Asiamoney Malaysia FX roundtable

Asiamoney, April 2012

Participants:

Yvonne Phe Kheng Peng, Managing Director, Markets, AmBank Group

Yeoh Seng Hooi, Small and Medium Enterprises Association Malaysia

Dato’ Shahril Ridza Ridzuan, Deputy Chief Executive Officer, Investment, Employees Provident Fund

Puan Sharizad Juma’at, Managing Director and CEO, AmanahRaya Investment Management (ARIM)

Moderator: Chris Wright, Asiamoney

Asiamoney: What do Malaysian clients want and need in terms of FX and risk management tools?

Yvonne Phe, AmBank: In this volatile market, especially over the last year, the FX market has frequently not moved in a usual way. There have been sudden big gaps up and down, which have hindered a lot of business operations. If you’re an importer, an exporter or a fund manager with underlying currencies in different denominations, then there are techniques banks can offer to help hedge FX exposures more effectively. We have a team in Ambank who are constantly engaged with clients in different industries, trying to understand the business and offer solutions to protect investment returns and profit margins by hedging.

AM: And what are clients telling you? Is the volatility making this a particularly difficult time for them?

Phe: In volatile markets clients are typically more risk-averse and would like to protect what they have. Clients know what they want to do as in business – where they should invest, what business they should venture into – and the most important thing for them is to protect their margins. They are very willing to listen in order to make sure they don’t have more uncertainty in the financial aspects of what they are doing, and to minimize the risk they are facing. We talk to some clients about hedging through forwards, which means the cash can be due in a few months or years time; and for some clients our research team will explain what our views are, and if they concur with that view there are strategies we can provide to limit downside.

The EPF is the most influential institutional investor in the country – and you’re growing your international assets. What do you need in currency and risk management?

Dato’ Shahril Ridza Ridzuan, EPF: At the EPF we manage the retirement savings for the workers of Malaysia. Our total assets are about RM450 billion plus. We’ve made a conscious decision to move some of that money to global markets, and we are roughly 14% invested outside Malaysia, and expect that to grow to 20%.

Depending on the asset class, we take views on the impact of foreign exchange movements and the risk of those movements.  The prime example would be fixed income: we believe it has a higher percentage of volatility from FX so we try to hedge it 100% back to ringgit. That way we can just focus on the credit and the yield. In the property market, when we invest overseas, we prefer to have between 40% to 60% hedging on those assets. The difference there is we have the opportunity to hedge through onshore financing, which serves multiple purposes: firstly as a hedge in terms of local currency credit versus local currency returns; secondly to manage our tax exposures in those countries; and thirdly as yield enhancements, as some form of debt leverage.

AM: Can the currency, in certain areas, be a potential source of returns – something you take a view on?

Shahril: We don’t take a view on currency as a yield in itself, we use it more as risk management. We’re not in the business of investing in currencies purely for gain. We use it as a means of protecting ourselves against movements in those currencies. The types of FX we are involved in are forwards and hedging, not pure investments in currencies.

AM: How do you hedge?

Shahril: When it comes to pure hedging contracts we work with a number of the banks in the market. We have a fairly transparent process in working out the best rates we’re going to get, and how many points we are going to pay for the contracts. We are well serviced by all the banks in Malaysia, including the multinationals. Property tends to be more onshore loans that we arrange; the last one we did was sterling, for buildings we invested in in the UK. A group of international banks did a club deal for us to raise the money.

AM: Is this a particularly challenging time, given what is going on in developed world currencies?

Shahril: It is a volatile time of course: you can see that movements in the forex rates have been increasing, and that does have an impact in terms of how we time our entry into certain markets. A year and a half ago, when we started to move into the UK, we had to take a view on where the pound was in relation to its long term averages against the ringgit and dollar. And we’re looking at a deal in Australia, where the A$ in particular has been volatile. A lot of your eventual total returns will depend on exactly at which point you buy into the currency, because you’re going to be holding those assets for a long period of time.

AM: There are high hopes in Malaysia for growth in the SME sector. What sense do you get from the SMEs you represent?

Yeoh Seng Hooi, SAMENTA: For SMEs, the biggest issue is volatility. When you talk about FX risk management, a lot of SMEs maybe don’t take that into account. Why? It could be because of their speculative, entrepreneurial nature. But their strategy tends to be: do nothing. Times have changed, and they do have awareness of simple strategies like forwards, but don’t know much about swaps and options. That needs to be improved through greater education and awareness.

