Muhammad bin Ibrahim: Financial markets and the ringgit - our
journey forward
Opening remarks by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia (Bank
Negara Malaysia), at the Financial Market Association (PPKM) Annual Dinner "Financial Markets
and the Ringgit: Our Journey Forward", Kuala Lumpur, 18 November 2016.
* * *
It is my great pleasure to address the members of the financial market industry at the Financial
Market Association of Malaysia's annual dinner. This dinner regularly held towards the end of the
year, has developed its own unique tradition and camaraderie.
Another year is passing by and we find ourselves in a very familiar situation; heightened volatility
and uncertainty, low growth and low interest rates. The specificities or circumstances behind
these may be different and indeed some of these developments were considered highly
unexpected or even irrational. Hindsight, which gives us 20/20 vision, does not necessarily
provide us with a better understanding. The global markets continue to be imbued with financial
market and policy uncertainties. To add to this, are the evolving geopolitical uncertainties and
challenges arising from Brexit and the impending changes following the recently concluded US
presidential elections. 2016 is turning out to be a year of many surprises, something that policy
makers tend to be uneasy with. I hope 2017 will bring less of these, but then for financial market
players, surprises, volatilities and uncertainties are not totally undesirable as they also bring
along lucrative trading opportunities.
For the ringgit exchange rate market, the past two years have been uniquely challenging. At the
end of 2014, the situation appeared rather benign. The ringgit was stable, market liquidity was
good, trading activity was healthy with market volumes averaging USD11.8 billion daily while the
volume for USD/MYR pair averaged USD8.3 billion in 2014. The subsequent period however,
precipitated by the weakening external conditions, falling oil prices and domestic uncertainties
have laid bare these notions. Volume and liquidity declined, bid-offer spreads widened and at
times, there were one-way markets which exacerbated any movements. Given these
developments, 2015 was a year where our actions were primarily geared towards stabilizing the
markets. While this was clearly achieved, it was not without cost; a reduction in foreign exchange
reserves, a markedly less liquid and volatile foreign exchange market, and a weaker currency. In
the midst of this, an important observation that became increasingly evident is the continued
vulnerability of our markets to the arbitrary and unpredictable devices of the offshore markets.
Adverse conditions brought on by the NDF market
Activities in the offshore market, in particular the ringgit non-deliverable forward (NDF) market,
had brought on observable adverse impacts to the onshore market. To our disappointment,
onshore players had become followers rather than leaders in determining domestic market rates.
Consequently, taking the lead from the NDF market, the ringgit exchange rate has been quite
volatile since last year, peaking at 23.1% for its 1-month historical volatility and is the highest
among regional currencies for this year. Of late, it has been trending down, but the average
volatility remains high at 10.1% compared to its 5-year average of 8.2%.
On a day-to-day basis, the ringgit was also volatile, particularly prior to the USD/MYR fixing time
even though it can be quiet throughout the rest of the day. As trade related FX transactions are
done throughout the day, it is highly perplexing as to why trading activities and observed volatility
have to be concentrated just prior to the fixing time. The only plausible reason for the above
phenomena is that it emanates from the fixing orders from non-resident financial institutions
(NRFI), the transactions of which are driven by NDF market activities. As NDF is settled using
fixing rate, NRFI have been using fixing orders to square their offshore NDF positions. As a
consequence of such speculative activities, the ringgit fixing rate has significantly diverged from
the onshore traded ringgit prices. The ringgit fixing rate was clearly out of sync with real trades
and investment activities done throughout the day.
The impact of NDF market volatility has been clearly pervasive in the onshore market. Several
FX traders in the domestic market were observed to be looking towards the NDF market to
provide cues in determining the opening market price for ringgit. And this behaviour continues
throughout the day in the pricing of the ringgit. Unfortunately, our media and public were also
drawn into taking the lead from these offshore rates as well. The sum effect of these behaviours
is that we inadvertently imported the NDF volatility into the onshore market. Given the
importance of this, let me dwell a little further on the dynamics of the situation.
The offshore market, which is driven by speculative interest, lacks the onshore market's diverse
spectrum of market participants and information. This was notably mentioned by the Federal
Reserve Bank of New York paper in May 2005, that an estimated 60 to 80 percent of NDF volume
is generated by speculative interest. Because of this, NDF tends to promote herd behavior which
compounds the lack of two-way market liquidity. Prices may move rapidly in one direction or
another driven purely by fickle sentiment, as well as leveraged positions taken on by the
speculators, making them inherently unsuitable to represent an efficient and objective price
discovery process for the ringgit. Compounding this further, the offshore NDF markets are highly
opaque and information on these markets can only be gleaned through the BIS' triennial survey
and other sources such as through mandatory reporting of derivatives and swap data
repositories on US financial institutions.
Actions by BNM/the market
With increasing concern over the offshore market negative spill-over impacts, BNM has taken a
broad spectrum of actions to reduce the speculative and damaging influence of NDF activities.
