KARACHI, March 15: Encouraged by three leading foreign banks, the State Bank is now toying with the idea of opening up gradually the derivatives market to hedge risks of interest and exchange rate volatility but with safeguards against speculation that devastates economies.
Aware of the impact of the derivatives on the financial markets, the governor of State Bank Dr Ishrat Husain is in favour of, step by step, gradual evolution of the derivatives market.
The regulators would tread the path cautiously. To quote the SBP governor Pakistan is known whether it is Badla or Satta market for its instinct for speculation. For the regulators, to make the distinction between a true hedging and speculation is going to be a big challenge. It is not going to be an easy task because of the predominant tendency to get multi- millionaires overnight. Derivatives may provide an opportunity to some who have these instincts.
It has to be ensured that derivatives are not used for overleverage or speculation purposes, putting it to systemic risk. It is going to be a tough assignment for the central bank. We have to unbundle the risks, mitigate these risks and try to hedge your risks. That distinction between hedging risks and speculation is not easy to come by in our cultural context.
Dr Ishrat Husain added that there is a constant struggle for the central bankers to ensure that we are not so over implicit to stifle the market innovation and not so relaxed to jeopardize the safety and soundness of the entire financial system. He promised to continue dialogue with the relevant market players including the PBA.
Giving his thoughts in his speech at a seminar organized by the Pakistan Banking Association (PBA) on “Derivatives — The Way Forward”, the governor said that Pakistan has been open and receptive to foreign banks, because of their transfer of knowledge, technology and best practices. Yet, he cautioned while learning from the experience of regional and international markets “we do not want to be guinea pig.” “We will adopt what is best for us,” he asserted.
The governor reckoned that we have to start with interest rates swaps particularly the way interest rates have evolved during the last one year — a very serious concern both for the regulators and the macroeconomic managers. We should try to hedge if the interest rates move in the other direction because the risk to the portfolios and the risk to corporates is quite significant. That requires appropriate strategies as products evolve that could mitigate risks over time.
The moving spirit behind the seminar were three leading western banks, ABN-AMRO, Citibank, and Standard Chartered Bank.
In his opening remarks, the PBA chairman Zubyr Soomro said that with the stability in macroeconomic fundamentals and opening of the domestic market, it was an appropriate time to move towards a derivative market to hedge risks in interest and exchange rate markets. However, in Europe and USA, derivatives have provoked a controversy. In the wake of large scale corporate accounting fiasco, derivatives are now being labelled as “weapon of financial destruction.”
However, the foreign banks see “derivatives as the way forward” in a volatile market with floating currencies and interest rates. And the Pakistan Banking Association is drawing up a road-map for the introduction of derivatives for the regulators to consider. In the seminar, a road-map was presented by Dr Shujaat Nadeem, regional director, sales and trading, Citibank.
In fact, the overall strategy for the opening up derivatives was unfolded by the speakers who were also invited from London and Singapore to make a presentation in the seminar presided over by the State Bank governor. Babur Mufti, director structured products, financial markets, from American Express London spoke of risk management. Michael Bass, global head, interest rate derivatives, Standard Chartered Bank Singapore dealt with the impact on regulatory developments on regional derivatives market. And “the standardized swaps and derivatives documents — legal framework” was the topic of presentation by Mehmood Mandviwalla, senior partner, Mandviwalla and Zafar. The governor acknowledged the contribution of the speakers in clearing up thinking on the issue and promised to look at the Malaysian regulatory model.
Naveed A Khan, chairman, PBA Treasury Committee which organized the seminar and set the agenda says a workshop on derivatives will be held soon.
The three prerequisites for derivatives market were also spelt out by Dr Ishrat Husain. One, the banks have to have systems, procedures, the expertise and internal controls in place to make the contribution. Two, you have the corporate clients who fully understand both the upside and downside risks of this particular instrument. The corporate clients should be fully on board. Regulators should be able to provide enabling environment in which there is balance between promoting market innovation and safeguarding the safety and soundness of the system.