Another issue is the bargaining position of SMEs with their customers. A couple of years back when the euro was strengthening against the dollar, it would make sense for an exporter here to be selling to a customer in Europe in euros – but they don’t have the bargaining position to dictate the currency, and European customers would still want to buy in dollars. So they don’t benefit so much from fluctuations. Also, even if they trade in another currency – for example, selling into China and trading in yuan now – they’re still buying goods or raw materials in dollars, so have to hedge that position as well.

Having said that, although they like to be a bit gung-ho and speculate a bit, SMEs should still hedge at least their costs. Some like to take no action, allowing market forces to dictate. More of them should be aware of the instruments available to mitigate these risks: SMEs should not be relying on forex gains as a profit motivation. It should be a risk management strategy rather than hoping to have extra gains because of fluctuations – it could go the other way and wipe out their gains.

AM: How can they be encouraged to do so? Does it come from greater exposure to foreign exchange?

Yeoh: Banks have roadshows where they go round working with chambers and associations like ourselves; recently we did one with AmBank, talking not just about forex risk but trade risk. As times change SMEs have more awareness of the risks that affect them. Now at least they tend to have accountants, rather than just an entrepreneur who decides everything, and they tend to look at some of these issues. But there is still a big need to educate.

AM: And when SMEs do want to use FX product, are the products they need already there, or do you need to see more from the banks?

Yeoh: Availability of forex lines is still wanting in the SME community. I don’t know about Malaysia but in Thailand, Siam Commercial Bank says SMEs only hedge 20% to 30% of their forex transactions; it would be good to get that up to about 50%.

Forex lines are not just dished out to SMEs immediately when you become a client of the bank. This availability is something banks should look into, especially for SMEs involved in international trade.

AM: Let’s hear from the investment management industry.

Puan Sharizad Juma’at, CEO, AmanahRaya Investment Management: ARIM is a licensed fund manager under the Securities Commission (SC), managing about RM7 billion in funds across multiple asset classes: equities, fixed income, alternatives, real estate, cash and funds. We work on client mandates, in two types: direct mandates from institutional funds, and retail funds under the SC’s guidelines. Retail funds are allowed to invest up to 30% in foreign assets, and in direct mandates it depends on the clients. We are currently managing ringgit and non-ringgit investments in equity, fixed income and real estate.

Our primary objective is to safeguard and preserve the value of clients’ investments. When it comes to hedging, these two mandates must be treated differently. Direct mandates for investment in non-ringgit assets would normally come with a hedging policy; in retail funds, we will work within SC’s guidelines and policies. Depending on the client’s sophistication level, we will work with them to arrive at an appropriate hedging strategy. There are no hard and fast rules about hedging policy: it depends at the end of the day on the objective of the funds. Most of hedging positions are for fixed income and funds, where the underlyings may be a mix of assets

AM: Do investors in Malaysia tend to want large overseas exposures?

Sharizad: You have a lot of investment options. For wholesale funds, we have to work within SC’s parameters and we do note SC’s concerns and objective: to protect the public at large. We also have 100% foreign funds, but under wholesale, and mainly from our sophisticated category of investors.

There are issues with retail funds when we enter into hedging transactions with financial counterparties – we don’t have much of a free hand to determine what would be the best hedging structure for the fund mainly due to availability of credit lines. For example, one of our biggest clients is our holding company, who we handle as a direct mandate. If we enter a hedging structure for them, the counterparty signing the document is the holding company, not the asset management company, and it’s easy for them to get a credit line. If we want a one year forward or a cross-currency swap over three or five years, we’ve got the flexibility to work for the best interests of the fund. But for a retail fund, the counterparty would be the asset management company, and banks are not so comfortable to give that flexibility to us because we have to go back to the trustee to get approval. At the most we can do a one year forward, which may not be the best hedging structure for the fund.

AM: So the reason you don’t have greater choice in hedging strategy is not the availability of product, but of lines?

Sharizad: Yes, for our retail funds mainly. The whole idea of entering into hedging positions is to preserve the value of your investments, and in the current environment you may not think one year is enough. If I only have a one year position when I think five years is best, that’s not the best hedging strategy for the fund.

AM: Yvonne, how do you respond to that?

Phe: This is a much talked about topic. The contentious issue with ISDA [International Swaps and Derivatives Association] and documentation is: who is the legal entity of the fund? In retail funds it’s the trustee, but the execution and operation is done by the investment manager. It has to be the trustee who signs. In Malaysia the trustee role is not as robust as elsewhere; there is a gap where trustees are not willing to take additional, legal roles, and engage in a tripartite agreement where the trustee, bank and investment manager can all sign. That’s the normal process overseas.

