BSP to review foreign exchange forwards

The Bangko Sentral ng Pilipinas will “review” the foreign exchange forward contract market in a bid to curb the growing volume—and possibly the rising speculative activity—through a facility originally meant to dampen the effects of foreign exchange speculation.

In an interview, BSP Governor Amando Tetangco Jr. said regulators wanted to examine the market for so-called “nondeliverable forwards”—or NDFs in banking parlance—to see if there was still “a real need” for it.

“We want to know if we should push for the development of more transparent hedging instruments for banks and their clients’ foreign exchange needs,” Tetangco said, noting that the end result of this review could mean nudging banks and other users toward a formal market for dollar contracts.

NDFs are synthetic financial instruments where banks and clients settle the difference between a contracted price and the prevailing spot price at some future date on an agreed volume of foreign exchange in local currency. It was introduced in the last decade to help minimize exchange rate volatility.

The volume of NDF transactions entered into by banks and their clients rose sharply, with regulators suspecting that this facility had become an avenue for speculative trading.

Tetangco said this situation had complicated the issue of large portfolio inflows into the country, which had caused financial market liquidity to threaten the inflation rate.

“Portfolio flows have continued and it is likely that this trend will persist,” Tetangco said. In the local context, a bank that buys NDFs creates a “long” US dollar position, which it must “square” by selling these dollars on the spot market. In doing so, the bank adds to the already large amount of dollars in the market, which then causes the peso to appreciate to levels that are uncomfortable for exporters and local beneficiaries of overseas Filipino workers.

Over the medium term, the BSP chief said the broader agenda of regulators called for the development of a more accurate interest rate “yield curve,” the establishment of deep benchmark issues and rates, and a “true forward market.”

In the forward market that would eventually replace NDFs, he said the results of the transactions would be “deliverable” and more transparent.

At present, Tetangco described the NDF market as “not too transparent” since prices were arrived at by calling several parties and receiving price quotes by phone, as opposed to a system where market-wide quotes are available for all market participants to see.