C, pays Bank G a fixed rate of 1.02% a year and receives the floating rate from Bank G. The dealer, Bank G, receives the floating rate on the same terms from H Securities and pays H Securities a fixed rate of 1.00% a year. Only the difference between the two fixed rates stays with Bank G.

A hedging counterparty cannot always be found right away, and market moves until the hedge is in place can bring the dealer either a gain or a loss. In a Federal Reserve Bank of New York analysis as of 2012, customers' large trades are often taken on by firms that make markets. Those firms hold the positions until they can offset the risk at a reasonable price13. Suppose the market moves before Bank G trades with H Securities, and the fixed rate Bank G has to pay rises to 1.10% a year. Compared with the 1.02% it receives, that is a loss of 0.08% a year, or 8 million yen a year on 10 billion yen. If instead it only has to pay 0.90% a year, it gains 0.12% a year, or 12 million yen a year. A broker does not become the counterparty to the trades it passes on or arranges, so it does not bear the profit or loss from these market moves. The difference between hedging and speculation is covered in Hedging, Speculation and Arbitrage.

Opposite interest rate swaps are not the only way to hedge. In interviews with dealers cited by the Federal Reserve Bank of New York analysis, interest rate swap dealers first try to offset their interest rate risk after a large customer trade. To do this, they use exchange-traded bond futures and purchases or sales of government bonds as well as OTC swaps. Dealers offset their swap positions either by trading with other dealers or with customers who want to trade in the opposite direction14. The Bank of Japan's analysis also notes that dealers use trades in cash instruments, futures and others to manage interest rate risk across all the trades they hold15.

Role on an exchange

On an exchange, market makers keep quoting buy and sell prices to meet investors' orders, while brokers pass investors' orders on to the exchange. Osaka Exchange runs a Market Maker Program for some of its futures and options, in which designated trading participants make markets. Making a market here means continuously quoting a price to sell (an offer) and a price to buy (a bid)16. Consider a hypothetical example in which a market maker in Nikkei 225 mini keeps quoting a bid of 29,995 and an offer of 30,005. Investors who want to sell and investors who want to buy then have someone they can trade with right away.

When a trade is matched against a market maker's quote, the trade is for the market maker's account. A trading participant may also make markets for the account of an end customer. In that case, Osaka Exchange may call that end customer the market maker, and the profit or loss belongs to the end customer17. Osaka Exchange sets conditions such as the hours for quoting and the maximum gap between the offer and the bid18. It gives discounts on trading fees and other incentives according to how well the conditions are met19. Tick sizes are covered in Contract Months and Tick Sizes.

Only the exchange's trading participants and similar firms can trade the futures and options listed on it. Consider a hypothetical example in which Company J places an order with K Securities to buy 2 units of Nikkei 225 mini. K Securities places the order on the exchange as an order on Company J's behalf. If the order is filled, the trade is Company J's. The Financial Instruments and Exchange Act limits who can trade on an exchange market to that exchange's members and trading participants20.

Collateral for customers' trades also goes to the central counterparty through the broker. A customer deposits margin with a securities company or similar firm. The margin then goes to Japan Securities Clearing Corporation (JSCC) through a securities company or similar firm that takes part in its clearing (a clearing participant)21.

Category under Japanese law

In Japan, both the business of trading derivatives and the business of acting as intermediary or broker for them are financial instruments business under the Financial Instruments and Exchange Act. The Act defines financial instruments business as carrying out any of the following acts, among others, on a regular basis (excluding those exempted by Cabinet Order and certain others)23.

Act Main role Financial Instruments and Exchange Act
Market derivatives transactions themselves (with some exceptions) Dealer Article 2, paragraph 8, item 1
Intermediation, brokerage and agency for market derivatives transactions Broker Article 2, paragraph 8, item 2
Intermediation, brokerage and agency for entrusting market derivatives transactions on an exchange market Broker Article 2, paragraph 8, item 3
OTC derivatives transactions, and intermediation, brokerage and agency for them Dealer and broker Article 2, paragraph 8, item 4

Only a person registered by the Prime Minister may carry out financial instruments business. OTC derivatives transactions and intermediation and similar services for them fall under Type-I Financial Instruments Business24. Banks and other financial institutions can carry out derivatives transactions not related to securities, and intermediation and similar services for them, on a regular basis. In that case, they register as financial institutions instead of under the registration above. A financial institution with this registration is called a registered financial institution25. The Banking Act also lists derivatives transactions (those specified by Cabinet Office Order), and intermediation, brokerage and agency for them, among the ancillary businesses a bank may carry out26.

