BSP sets rules of forex hedging facility

Lawrence Agcaoili - The Philippine Star

MANILA, Philippines — The Bangko Sentral ng Pilipinas (BSP) is issuing new guidelines covering the foreign exchange forward contract market, including imposing a cap on a bank’s total gross exposures, as well as stricter sanctions to mitigate potential build-up of systemic risks.

In a draft circular on the proposed amendments to derivatives regulations of banks, quasi-banks, and trust corporations, the BSP said there is a need to mitigate the build-up of risks, and at the same time protect against undue concentration in market usage of non-deliverable forwards (NDFs).

“The BSP is cognizant that NDFs may, directly or indirectly, create system-wide risks even if there is no delivery of principal amounts and even when NDFs are used as a hedge,” the regulator said.

Peso NDFs refer to a forward foreign exchange contract involving the value of the peso against a foreign currency at a specified maturity date on an agreed notional amount.

Only the net difference between the contracted forward exchange rate and the spot exchange rate between the peso and the foreign currency at the fixing date shall be settled. Banks may transact NDFs with offshore or onshore counterparties.

The BSP said only universal and commercial banks would be allowed to engage in NDFs and a bank’s exposure to all forms of peso NDF transactions, including the sum of sales and purchases, would be limited to a fixed percentage of its capital base to mitigate any potential build up of systemic risks.

“Unless otherwise amended, the said limit is 20 percent of unimpaired capital for domestic banks. Foreign bank branches shall have a limit equal to 100 percent of their unimpaired capital,” the BSP said in the proposed guidelines.

It is common knowledge that NDFs that are supposed to be meant for hedging are used by erring banks for speculative activities resulting in a more volatile peso.

The BSP said all NDF transactions would be covered by the appropriate reports prescribed by the supervising sector of the central bank.

Likewise, stricter sanctions, including reprimand for the directors and officers responsible for the violation, with a warning that subsequent violations will be subject to a more severe punishment.

Furthermore, banks in breach of the limits will be required to submit remedial plan to comply with the limits.

On the other hand, subsequent violations will result in the closure of all outstanding NDF positions and restriction or prohibition on the bank from requesting new authority or license of any sort.

Banks that are repeat offenders will also be prohibited from declaring dividends, while the regulator could issue cease and desist order preventing them from conducting business in an unsafe and unsound manner.

Over the years, the BSP has been undertaking pre-emptive measures signaling against those using NDFs for speculative purposes that could destabilize should market conditions reverse quickly.

The regulator has deployed the risk-based capital mechanism to discourage undue speculation as NDFs became attractive vehicles for speculative funding flows.

Rising NDF transactions reinforce the view that there is more to NDF activity than just an intention to hedge, exposing heightened market risk from the market’s volatility.

The BSP has assigned a higher risk weight equivalent to a capital adequacy ratio (CAR) of 15 percent for NDFs, higher than the central bank’s threshold of 10 percent.

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