Release of 3Q GDP figures by Bank Negara Governor Datuk Muhammad Ibrahim.
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% of NDF volume is generated by speculative interest.
Because of this, NDF tends to promote herd behaviour 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....
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 capitalise 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.
* See also “Bank Negara takes a firm stance” and “Can the central bank wipe out NDF?”
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