Notes

  1. Osaka Exchange, "指数先物取引制度要綱" (Outline of the index futures trading system, in Japanese; as of April 13, 2026), page 2, I.1(2) "Large取引、Mini取引及びMicro取引" (Large, Mini and Micro contracts). ↩

  2. Japan Financial Literacy and Education Corporation (J-FLEC), "証券会社ってどんな会社？" (What is a securities company?, in Japanese; Kinyu Keizai Navi), "証券会社の4大業務" (The four main businesses of a securities company). ↩

  3. Japan Exchange Group, "取引参加者（用語集）" (Trading participant: glossary, in Japanese). ↩

  4. Japan Exchange Group, "自己・委託区分発注（用語集）" (Orders flagged as proprietary or customer: glossary, in Japanese). ↩ ↩2

  5. Federal Reserve Bank of New York, "An Analysis of OTC Interest Rate Derivatives Transactions: Implications for Public Reporting" (Staff Report No. 557, March 2012), pages 3 to 4, "II. Background on the IRD Market." ↩

  6. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた円金利スワップ市場" (The yen interest rate swap market seen through OTC derivatives trade data, in Japanese; Bank of Japan Review 2021-J-7, June 2021), pages 1 to 2, "金利スワップ取引の概要" (Overview of interest rate swaps). ↩ ↩2

  7. The same document, page 2, "店頭デリバティブ取引データの概要" (Overview of the OTC derivatives trade data), and page 7, footnote 2. ↩

  8. The same document, pages 2 to 3, "（取引高）" (Trading volume) in "高粒度データからみたわが国円金利スワップ市場の特徴" (Features of Japan's yen interest rate swap market seen through granular data). ↩

  9. CFTC proposed rule "Swap Execution Facilities and Trade Execution Requirement" (Federal Register, November 30, 2018), page 61957, "c. Swaps Broking Entities, Including Interdealer Brokers." ↩

  10. The same document, page 61958, "(1) Structure and Operations of Swaps Broking Entities, Including Interdealer Brokers." ↩

  11. The same document, page 61958, the second paragraph of "(1) Structure and Operations of Swaps Broking Entities, Including Interdealer Brokers". ↩

  12. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた円金利スワップ市場" (in Japanese), page 2, "金利スワップ取引の概要" (Overview of interest rate swaps). ↩

  13. Federal Reserve Bank of New York, Staff Report No. 557, page 14, "VIII. Notional Trade Sizes." ↩

  14. The same document, page 18, "IX. Market-Making Activity." ↩

  15. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた円金利スワップ市場" (in Japanese), page 7, footnote 1. ↩

  16. Osaka Exchange, "先物・オプション取引に係るマーケットメイカー制度の取扱い" (Handling of the market maker program for futures and options, in Japanese; amended June 30, 2026, effective August 3, 2026), page 1, II.1 "定義" (Definitions), and pages 3 to 4, II.2 "対象取引・種類" (Eligible products and types). ↩

  17. The same document, pages 1 to 2, the remarks column of II.1 "定義" (Definitions), and page 8, II.4(2)① "取引手数料の割引" (Trading fee discounts). ↩

  18. The same document, page 7, II.4(1)① "マーケットメイクの条件" (Market making conditions). ↩

  19. The same document, page 8, II.4(2) "PMM のインセンティブ" (Incentives for PMMs). ↩

  20. "金融商品取引法" (Financial Instruments and Exchange Act, in Japanese; English translation: Japanese Law Translation), Article 111, paragraph 1. "Members, etc." means members and trading participants (Article 81, paragraph 1, item 3). ↩

  21. Japan Securities Clearing Corporation, "先物・オプション取引に係る取引証拠金" (Clearing margin for futures and options, in Japanese), "顧客が差し入れる証拠金" (Margin deposited by customers). An English version is available: "Margin on Futures and Options," "Customer Margin." ↩

  22. Osaka Exchange, "先物・オプション取引に係るマーケットメイカー制度の取扱い" (in Japanese), page 5, II.3(2) "マーケットメイカーの指定申請" (Applications for designation as a market maker). ↩

  23. "金融商品取引法" (Financial Instruments and Exchange Act, in Japanese), Article 2, paragraph 8, items 1 to 4. ↩

  24. "金融商品取引法" (in Japanese), Article 29 (registration) and Article 28, paragraph 1, item 2 (Type-I Financial Instruments Business). ↩

  25. "金融商品取引法" (in Japanese), Article 33, paragraph 3, Article 33-2, item 3, and Article 2, paragraph 11 (registered financial institution). ↩

  26. "銀行法" (Banking Act, in Japanese; English translation: Japanese Law Translation), Article 10, paragraph 2, items 12 and 13. ↩