Do & Tell

rnGovernor Jayewardene was speaking at a derivatives seminar organised by the National Wealth Corporation, a enterprise connected to the Mahapola Trust.rn

rnDerivatives, such as futures/forwards, options, and swaps, transfer risks from one party to another usually by separating it from the underlying asset.rn

rnBut some such instruments can be extremely complex and new permutations of derivatives crop up often in financial markets.rn

rnldblquote Many Central Banks had made weak attempts at regulation but they have given up in the end, dblquote says Jayewardene.rn

rnldblquote The general agreement on this subject is that there should be efficient accounting and auditing systems to recognise derivative products and account for exposures arising from them."rn

rnJayewardene says the IAS 39 standard, which deals with derivatives, was a good place to start.rn

rnNational Wealth Corporation has teamed up with the Singapore based financial services company Refco to allow local firms to trade in the Singapore SGX-GT (former SIMEX) exchange.rn

rnCentral Bank of Sri Lanka encourages derivatives for hedging (to avoid risk), but it frowns on speculation (deliberately taking on a risk to make a risk based on a particular view of the market).rn

rnNatWealth Chief Mangala Boyagoda says international financial markets have witnessed excessive volatility in recent times.rn

rnThe weakness of the dollar, versus the Euro, the sudden rise in gold and petroleum prices, has exposed companies to different risks. This volatility generates a need for hedging.

rnldblquote Any business is exposed to financial risks, dblquote says Boyagoda. ldblquote We are seeking to address these risks and manage them. dblquotern

rnEuropean firms faced with a rising Euro, are thought to be heavily hedging their exposures in a bid to protect profits.

The Bank of International Settlements reports that the value of outstanding currency derivatives rose by a third in the first half of 2003 alone.

rnldblquote Although it is difficult to design a comprehensive regulatory scheme for derivatives we can always come up with some guidelines or standards, which are self regulating in nature, dblquote says Governor Jayewardene.rn

rnldblquote The rules that which market participants themselves adopt should be shared with the regulator; that should provide a basis for surveillance of derivative transactions, dblquote Jayawardene said. rn

rnCentral Bank will encourage strengthen of internal controls so that taking on of lquote imprudent risk is discouraged.rn

rnOTC derivatives, sometimes tailored for one-off situations can be complex and difficult to understand.

The real risks of credit derivatives, which put insurance firms in difficulty and even led to default in recent times, were not understood even by those who wrote them, until it was too late. rn

Securitization and off balance sheet vehicles, which again transfer risks, have also been also been used fraudulently in some of the biggest corporate scandals in the US.rn

rnBut Refco is offering electronically exchange - traded, standardised products, whose exposure can be monitored with relative ease.rn

rnldblquote Traders, their management, compliance officers, can monitor the exposures of the traders, the company or even customers, on a real time basis, dblquote says Refco Managing Director Robert Tan. rn

rnNatWealth however is not offering rupee-forex derivatives through their Refco tie up, but non-rupee cross currency futures (standardized exchange traded forwards), options and commodity derivatives (crude, gold futures).rn

rnAt present, dollar interest rates are at an almost historic low. Though spare capacity in the US economy is still keeping inflation fears at bay, analysts do not expect rates to go down much further, given the state of US government finances.rn

rnWith rates more likely to go up than down, local firms with US dollar borrowings based on the 3 month LIBOR could fix their rates by doing a rate swap, says Dhammika Ranawana who heads NatWealths securities trading arm.rn

rnThis could be cheaper than going for long-term dollar borrowings, assuming that there were willing lenders in the first place.rn

rnThough Sri Lankas financial markets were liberalised more than 20 years ago, derivatives have not really caught on.

Though some currency and rate swaps as well as forward rate agreements have been written from time to time.
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rn

rnldblquote We have allowed a some type of Darwinian evolution of financial institutions and instruments, because we were concerned about the capacity of the players and the system to bear this, dblquote says Governor Jayewardene.rn

rnldblquote This is the way by which all operators in the system would be fully aware of the inherent risks in the markets and they would not move blindly or recklessly in developing the relevant market. dblquotern

rnIronically, in Sri Lankas forex currency markets, the most popular OTC derivative, the US dollar forward, is struggling.

Though importers want forward cover, it is becoming increasingly difficult to cover their positions, says one dealer, as few players are quoting forward.rn

rnldblquote We match deals inside and still give cover to some customers, dblquote one dealer told LBO. ldblquote It is difficult to refuse cover to good customers. dblquotern

rnHardly any forwards now go beyond three months, and some dealers say premiums are above the interest rate differential.rn

rnThe rupee has been under pressure since the dissolution of parliament and traders in turn have come under pressure from Central Bank not to rock the boat too much by buying large volumes of dollars, but cautious treasurers do not want to carry positions.rn

rnA far cry from the cosy situation a few months back, when dealers were generating rupees in the forward market, investing in government bonds, and were busily collecting the profits.rn

rn

-Asantha Sirimanne: asantha@vanguardlk.com rn