BY FINTAN NG

THE onshore or domestic US dollar-ringgit trade has increased markedly ever since Bank Negara started to scrutinise currency-hedging trades and require banks to adhere to rules that were already in place where the offshore or non-deliverable forwards (NDF) trade is concerned.

The NDF or offshore market rate is used as a hedge by traders where there are restrictions over the currency’s trading, that is convertibility, or where there is very little liquidity for the currency. As a hedging instrument, it is used as a benchmark or guide on the ringgit’s direction versus the US dollar. The trades, operating on a 24-hour basis, are settled in US dollars.

According to the central bank in a press statement, the Malaysian bond market saw a 123% jump in trades transacted during the week of Nov 14 to Nov 18 compared to the preceding week to RM39.7bil. In the foreign-exchange market, there was a 55.4% rise in trades in the same period to US$49.1bil.

To prove a point that measures, already part of the Foreign Exchange Administration (FEA) rules, taken to clamp down on the NDF market was working, it noted that non-resident participants, such as corporates, global asset and fund managers, as well as clearing and custodian banks continue to transact in the Malaysian financial markets.

“Malaysian financial market remains open with the adherence effectively in place. Liquidity continues to be available supporting smooth and orderly functioning of Malaysian financial market in intermediating the needs of market participants,” it says, adding that the requirement for onshore banks to adhere to the rules preventing facilitation of the NDF market is in line with well-established policy.

It says this is to protect the interest of the real sectors and genuine investors in the Malaysian financial market from undue ringgit volatility. “Ringgit prices and its volatility had been affected by activities and prices in the offshore NDF market which is not necessarily reflective of economic fundamentals and underlying trade and investment activities,” it says.

The transactions were intermediated by 58 Malaysian onshore banks, which include 19 foreign banks that are subsidiaries of regional and large global banks. Bank Negara says that a number of foreign banks have begun discussing with it on their financial market transaction needs to facilitate smooth transition during this period, without causing market disruption.

It says that the members of the Financial Markets Committee (FMC) welcomes the initiatives and strategies to deepen the liquidity of the onshore market while providing more flexibility for market participants to manage foreign exchange risks with onshore banks.

But how long will it take for the measures to have an impact is another matter. A Bank for International Settlements (BIS) study titled “Non-deliverable forwards: 2013 and beyond” published in March 2014 shows that it can take years before the rate set by the onshore or domestic market become the benchmark.

If analysts are to be believed, liberalisation of the onshore currency market is the only way by which the uncertainty that hangs over the ringgit can be eliminated. This means allowing non-residents to hedge the currency forwards domestically, which will make the NDF market unnecessary.

While the FEA rules are not new, the stricter adherence have been interpreted by traders as the central bank trying to impose capital controls by stealth despite Governor Datuk Muhammad Ibrahim’s assurance that no such moves were even being planned.

[slider id='81590' name='StarProperty' size='full']

However, the ghosts of the Asian financial crisis of 1997/1998, when capital controls were imposed and the ringgit ceased to be internationally traded, hovers over the current problems plaguing the ringgit, which has weakened across the board and not just against the greenback.

But the BIS study shows that even if the currency market is liberalised, it does not necessarily mean that the NDF market will be done away with immediately. The BIS cites the Australian dollar as an example of how even when the Australian dollar onshore market opened up in 1983, the offshore market existed until 1987.

It noted that the NDF share of trading in the rouble has declined even more gradually despite the rouble being fully convertible from mid-2006. Russia made the decision to liberalise its currency market amid current account surpluses, large foreign exchange reserves and plans to internationalise the rouble.

“Since then, the London data show that NDFs fell from 75% to 80% of forwards in 2008 to about half in April 2013. Especially given the bounce of the NDF share back to more than 60% in October 2013, the rouble NDF cold linger for 10 years after its liberalisation in 2006,” the BIS says.

Where the NDF market continues to exist, the BIS study says the South Korean example shows that banks’ ability to trade in both the onshore and offshore markets has kept the rates gap between them narrow. “Key to the market development is an acceptable and representative mechanism for determining the market average spot rate for the NDF to settle on,” it adds.