At AmBank, we extend certain credit lines – granted, they are short dated, because of the uncertainty in the legal documentation. We would like to extend more to small businesses but legal counsel say: you can’t claim anything here without a tripartite agreement. It’s Catch 22. We have raised this with regulatory bodies. If we want to deepen hedging and engage the fund management industry to do more, then they need to be able to exercise their view. We are constantly looking at resolving this gap.

AM: What needs to change for you to give her the products she needs? Is that in the hand of the regulators?

Phe: It’s not the regulators, it’s in the hands of the trustee. Typically a trustee is a bit sticky in signing a legal document.

Puah Sharizad, does that make sense to you?

Sharizad: From a bank’s point of view, we will provide as much information and documentation as we can. As an institution I have gone through the process of negotiating ISDA terms and limits – importantly we want to know what else does a bank require from us and our trustee?

Phe: It’s the same ISDA documents we are talking about, just made tripartite in terms of signing it. Internally, we are looking at relaxing terms for funds in particular so we can extend further, bridge that gap, increase the tenor of hedging. Because ultimately the deeper the liquidity and the more participants, the better the pricing to the client. If nobody participates it becomes a one way street. It’s a win-win situation to have more participants in contracts on a long-dated basis because the spread will narrow quite tremendously.

AM: How about Mr Yeoh’s comment about the availability of lines to SMEs?

Phe: The SME sector is a key pillar that all banks would like to have. All banks are willing to look at their credit lines and say: you should have an FX line, because SMEs are subject to FX fluctuations. If a client agrees with our view, we say: how about you buy insurance? Risk management is all about insurance – paying something so you don’t become subject to a particular risk. Some SMEs will say they’re not familiar with option strategies, but we say think of it as insurance: if rates go up to such and such, you are protected. An option strategy means a small premium up front – or collecting one sometimes – and although you might not enjoy the upside as much as you would, you are protected. We tell clients: you don’t have to hedge 100%, do 50% or whatever you would like to do.

Yeoh: Of course theoretically SMEs should be looking at that, but still there is the speculative nature of them. They should be aware that a 10% movement could wipe out their profits: in a volatile market, it can happen.

But in terms of availability of forex lines, banks are trying to do something, but it’s usually packaged together with a credit line which involves collateral and has to be assessed from a credit perspective. If you are manufacturer, it’s easy to provide collateral because you have assets; traders don’t tend to have such assets to pledge. But they still need forex lines.

I know a certain multinational bank in India where there is a dedicated forex advisory desk for the SMEs. The big boys have their professionals who will be working on all their risk management for them, but SMEs need hand-holding and support. I think banks should have dedicated forex advisory desks here to introduce SMEs to various instruments.

AM: One assumes availability of lines and collateral are not issues for the EPF, but what issues arise from your sheer scale in terms of liquidity, particularly as you go more international?

Shahril: Liquidity is still an issue. At the scale we operate on, it is not that easy to get enough commitment from the banks, particularly from the currency pairings we are in. It is relatively easy to get ringgit-dollar pairs, but we have investments in a variety of markets such as Indonesia and Thailand. It’s not easy for us to get a ringgit-baht or ringgit-rupiah hedging pair, not in the volumes we do. We tend to work with banks in a two-stage way: hedge ringgit-dollar, then get banks to do the second leg, dollars to whatever currency we are looking at. It is cumbersome, and a result of the lack of a liquidity pool.

Over time, as we put more money into the market, we are trying with the banks to make sure there is enough liquidity and commitment available to allow us to continue to do what we do – 100% hedging on fixed income and onshore funding for other assets. Onshore funding is fine, we have access to banks willing to work with us on that; it’s more cross-currency swaps where there are limitations.

AM: We hear so much about growing intra-Asean flows; will that fix the situation?

Shahril: I think it will. As more trade is done on the commercial side, it will provide liquidity for us as well. It’s a two way thing: as the industry grows, so does the ability of counterparties.

AM: Malaysia is the most sophisticated Islamic finance market in the world. How does that affect forex risk management?

Shahril: Whether Islamic or conventional, we view assets as part of a pool. The EPF as a whole is essentially a conventional fund, because we don’t provide a Shariah-compliant pool of assets separately for contributors. But 35% of our assets are Shariah compliant and we’ve been working on increasing that percentage; also the conventional side is operated on an ethical screen similar to Shariah. There’s probably a big degree of overlap so the total volume of compliant assets is probably much higher.

We have funded a couple of asset managers with Shariah-compliant mandates for global fixed income, and they are investing now. From an FX point of view we don’t treat it any differently; we hedge it using forwards and cross currency swaps. Global Shariah is predominantly a dollar market so there’s no problem with liquidity of contracts, and locally it’s ringgit based, plus the Malaysian Shariah market is the biggest in the world anyway.

