AMIDST the flurry of activities that have emerged following the falling value of the ringgit, what appears to be clear is Bank Negara taking concrete steps to develop the foreign exchange (forex) futures market within the country.
This is an integral part of the central bank’s objective to diminish the influence of the offshore trading of the ringgit in a platform known as the non-deliverable forward (NDF) market.
Towards this end, Bank Negara last week announced measures that would make it easier for hedging activities to be carried out in the domestic market.
It said that approvals would be given to financial institutions to carry out the hedging activities in the local market with regards to the US dollar and China’s yuan without the need to furnish documents.
The customer only needs to give a declaration that they are hedging for genuine trade and investment-related transactions. Also, the hedge undertaken can be cancelled freely.
This represents a marked shift from the past.
Although hedging facilities in the domestic market have been around for the longest time, they are not popular for a few reasons. Amongst them is that the documentation process is tedious and the customers are not allowed to undertake “dynamic hedging”.
“Dynamic hedging” effectively means entering into and coming out of a hedge involving the US dollar-ringgit freely, without having to endure delays and filling up many forms.
No doubt, “dynamic hedging” borders on speculation. But then, every capital market has to have an element of speculation to garner interest. Speculation adds to the volume of transactions and is healthy if not excessive.
If there is excessive speculation, then Bank Negara as the guardian of the ringgit has to step in.
Both the measures announced by the governor are only the start of a tedious journey for Bank Negara to reduce the NDF market’s influence on the exchange rate in the domestic market.
It represents convenience for local exporters, importers or genuine investors to hedge their exposure.
However, it is not sufficient to jump-start the domestic hedging market.
Apart from ease of doing business, the cost of undertaking the US dollar-ringgit hedge in the domestic market has to be competitive compared to the NDF market.
For that to happen, the central bank has to ensure the supply of the US dollar at competitive rates to the local financial institutions.
This is what some deem as a “hand-holding period” where the supply of US dollars to local financial institutions are at rates where customers can take up hedging positions at a cheap cost.
At the moment, there are two things that favour the offshore market when it comes to hedging – the ease of doing business and more attractive rates.
When we talk about the ease of doing business, the NDF market does business with no questions asked. It also offers “depth” and range in hedging positions.
As for “attractive rates”, it means that a customer gets a better rate for the US dollar in the NDF market compared to the domestic market. This is only to be expected because the NDF market is a US dollar-settled market and there is ample supply of the greenback.
In the domestic market, at the moment, Bank Negara is the only party supplying the dollar. And pricing is still high compared to the offshore market.
At the end of the day, if the customer finds that the cost of hedging the US dollar exposure is cheaper in the domestic market compared to the NDF market, then they will move their business here.
Over time, there will be more transactions, and hopefully, the domestic market will be able to build the “depth and range” of hedging instruments at cost-effective prices.
At the moment, the cost to hedge the US dollar exposure in the domestic market is relatively expensive compared to the offshore market.
The US dollar and ringgit transactions in the domestic market only increased after Nov 11 when Bank Negara imposed tight scrutiny on the movement of the greenback.
However, a longer-term solution is for Bank Negara to intervene and supply the US dollar at competitive rates to the local financial institutions to price the hedge competitively compared to the offshore market.
This will reduce the reason for companies to hedge their exposure in the offshore market.
This “hand holding” strategy to kill off the NDF market is not new. It was used by the Royal Bank of Australia (RBA) to “kill” off the trading of the Aussie dollar in the NDF market prior to 1983.
There were restrictions on the Australian dollar prior to 1983, which resulted in the emergence of an NDF market for the Aussie dollar.
However, over time, the Government built up a hedging platform in the domestic market where the settlement is with the Aussie dollar. It only came about after some period of “hand holding”, where the RBA provided enough forex at competitive rates.
Hopefully, the same can happen to the ringgit over time.
The challenge is that during this “hand-holding period”, someone has to bear the cost of supplying cheap US dollars. And it certainly will not be the banks.