Stricter rules on NDFs out this month

MANILA, Philippines – The Bangko Sentral ng Pilipinas (BSP) is set to issue stricter rules on hedging instruments particularly non-deliverable forwards (NDFs) within the month to control liquidity amid the strong inflow of foreign capital and at the same time minimize market risks.

BSP Governor Amando Tetangco Jr. said in an interview with reporters that the bank regulator is set to come out with the final version of a circular governing the new rules on NDFs within the month after completing a series of consultations with major players in the banking industry.

“We have exposed a draft circular to the banks to get their reactions. We will have this consultations and dialogue with the banks before coming out with the final version of the circular,” Tetangco said.

An NDF is a forward contract between two parties to buy or sell an asset such as foreign exchange for an agreed price and settlement in the future. Counterparties settle the difference between the contracted NDF price and the spot price upon maturity.

However, reports submitted by banks to the BSP showed that NDFs are used as an hedging instrument but also for speculation prompting the bank regulator to come up with stricter rules on the hedging instrument.

The BSP through Memorandum Number M-2011- 28 has required banks to report their NDF transactions daily instead of weekly starting last June 1 to closely monitor the NDF market and curb volatility in the peso-dollar exchange rate.

The proposed circular seeks to raise the current market risk weight of 10 percent so that banks would have to set aside more capital to cover their NDF exposure. The initial threshold being considered is raising the risk weight to about 187.5 percent.

“That is not a firm figure. We never do anything arbitrary,” the BSP chief clarified.

Banks earlier reached an agreement to cut their NDF volumes by 20 percent as transactions shot up late last year until early this year wherein bulk were speculative in nature resulting to increased peso volatility.

Latest data released by the BSP showed that the net inflow of foreign portfolio investments or “hot money” jumped 230 percent to $3.06 billion in the first eight months of the year from $925.96 million in the same period last year as foreign capital continued to flood emerging market economies including the Philippines albeit at a slower pace over the past few weeks.

Gross inflow of foreign portfolio investments or hot money more than doubled to $11.834 billion in the first eight months of the year from $5.766 billion in the same period last year while outflows jumped 81.3 percent to $8.776 billion from $4.84 billion.

Major sources of hot money in the first eight months of the year included Singapore, the United Kingdom, US, Luxemburg, and Hong Kong.

Strong capital inflows could stoke up inflation through excessive liquidity in the financial system.

As a preemptive move to keep inflation expectations well anchored, the BSP’s Monetary Board raised interest rates by 25 basis points last March 24 and by another 25 basis points last May 5 due to the continued build up in inflation pressures brought about by escalating prices of oil and food in the world market. This brought the overnight borrowing rate is currently pegged at 4.50 percent while the overnight lending rate is at 6.50 percent.

Monetary authorities believed that strong liquidity in the financial system amid continued strong capital inflows blunted the impact of adjustments in the monetary policy stance on market interest rates.

This prompted the BSP to raise the reserve requirement for banks by 200 percentage points to 21 percent from19 percent last June 16 and July 28 as a preemptive move to counter any additional inflationary pressures from excessive liquidity. The twin increase is expected to siphon off at least P70 billion from the financial system.