AM: How about in the asset management industry?

Sharizad: Some of our funds are Shariah-compliant. There is an issue with hedging: we have looked at several proposals from the banks but we need to find out whether the hedging structure is acceptable to our Shariah committee. The market as a whole is still working towards an accepted hedging structure for Shariah products. Many structures are index-related, and our Shariah council is still trying to digest if that is acceptable. Hedging strategy or product for Shariah investment is still pretty limited and we would like to see some improvement on that.

As a fund management company, when we launch a fund we want to make sure it is well taken up, so the market reach is very important to make it an Islamic fund, because it can cater for both – hence the importance of this Islamic hedging requirement.

AM: Is this an issue for SMEs?

Yeoh: SMEs welcome all kinds of facilities. So when banks like Bank Islam offer them credit lines, if it’s on attractive terms they will be more than happy to have another option they can tap, whether Shariah compliant or not.

AM: Yvonne, where are we up to with Shariah compliant hedging strategies from the banks?

Phe: We do have simple Islamic hedging strategies for clients, but as Sharizad pointed out, there are different interpretations of whether they are Shariah compliant. In Islamic products, whether FX or rates or sukuk, there are generally accepted Shariah principles we can use. Plain vanilla Islamic FX, profit rate swaps, commodity murabaha – that can all be done. But when it comes to more complicated strategies like index-based, it comes down to whether the Shariah council deems them acceptable. If you talk about hedging strategies, it’s a derivative, whether you like it or not; it has to derive from somewhere. How do you them structure it to make sure it is compliant? Also you can have a product in the Asia market where if you go to the Middle East you might find it’s not acceptable there. Different scholars have different thoughts. We’ve yet to see common ground on interpretation.

AM: Let’s talk about the ringgit itself. It has gone from restriction in the Asian financial crisis to being steadily more open and is now almost, but not quite, completely unrestricted. What will or should happen next?

Shahril: For us, the issue of whether the ringgit is fully liberalized or not has minimal impact on our ability to put money out for investment. If you talk to other people in the industry, they say there is no impact on them either: anyone with a genuine need to convert ringgit has no problem. It’s a misconception that there is a restriction on people’s ability to move money in or take it out – that hasn’t been the case for some years. There is no barrier to anyone like us.

The direction now is more about looking at where the flows are coming from. We are seeing a great deal of interest from overseas investors who like the stability of yields in markets here, especially those in Islamic investments. Foreign participation in fixed income has topped 30% now. The danger of course is if there is a sudden pullback, a de-risking of people’s views, but that is not just Malaysia-specific but applies to most emerging markets.

AM: That’s the big question. Bank Negara claims Malaysia can withstand flows in and out much better than it used to, because the financial markets and banking sector are much stronger and deeper now. Is that the feeling around the table?

Phe: If you look at the different phases of what we have gone through from the 97 crisis to subprime in 07 and then now, the flow of funds is always very fluid. They chase here when money can be made, and that’s normal. In Malaysia, and the region, looking at FX there are huge movements. We have seen that in one month we can swing below 3 to the dollar and above 3.2. Why? Is it movements of funds or external factors? Typically it’s always external, because that causes investors to change their asset allocations. We can’t ignore the fact that liquidity in the market, and whether we can sustain it, is not always about our own financial system or economy.

Yeoh: The main concern for SMEs is about stability. You have short term euphoria when you benefit one way, but over the long term it’s the stability of the currency that’s important. If you try to ride volatility and make extra gains, it can work both ways. Especially with the international trade environment being so competitive, you should take a risk management strategy and protect your downside – because that’s why you’re in business, not to speculate, but to make money from your business.

There’s also the changing importance of trading partners. We’re trading more with China and Asean countries, so how the ringgit fares against the yuan is an important consideration. There are a lot more bilateral currency arrangements between countries now, and more options instead of just trading against the dollar. We already have an FTA with India, for instance.

AM: In practice are Malaysian businesses making much use of the new opportunity to settle in RMB offshore?

Yeoh: From what I know, not so much. We are still buying raw materials in dollars, and some Chinese sellers are asking for dollars rather than RMB. But there’s an opportunity for trading in RMB to grow.

Phe: From one year ago we can settle trades using RMB-ringgit cross-rates. That tells you Bank Negara is encouraging people to settle trades using the cross-quote rather than a two-stage dollar-ringgit and dollar-yuan cross. That helps to minimize costs. Statistics from the regulator show that 30% of bilateral trade with China is settled in RMB direct to ringgit. This is encouraging.

