BSP tightens rules on hedging instruments

MANILA, Philippines - The Bangko Sentral ng Pilipinas (BSP) is confident that the imposition of stricter rules on hedging instruments particularly non-deliverable forwards (NDFs) starting January next year would help curb speculative activity in the foreign exchange market.

BSP Governor Amando M. Tetangco Jr. said the decision of the central bank to impose a 50-percent increase in the market risk weight on NDFs would help execessive volatile movement of the local currency against the dollar.

“Possibly, to the extent NDF’s 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 stressed.

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.

The BSP agreed to assign a higher risk weight on NDFs equivalent to a capital adequacy ratio (CAR) of 15 percent starting January next year instead of the current risk weight equivalent to a CAR of 10 percent.

The higher weights would apply to the net open position of NDFs on Jan. 1 next year to ensure an orderly transition to the new capital charge and to allow modifications in the BSP template for calculating CAR.

Under the standardized approach for calculating capital adequacy, the outstanding balances of instruments which are dependent upon market rates are multiplied by assigned risk weights. Summing the product across all related instruments will generate the market risk component of the CAR.

Tetangco said the move was a pre-emptive measure signaling against those using NDFs for speculative purposes that could be destabilizing should market conditions reverse quickly. 

He added that 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.

“In a sudden market reversal, such speculative activity especially if based on a largely one-way market view can be very de-stabilizing,” the BSP chief explained.

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. 

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 the bulk were speculative in nature resulting to increased peso volatility.

The BSP had publicly welcomed the initiative of market players to contain the growth of the NDF market but believes that the aspect of system-wide risk needs more explicit regulatory treatment.

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.