KARACHI, Aug 17: The financial derivatives market is set to take off as a local bank has joined the exclusive club of authorized derivatives dealers or ADDs that are allowed to undertake derivative business.

In November 2004, the central bank had allowed banks and DFIs or development finance institutions to issue financial derivatives after meeting the criteria set for this purpose. Before that, they were supposed to secure prior permission of the State Bank to transact derivatives business on case-by-case basis. Taking advantage of this permission, two foreign banks, Citibank and Standard Chartered got the status of ADDs and conducted several derivatives transactions.

Now the central bank has also designated United Bank as an ADD. UBL is the first Pakistani bank that has become an ADD, as rightly claimed in their press release issued on Wednesday.

Bankers say with a local bank joining the exclusive ADD club, the derivatives market seems to have reached its take off stage. “The evolution of derivatives market is a direct outcome of both financial sector reforms and de-regulation of interest rates and exchange rates,” says Mr. Zubyr I. Soomro.

Mr. Soomro, a former chairman of Pakistan Banks Association and head of Citibank in Pakistan is among those who pioneered the idea of financial derivatives in Pakistan. Citibank was the first bank to become an ADD.

The SBP guidelines issued in November last year for transacting financial derivatives business envisaged regulatory framework and necessary operational and risk management standards keeping in view a very high level of inherent risk.

Senior bankers say that under financial derivatives transactions, the market has so far seen more of currency options rather than interest rates option. Under the currency options, the customers reach agreement with their bankers for hedging exchange rate risks and under the interest rates options they seek hedging of interest rates risks. Bankers say that the volume of derivative business has grown rapidly since the laying down of the criteria for banks and DFIs to become ADDs but they cannot quantify the same. Most of the financial derivatives transactions have been conducted by large business groups that are involved in exports and imports on a big scale to mitigate the perceived risks arising out of uncertainty in exchange rates and interest rates.

“The derivatives involve complex transactions that have to be very carefully understood by all parties involved. They have to be suitably implemented and accounted for and the risks have to be very closely monitored,” says Mr. Zubyr Soomro.

The fact that UBL has been allowed by the central bank to deal in financial derivatives shows that local banks have started to get the high quality expertise needed for transacting derivatives businesses.

Derivatives are not only going to help the banks and their clients hedge their risks, it is also going to make money market and foreign exchange market more mature in Pakistan. That is the need of the hour given the fact that Pakistan is fast integrating its financial sector with the international market — and that the opening up of its interest rates and foreign exchange regime carries a wide variety of risks as well.