BSP curbs use of NDFs for speculation

MANILA, Philippines - The Bangko Sentral ng Pilipinas (BSP) has successfully curbed the use of hedging instruments particularly non-deliverable forwards (NDFs) for speculative purposes by reducing the volume of transactions by as much as three-fourths after imposing stricter rules last Jan. 1.

BSP Governor Amando Tetangco Jr. said in an interview with reporters that the volume of NDF transactions by banks stood at about $4 billion as of April 4 from a high of $16 billion as of the middle of last year.

 “The volume of NDF transactions has stabilized to $4 billion from about $16 billion. It is down to a quarter,” Tetangco stressed.

The BSP imposed stricter rules on hedging instruments particularly NDFs through the imposition of a 50-percent increase in the market risk weight to control liquidity amid the strong inflow of foreign capital and at the same time minimize market risks effective Jan. 1.

The central agreed to assign a higher risk weight on NDFs equivalent to a capital adequacy ratio (CAR) of 15 percent starting Jan. 1 instead of the previous risk weight equivalent to a CAR of 10 percent.

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.

He pointed out that the volume of transaction stabilized as the net open position of NDFs carries a higher market risk capital charge consistent with a CAR of 15 percent instead of 10 percent.

 The stricter guidelines were imposed as a pre-emptive measure signaling against those using NDFs for speculative purposes that could be destabilizing should market conditions reverse quickly.

The approach to deploy the risk-based capital mechanism to discourage undue speculation is considered more equitable, incentive compatible, and market-friendly than outright prohibition or arbitrary caps.

 “We did not close the NDF facility,” he explained.

The took the initiative as a macro-prudential policy move in October last year. Macro-prudential measures pertain to those that are geared primarily to preserve overall financial stability as opposed to re-enforcing the safety and soundness of individual institutions which remain well-capitalized at present.

NDFs could be effective hedging instruments for those who may not have sufficient foreign exchange assets to settle their future foreign exchange obligations. However, NDFs also became attractive vehicles for speculative fund flows in a situation where the market has increasingly taken a one-way view that the peso would strengthen over time.

On three separate occasions this year, the market had voluntarily set limits on banks’ net open NDF positions. 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.

The BSP through Memorandum M-2011- 28 has been closely monitoring NDF transaction by requiring banks to submit daily reports instead of weekly starting last June 1 to closely monitor the NDF market and curb volatility in the peso-dollar exchange rate.

 “We will see if there will be other policy steps needed in the future or policies that we can take in the future. We are closely watching the type of capital flows,” Tetangco said.

Tetangco earlier reported that the Philippine peso was in the middle of the range in terms of movement and volatility in Asia amid the weak economic growth in advanced economies led by the US and the sovereign debt crisis in Europe.