Central banks are looking to minimize volatility, and cutting the dollar out of the equation helps to stabilize currencies for the Asian region. We’ve also contributed to the code we have to put in Reuters screens, so clients see that, call us, and we will clear the trades. It’s still cumbersome in documentation; there’s a lot of work behind the scenes to make sure it is a trade-related invoice and so on.

Sharizad: So far we have no investment or exposure in RMB but may be looking at such investments if the opportunity arises.

AM: Does the internationalization of the RMB represent an opportunity for the EPF?

Shahril: We are not that heavily invested in RMB denominated assets. That may change in time as we have more openness. A lot of our exposure to China is indirect, via Hong Kong or resources in Australia, or manufacturers in the US who export to the Chinese market. So our exposure to China is still dollar denominated. For international fund managers and private equity managers, it is still easier for them to think in dollars than RMB; it’s easier than having to hedge a RMB-ringgit pair where there is no liquidity. Khazanah has already done one issue in RMB which went very well; but we are not in the business of investing in currencies and are ambivalent about the RMB just for the purposes of getting RMB exposure.

Question from floor: Many hedging positions are subject to mark to market, and one of the biggest concerns of our clients is that doing so may hit the P&L. In Malaysia we have not yet fully implemented FRS139 [a new accounting standard]; do panelists see this as a concern?

Shahril: We are FRS139 compliant and we do mark to market our forex exposure. For us, it’s important to have a forex risk strategy to manage the impact on our P&L. It’s fine if the underlying asset is in dollars and you take a hedge for a similar value. And it makes a lot of sense for a retirement savings fund like the EPF to look at ways to reduce volatility in price and asset fluctuations.

Yeoh: For most SMEs exposures are usually shorter term, three or four months, so it makes more sense for them to just go into a position and cover it. For trade positions, it’s not that relevant.

Phe: From the bank perspective we are FRS139 compliant. From a client perspective we do see a lot of requests in terms of mark to market positions we have to give prices to. Incorporating mark to market into a P&L is something we look at closely with clients, because ultimately auditors have to agree with how they publish their accounts.

Sharizad: We are managing client mandates which generally are all mark to market, usually on the FRS139 requirements. Normally a client would be very much aware of the impact on the book, so normally we break it down into two parts when we report, whether the numbers are coming from the underlyings or the hedging position.

Question: Does FX volatility affect the local banking market and competition?

Phe: If you look at recent volatility in the market there was an example last year during the euro crisis when we saw swap points move to the left – meaning the risk is building – and the FX swap market on the short end of the curve, up to one year, totally closed down. No-one dared to quote. The market just closed. For a week, nobody was there with a direct cross. Then there is a ripple effect going back to all the clients.

AM: How does the new Financial Sector Blueprint from Bank Negara Malaysia affect you all?

Shahril: Hopefully it’s an opportunity for the market to grow in terms of sophistication, availability of product and pools of liquidity. That will allow people like us to take advantage. As we grow out assets overseas, the question is whether the banking industry can keep up in providing risk management capability. We intend to get to 20% non-ringgit assets by 2014, and by then our AUM will be about RM540 billion, so you’re talking about RM100 billion of non-ringgit assets. The ability to manage the forex volume of RM100 billion is uppermost in our minds right now. A portion of that will be offshore-funded, so that’s fine; but there’s an opportunity for banks to grow here in this direction.

Yeoh: It is positive that local banks are going regional – for example in emerging markets like Cambodia, Vietnam, Burma and Indonesia. That’s positive: you can have a friendly banker who knows your track record there. We are concerned about what happens to the other currencies we trade with, such as the dong or the Burmese kyat; it all has implications for the buying power of customers and the ability to repatriate funds back to Malaysia. If we have good bilateral payment arrangements, that becomes less risky.

The usual complaints would be around the availability of lines, but the SMEs themselves also have to change their mindset in terms of financial management and coming out with proper audited accounts to help them get access to available funds. With that, hopefully we can ride on the momentum of growth. FTAs are very positive and improve access to markets, creating new opportunities.

Sharizad: When you talk about the evolution of the fund management industry, we would like to see Malaysia as an Islamic financial hub. This is where we have the edge over other markets. But it is not without challenges: we have mentioned harmonization, where we have not seen much improvement at the international level. Malaysian scholars may champion initiatives on Shariah-related products but when you want to go international, you need more international participants to make it happen.

Phe: Looking at the masterplan, the regional footprint is key. For us at AmBank, we have ANZ as a partner bank and we leverage on the international connectivity and the presence they have across the group to work with clients, whether on the trade side or retail banking, for example. That is where the international connectivities are: leveraging on the footprints of partners.