Because of the estimated volume and its opaqueness, the NDF market clearly has the potential
to undermine the integrity and financial stability of the onshore market. BNM has the responsibility
to ensure orderly functioning of the foreign exchange market and to maintain public confidence in
the financial system. We have, over the years, taken proactive actions to slowly root out the
speculative elements in the onshore market.
From end 2014, we have significantly reduced the availability of short-term central bank papers
that were used for short-term investments that support the NDF market and speculation on the
ringgit. Such actions were taken despite our cognisance that such papers provide an efficient
liquidity management instrument to our own market players. But increasingly, over the years, it
had become an instrument of choice in facilitating the speculative flows. Holding of these papers
had been dominated by the NRFI. At one time, as much as 96 percent of our BNM short term
papers were held by NRFI. The yields on these papers have consistently trended below the
policy rate showing the extent of speculative elements, which would not happen under normal
circumstances. Consequently, we no longer issue these papers on a regular basis.
In 2015, to ensure a more reflective pricing mechanism of the domestic market, a more direct
attempt to cut off the pricing linkage between onshore and the offshore market was made. Banks
were prohibited to quote fixing orders to NRFI that do not have firm underlying trade
commitments. As NDF is settled offshore based on ringgit fixing rate, the prohibition ultimately
raised the basis risk, and financial cost, of hedging NDF transactions in the onshore market.
While this measure may appear harsh, it has worked to some extent to reduce the NDF related
flows into the onshore financial market.
In mid-2016, following extensive discussions with financial market players through the FMA, we
reviewed the ringgit fixing mechanism to enhance its integrity. The new fixing, now known as KL
USD/MYR reference rate, uses transaction data in the determination of the reference rate.
While it enhances the credibility of the fixing mechanism, the new methodology has also greatly
reduced the ability of the offshore NDF related transactions to capitalize on the reference rate
process. The initiative, which was implemented smoothly with positive market response, also
had the desired outcome in further reducing the volume of ringgit speculative flows.
Throughout the year, we have also strengthened our monitoring of compliance to the existing
Foreign Exchange Administration (FEA) rules. FIs have been strongly reminded to be cautious in
facilitating FX transactions, particularly with NRFI, to ensure that they do not become unwitting
facilitators of ringgit speculative activities. Accordingly, we expect banks to conduct robust due
diligence and Know-Your-Customer (KYC) process to fully understand clients' transactions. We
believe that the enhancement of such processes will enable banks to detect transactions that
could be related to NDF activities in ringgit. Prompt supervisory intervention will be taken against
any individuals and banking institutions that are found to facilitate NDF market activities.
Another area which we looked at was the exchange traded ringgit products in the offshore
markets. As part of our policy of non-internationalization of ringgit, we prohibited the trading of
ringgit assets and products outside of our jurisdiction. It undoubtedly the opaque pricing
mechanism has adverse impact on the domestic financial market, price discovery process and
the stability of the financial market.
Accordingly, when there were reports of ringgit futures contracts being introduced on offshore
exchanges, we issued reminders to onshore financial institutions and corporations against
participating in them. The prohibition also encompassed engaging in any onshore FX transaction
with non-residents that could be deemed as facilitating offshore ringgit transactions. These rules
are not new but have been there all this while.
We also instituted several measures this week as volatility also picked up sharply after the US
Presidential election result. Because of adverse consequences on genuine investors and
businesses, we should no longer tolerate the NDF market and its damaging influence over the
onshore pricing of ringgit.
Let me make it doubly clear on this. Onshore banks are reminded against quoting onshore ringgit
opening price referencing to the offshore prices. Markets should not price ringgit excessively or
out of sync with the underlying fundamentals. We have also reminded onshore banks to avoid
dealing in FX with non-resident banks suspected of engaging in NDF speculative activities except
for those that provide confirmation of their non-involvement in the offshore ringgit NDF market.
This week has seen many noises surrounding these measures. There is no new policy on
capital flows.
There is no proxy capital control either. In fact, Malaysia's capital account remains free with free
mobility of inflows and outflows of capital for investments. The market remains open to all market
participants and we shall ensure the necessary liquidity to the market.
In essence, the measures that were instituted over the past week are consistent with our long
standing policy of non-internationalisation of the ringgit and one that we expect banks to fully
adhere to without exception. We do not recognize or condone the non-deliverable ringgit offshore
market. Those who engage in NDF or NDF-related transactions are doing so at their own peril.
I understand that to some, these are challenging measures but as I mentioned earlier, they are
not new. We need to remove the negative influence of the NDF activities that impacts the
smooth functioning and stability of the onshore financial market. We need to protect the interest
of genuine investors and businesses, irrespective of whether they are foreign or domestic. Only
through a concerted effort by all the stakeholders of the ringgit market, can this objective be
achieved. We need to remember, that integrity and proper functioning of our financial market is in
the interest of every market participant, and all of us have a role to play towards achieving this
objective.
Way forward
To overcome these challenges and to take on new direction and impetus, we had formed the
Financial Market Committee (FMC) earlier this year. Besides tackling the various issues, risks
and challenges of navigating these uncertain and volatile times, the FMC has been mandated to
formulate and propose strategies to take the financial market development forward. I would like to
thank the members of the Financial Market Committee and industry association representatives
for collaborating with us for the common and greater good of market development.
