Asia Risk, December 2009
A few years ago, Thailand was not popular with foreign derivatives bankers. As the Thai baht went through a period of increasing volatility, regulators became more and more restrictive on the sale of derivatives, telling banks to submit lists of products they want to sell for approval. “At the time it was very annoying: I thought it was too draconian,” says one banker.
But Thailand’s stringency on derivatives paid off when markets turned really nasty. “In the two years or so before the global financial crisis, every new structure you wanted to bring out, you had to take it to the regulators to get an approval done for the product,” recalls Adam Gilmour, managing director and co-head of corporate sales and structuring for Asia at Citi. “That meant that by the end of 2008, when the crisis was at full steam, they had good practices in place: solid documentation, no speculation, and robust product risk they could feel comfortable about. It put them in very good stead for the crisis.”
The Bank of Thailand recognises derivatives are important for its companies – particularly with such a volatile currency – and so despite its stringency it has been gradually relaxing laws, most recently in August. The box in this article gives more details but in essence it widens the ability of companies, institutional investors and individuals to enter derivative contracts linked to foreign variables, be they indices, currencies or rates.
Thai derivative volumes are not large. Bank of Thailand data shows that in September 2009, total outstanding Thai baht interest rate swaps at Thai commercial banks came to Bt2,231 billion, or US$67 billion [CHRIS: THIS IS SOURCED FOM BOT DATA – DOES THE FIGURE SOUND HIGH TO YOU?]. While that sounds a lot, the Triennial Central Bank Survey, which compiles data on derivatives and forex from the world’s central banks, gives an indication of how Thailand really compares on a world scale: in its last published survey, in 2007, total average daily turnover of OTC derivatives market activity – including foreign exchange and interest rate – was US$5 billion, compared to US$210 billion for Singapore. Similarly Thailand’s reported foreign exchange market turnover – in total, not just derivatives – was US$6 billion, or 0.2% of the world’s total; Singapore’s was US$231 billion. One foreign banker puts it like this: “If I cut the universe [of Asian markets] into a top and a bottom half, Thailand would be in the bottom half, but near the top of it.”
Nevertheless, Thai officials consider themselves accommodative to derivatives, within reason. The Bank of Thailand describes its policy on derivatives to Asia Risk as “to accommodate development in order to make available as many risk management tools as possible, while ensuring financial system stability and financial institutions’ soundness. In other words, the challenge is to strike a balance between the flexible environment to foster innovation and maintain system stability.”
The bank says it is guided by five principles in formulating the supervisory framework for derivatives business: efficient risk management, appropriate to the nature and complexity of the business; financial and economic stability; sufficient customer protection; relevant prudential regulations being in place; and sufficient information for supervisory purposes. It also claims have put “considerable effort and resources” into education, human resource development, accounting standards and the resolution of tax issues.
Those in Thailand who watch the market closely consider the Bank of Thailand accommodating without necessarily being enthusiastic. “It’s a small market from an international perspective,” says Komkrit Kietduriyakul, partner at Baker & McKenzie in Bangkok. “But the Bank of Thailand has tried to support it – they understand derivatives and believe they can be useful.”
Others find it can be bureaucratic, but works. “I’m very positive about Thailand,” says a foreign banker in Singapore. “There is plenty of bureaucracy, and it takes a long time if you want to do a new structure – getting it approved can take months. But it’s a lot better than a lot of other markets like Indonesia, where the industry shut down completely with the financial crisis.” He adds: “If I develop a new product, there’s a mechanism to take it to the Bank of Thailand and to be able to get it approved. They might be a little bit tight on the documentary restrictions, but there is a clear path.”
Most things a corporate would need to do, they already can. “As long as it is a hedging transaction, it’s basically OK for corporates,” says Komkrit. “What they don’t want to see is speculation by corporates, and the most sensitive issue is the Thai baht position for non-residents. Their experience in the last crisis [the Asian financial crisis] means they don’t want non-residents manipulating the baht.”
One could argue that the volatility in the baht makes it particularly essential for Thai companies to have access to derivatives since the penalty for not hedging a currency exposure can be severe. In particular, Thai exporters and importers are heavily exposed to the US dollar. The Bank of Thailand acknowledges that Thailand’s managed floating exchange rate and the global financial crisis “has led to more volatile exchange rates in the emerging market countries, including Thailand” and says that “hedging exchange rate risk is a necessity for Thai companies to protect themselves against volatility of exchange rates.” The Bank reckons it has “continuously encouraged” the business sector to hedge exchange rates, and hosts numerous seminars to help small and medium enterprises understand why and how. It also publishes an SME risk management manual. In any event, it says the recent relaxations have made it easier for companies to hedge, and to use foreign currency accounts.
What next? In November the Bank of Thailand issued its Financial Sector Master Plan Phase II, which covers a host of issues around the Thai financial system. Although the public announcements about the plan don’t mention it, people close to it say that it pledges to support the development of credit derivative transactions, as well as continuing to encourage interest rate derivatives and urging participants to use ISDA market agreements (which, in practice, they generally do anyway). “I think credit derivatives will become more popular in the Bangkok market,” says Komkrit.
For the Bank of Thailand’s part, it’s open to the idea of further openness. “We are supportive of the liberalization of the derivative regulation in Thailand, as long as the stability of our system is maintained,” says the Bank. But further change seems unlikely in the short term: “The current regulatory environment seems to be appropriate to accommodate the current level of market development and provide enough hedging instruments for our exporters and importers.” In other words, for now, it’s as open as they feel it needs to be.
Box: The August liberalization
On August 5 Suchada Kirakul, assistant governor in the financial markets operations group of the Bank of Thailand, announced a series of liberalization measures. Most were about investment in securities abroad, but they also had a significant impact on the derivatives market.
The changes were:
What’s the impact? The Bank of Thailand tells Asia Risk: “The relaxation has provided alternative investment channels for the institutional investors so that they can further diversify their investment and enhance their investment returns through derivatives.” It has also helped institutional investors with their risk management by allowing them to hedge risks such as commodity prices and interest rates more flexibly and cheaply, the bank says. “Additionally, the relaxation has added more flexibility in foreign exchange risk management of Thai exporters and importers, enabling them to hedge their foreign exchange exposure more efficiently.”
At the individual level, residents have a greater range of investment products, while it also gives domestic commercial banks a chance to offer structured products to a much wider customer base than before. “More structured notes and deposits traded in the market could possibly help reduce transaction costs and add more investment products to the domestic market.”