BSP chief sees tighter rules on hedging tools to curb peso speculation

The Bangko Sentral ng Pilipinas (BSP) sees stricter rules on hedging instruments, particularly non-deliverable forwards (NDFs) starting next year, as reducing speculative activity in the foreign exchange market. BSP Governor Amando Tetangco Jr. said the central bank-Monetary Board decided to raise by 50 percent the market-risk weight on NDFs to tone down the excessive volatile movement of the peso against the US dollar. 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; then they settle the difference between the contracted NDF price and the spot price upon maturity. “Possibly, to the extent NDFs are being used by banks to exploit a view on the peso. The main purpose of the measure though is to tone down excessive speculative activity as a macro-prudential measure," Tetangco said. Macro-prudential measures are to those geared primarily to preserve overall financial stability as opposed to re-enforcing the safety and soundness of individual institutions which remain well capitalized. Preemptive measure vs speculators The Monetary Board will begin assigning a higher risk weight on NDFs equivalent to a capital adequacy ratio (CAR) of 15 percent beginning January next year — as compared to the current 10-percent CAR. Starting Jan. 1, the new weighting ratio will apply to the net open position of NDFs to ensure an orderly transition to the new capital charge and to allow modifications in the BSP template for calculating CAR. The standardized approach for calculating capital adequacy multiplies by assigned risk weights the outstanding balances of instruments which in turn depend upon market rates. Summing the product across all related instruments generates the market risk component of the CAR. Tetangco explained that the measure would preempt speculators whose use of NDFs could destabilize the economy should market conditions rapidly change. “In a sudden market reversal, such speculative activity especially if based on a largely one-way market view can be very de-stabilizing," he said. Private initiative, public regulation Just this year, the market had on three separate occasions voluntarily set limits on banks’ net open NDF positions. Banks had earlier agreed to cut their NDF volumes by 20 percent as transactions rose late last year until early this year, on the observation that these were speculative in nature and had increased peso volatility. Even as the BSP welcomed the market players’ initiative to contain the growth of the NDF market, the country’s top financial regulation body believes the aspect of system-wide risk needs more explicit regulatory treatment. BSP Memorandum No. M-2011- 28 has required banks starting last June 1 to report their NDF transactions daily instead of weekly to closely monitor the NDF market and curb volatility in the peso-dollar exchange rate. Tetangco explained that deploying the risk-based capital mechanism to discourage undue speculation is more equitable, incentive-compatible, and market-friendly than outright prohibition or arbitrary caps. — MRT/VS, GMA News