The FMC and its subcommittees have met several times. Some of the initiatives have already
been rolled out; such as the extending of trading hours for the FX market and the KL USD/MYR
reference rate. Some are going through the woodworks of development. I would like to discuss a
few here.
1. We are embarking on a progressive journey of a more liberalized and conducive financial
market operating environment. As a concrete step, I would like to announce the introduction
of a pilot program for the USD/MYR and CNH/MYR markets. Under this program, residents
will be allowed to undertake hedging transaction for USD and CNH against ringgit without the
need for sighting of the underlying documents. Subject to a position limit, only a declaration
by the customers will be sufficient. Accordingly, cancellation of the hedging will also be freely
allowed.
2. To further complement this, the Bank is also currently working with the Securities
Commission and Bursa Malaysia to facilitate the introduction of USD and CNH against
Ringgit futures for the onshore exchange. Similar to the interbank market, these will, for
now, be subjected to position limits, and for now only applicable to residents. We shall
review this policy from time to time, with a view to further liberalise the rules.
3. The Financial Market Committee (FMC), through an industry-driven effort, is in the final
stages of rolling out an operational framework for Foreign Exchange Administration (FEA)
compliance. This will be an industry standard that sets the minimum due diligence and list of
documents required for FEA. Further to this, a standard summary of the relevant FEA rules
to facilitate common understanding and consistent interpretation among market participants
is being formulated. It is expected, through this important initiative, there would be better
clarity and greater efficiency for the financial institutions and their customers, in undertaking
FX and hedging transactions.
Taken together, these three measures are targeted at residents such as the Small and Medium
Enterprises with a view to expand their access to hedge freely and directly with onshore banks.
This flexibility will provide the avenue for simplified processes and flexible hedging activities within
prudential limits and incentivise residents to use onshore banks for their hedging needs.
These are but first steps. We will be looking at further measures, similar to these. The idea
behind these measures is to make our onshore financial market more flexible, facilitative and
competitive. In other words, we are deepening the onshore markets towards becoming the main
actor to conduct the foreign exchange needs of our economy. This journey will be exciting and
require some behavioural changes. But we have no doubt that with the full support of the
industry, we can achieve these outcomes.
I envisage the FMC and the industry to further collaborate and come up with the new strategies
and ideas to deepen and support the development of our onshore market. Beyond trade or real
sector activities, we should look at financial investments, in particular the non-resident investors
in our bond market. We have 33.7% of our Government bond market held by such investors.
There are opportunities in this domain.
Where are they hedging their foreign exchange exposures? What product can the industry offer
for them to hedge onshore? Given these obvious opportunities, we need to develop solutions that
will benefit the industry as a whole.
The significant overseas investments by residents and foreign currency exposures arising from
trade activities create a need for the domestic hedging market to be further deepened. In 2015,
FX market transactions volume reached a staggering USD2.52 trillion, yet currency derivatives
such as FX forwards and options only made up 5 and 1 percent of the total volume, respectively.
Similar concerns also exist for the bond market. Both government and corporate bonds are still
primarily held by residents, and we have one of the largest corporate bond markets in the region.
Yet, this does not translate into the development of active hedging market activities. Credit
derivatives made up less than 1 percent of ringgit derivatives volume in 2015. This prompts
several questions. Are our investors able to hedge effectively or efficiently manage the exposures
of their portfolios? What instruments are on offer or traded in our markets that can serve as such
tools? What are the policy changes that require rethinking to enable us to develop a deep and
liquid hedging market? These are all issues that the FMC will deliberate and offer solutions.
We all share the aspiration for our onshore financial market to become a highly competitive
market. Not just the foreign exchange market but across all its market segments; money,
interbank, bond and the derivatives markets. A market where pricing of ringgit assets are fully
determined by a robust price discovery process onshore, driven by real trades and
nonspeculative investment activities.
We envision a financial market, where it has the breadth to cater to increasingly sophisticated
needs of diverse market participants, going beyond trade and financing towards facilitating more
effective and efficient risk management activities. A financial market, where it also has the depth
to sustain and face any volatility in the market. A financial market, that has ample liquidity across
different instruments in all market segments, and extends beyond the ringgit, to the point where it
can anchor regional trades and investment activities. Ultimately, we want our onshore financial
market to be the market of choice for all market participants, including non-residents, to meet all
their financial needs.
Before I end my speech, I would like to announce an award that will be presented to a leading
derivative bank at the next annual PPKM dinner. The rationale is to give public recognition to an
institution that contributes towards raising the volume and value of transactions in the FX
derivatives market.
Last but not least, let me take this opportunity to congratulate the FMA on its accomplishments
this year. FMA recently signed a collaboration agreement with the Asian Institute of Chartered
Bankers and Asian Business School that would contribute towards enhancing the integrity,
ethical standards and professionalism of market participants. FMA certainly has been an
important driver and partner to bring the financial market development to a higher level. And
organizing this annual event is also one of its perennial successes. On this note, I wish tonight's
dinner will be an occasion for us to enjoy and cherish.