BSP Supervisory Frameworkon Hedging Activities

Conference on Gearing Up for External Competitiveness13 September 2010

Marco Polo Hotel, Davao City

ANNALIZA G. TAN-CIMAFRANCA, CIA, FRM

Head, Capital Markets Specialist Group

Supervision and Examination Sector

Presentation OutlinePresentation Outline

� Overview of Philippine derivatives market

� Regulations governing Hedging Instruments

� BSP Risk Management and Sales and Marketing Guidelines on Hedging Instruments

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Figure 1. Derivatives Volume (USD Billions)

Philippine Banks Philippine Banks –– Outstanding DerivativesOutstanding Derivatives

Overview of Philippine Derivatives MarketOverview of Philippine Derivatives Market

Figure 2b. Derivatives by Product Type (2000)

92%

8%0%

FX Forw ards & Sw aps Options IRS

Figure 2a. Derivatives by Product Type (2009)

60%

16%5%

19%

FX Sw aps FX Forw ards IRS Options, etc

Philippine Banks Philippine Banks –– Outstanding DerivativesOutstanding Derivatives(Dec. 2000 vs. Dec. 2009)(Dec. 2000 vs. Dec. 2009)

Regulation Governing Hedging InstrumentsRegulation Governing Hedging Instruments

� BSP Circular No. 594 - Guidelines on derivatives activitiesof Banks

� BSP Circular No. 668 - Guidelines on derivatives activitiesof Non-Bank Financial Institutions with Quasi-BankingAuthority

� Authority of Banks to offer hedging instruments

� Risk management guidelines

� Sales and marketing guidelines

What are the allowed hedging instruments?What are the allowed hedging instruments?(Cir. 594)(Cir. 594)

� Universal banks and commercial banks cangenerally offer, among others, the followinginstruments without prior BSP approval:

� FX forwards, swaps, currency swaps up to 3

years

� Interest Rate Swaps and Forward Rate

Agreement up to 10 years

� Universal banks and commercial banks withappropriate derivatives licenses can offerother derivatives/hedging instruments

� Additional authority are granted upon on-site

validation of banks’ capacity

Risk Management GuidelinesRisk Management Guidelines

� Ensure banks have capacity and ability to manage risks

arising from engaging in derivatives activities, including

offering hedging products to clients.

Sales & Marketing GuidelinesSales & Marketing Guidelines

� Prescribe minimum standards on

sales and marketing practices to

protect clients.

� Ensure banks implement sound and

ethical sales and marketing

practices.

Responsibilities of Banks OfferingResponsibilities of Banks OfferingHedging FacilitiesHedging Facilities

� A bank should ensure that:

� a client understands the nature of the transaction;

� the transaction meets the client’s objectives and risk tolerance; and,

� there is sufficient, accurate and comprehensible information disclosure regarding products offered.

Client Suitability ProcessClient Suitability Process

� A bank should ensure that the derivatives are appropriatefor client’s hedging needs through a client suitabilityprocess.

� Obtain client information about financial situation,experience, and objectives relevant to desired hedgingproducts/services.

� A bank should ensure that the clients’ objectives areclearly identified.

DisclosuresDisclosures

� To ensure clients understand the nature, benefits and

risks/costs of products.

� Banks must explain products they offer to enable clients to

make informed decision.

DisclosuresDisclosures

� Minimum disclosures should be in writing; clients to signthe disclosure statement to affirm of their receipt andunderstanding.

� Product disclosures:� Nature of the products, including underlying (e.g. FX rate)� Tenor of instrument� Fees and charges� Benefits from the instrument� Risks

Sales and Marketing PersonnelSales and Marketing Personnel

� Should be knowledgeable about

derivatives being sold.

� Bank should implement, and maintain a

comprehensive system of training of

personnel geared at enhancing technical

knowledge to enable them to understand,

explain the nature and risks of a bank’s

derivatives products and ensure client

suitability.

Responsibilities of Board andResponsibilities of Board andSenior ManagementSenior Management

� BOD and SM are made liable

for acts committed by sales

and marketing personnel

To hedge or not to hedge?To hedge or not to hedge?Advantages Disadvantages

• Protection against price

movements

• Not necessarily maximizes

revenue or minimizes cost

• Operational efficiency • Cash flow must be known

with reasonable certainty

• Improve budget forecasts • Some hedging instruments

involve cost (e.g. FX options)

SummarySummary� BSP regulations provide dealer banks general authority to

sell hedging products to clients: (FX) Forwards and (FX,Interest rate) swaps with tenor restrictions

� (FX) options may likewise be offered by banks withappropriate derivatives licenses.

� Prudential regulations ensure:

� Banks have capacity to offer hedging facilities.

� Banks implement sound and ethical sales and marketing practices

to promote customer protection.

� The decision to hedge a particular exposure shouldconsider risk appetite, economic implication and financialsophistication

Thank you!Thank you!Thank you!Thank you!

Tan-CimafrancaAG@bsp.gov.ph