OVERVIEW OF DERIVATIVES
Conception of Derivatives
A derivative is a financial instrument whose value is contingent upon the values of underlying variables, as defined by Hull J in "Options, Futures and Other Derivatives" (7th edition, 2000).
In "Derivative Securities: Pricing and Hedging," derivatives are defined as contracts or securities that guarantee a future payment, with the amount contingent on the performance of an underlying asset up to the payment date.
Basic Purposes of Derivatives
Future market prices are influenced by the supply and demand of assets, which are affected by various factors such as climate conditions, political events, debt defaults, refugee movements, land reclamation, and environmental health Understanding this information plays a crucial role in shaping commodity prices through a process known as price discovery.
The primary purpose of derivatives markets lies in effective risk management, which involves assessing the desired and actual levels of risk This process is essential for aligning the two levels of risk, and it can be divided into two main categories: hedging and speculation.
Hedging involves investing to minimize the risk of adverse price movements in assets, while speculation entails balancing the potential for significant gains against the risk of losing the initial investment Nowadays, both hedging and speculation strategies, along with derivatives, serve as essential tools for companies to manage risk more effectively.
Derivatives can enhance market efficiency for underlying assets by increasing liquidity, which helps reduce transaction costs Insufficient liquidity often leads to elevated transaction expenses, potentially discouraging investments and hindering capital accumulation.
Derivatives facilitate the opposite result by offer investors more profitable options and efficient insurance of risk management
Derivatives play a crucial role in enhancing market liquidity, which in turn reduces transactional costs and boosts business efficiency This improvement leads to lower capital-raising expenses and increases the available capital for productive investments.
Characteristics of Derivatives
The value of derivatives is directly influenced by fluctuations in the price of the underlying asset, which can encompass a wide range of financial instruments and non-financial variables These underlying assets may include interest rates such as LIBOR and EURIBOR, commodities like gold, oil, and rice, exchange rates of foreign currencies, bonds, stock indexes, and even non-financial variables such as weather and rainfall.
Derivatives typically involve lower initial investments compared to other contract types, as no actual cash or assets are exchanged until the contract matures In the listed derivatives market, investors only need to deposit a fraction of the derivative's value to engage in transactions, allowing for greater market concentration and accessibility.
Trading occurs on a predetermined future date specified in the contract, with payment options including physical delivery or cash settlement For commodity-based derivatives, transactions typically involve the transfer of the physical asset, while financial instrument derivatives usually settle in cash through a Clearing Organization.
Derivatives Markets
A significant volume of derivatives is traded on major exchanges, including the New York Stock Exchange (NYSE), the Chicago Board of Trade (CBOT), and the London International Financial Futures Exchange (LIFFE).
Hoang Linh Hong ATCA – K14 is characterized by its high liquidity, as all contracts are highly standardized To mitigate the risk of non-fulfillment of promised payoffs, it is mandatory for one or both parties to provide refundable deposits.
A significant portion of derivatives contracts is conducted in the over-the-counter (OTC) market, where contracts are customized to meet specific risk management needs between two parties These OTC contracts often feature more complex payoffs compared to exchange-traded derivatives (ETD), as they can depend on multiple share indices However, OTC derivatives tend to have lower liquidity due to their lack of standardization.
Types of Derivatives
In the book An Introduction to Futures and Options by Chicago Mercantile
Exchange Group, forward and futures contracts are defined as follow
A forward contract is a private agreement to buy or sell a commodity at a specific price on a specific date (page 5)
A future contract is a legally binding, standardized agreement to buy or sell a standardized commodity, specifying quantity and quality at a set price on a future date (page 7)
A forward contract is characterized by the specific terms mutually agreed upon by both parties, making it a unique and non-standardized agreement This flexibility allows for the customization of key elements, such as the volume of the underlying asset and the price, tailored to the needs of the involved parties.
Forward contracts operate outside centralized markets, which means that the parties involved assume the risk of potential default by their partners regarding payment or asset transfer at maturity However, this structure helps minimize counterparty risk.
Hoang Linh Hong ATCA – K14 through Clearing Organization under a certain mechanism on the exchanges
However, both the buyer and seller are legally bound tightly to fulfill the obligations of the contract, unless both parties agreed to cancel the contract
Forward contracts are held until maturity and are not traded on centralized markets This results in bilateral clearing, meaning that the transaction parties cannot transfer their positions to third parties and must uphold their contractual obligations.
The forward market is characterized by low liquidity due to the customization of products, and it carries a high risk of default, particularly because there is often no guarantee provided by a reputable intermediary.
Standardized forward contracts are agreements that specify the value and quantity of underlying assets, as determined by the relevant authority These contracts typically involve underlying assets such as stocks, bonds, indices, foreign currencies, interest rates, and commodities.
Futures contracts are traded on the ETD market, requiring investors to deposit a specified proportion with the derivatives clearing organization The initial escrow amount, determined by regulatory bodies, varies for each type of futures contract The Stock Exchange and Clearing Organization play a crucial role in safeguarding the rights and obligations of all participants involved in the trading process.
Futures contracts are managed by an Offset Organization, which records them at current daily prices through a process known as daily mark-to-market This Clearing Organization acts as an intermediary, facilitating transactions by serving as the buyer to the seller and the seller to the buyer By conducting daily accounting at current prices, the Offset Organization effectively minimizes the risk of default among the parties involved.
Investors may close the position at any time during trading futures contracts Investors holding long position (sell) can close their positions by
Hoang Linh Hong ATCA – K14 taking short position (buy) in similar transactions This feature encourages traders to use flexible capital without incurring strict legal constraints as in the forward contract
Futures contracts, while sharing key features with forward contracts, offer greater liquidity and reduced risk due to their presence on exchanges that implement a multilateral clearing policy.
Figure 1.1:Procedure of Forward/Futures Contract
Two parties enter into a contract that outlines the maturity date, commodity, quantity, and forward price On the maturity date, both parties fulfill their contractual obligations, with the seller required to sell and the buyer required to purchase the specified quantity of the commodity at the agreed forward price.
In a forward transaction, cash or assets are exchanged only upon the contract's maturity The forward price is typically compared to the spot price, which is the price at which the asset is traded, usually within two business days This comparison highlights the difference between the two pricing mechanisms.
Hoang Linh Hong ATCA – K14 between the spot and the forward price is the forward premium or forward discount
Futures contracts are standardized and traded on exchanges, while forwards are customized agreements traded over the counter between two parties This flexibility allows forward contracts to be tailored to specific needs Both types of contracts can be settled through delivery or cash, but futures offer greater liquidity, making them easier to unwind.
Both parties are required to adhere to the standardized contract set by the exchange, which includes agreeing on a settlement date and terms similar to those of forward contracts Upon maturity, the seller must deliver the commodity to the buyer, who is then responsible for completing the settlement.
To exit a futures commitment before the settlement date, holders must offset their position by selling a long position or buying back a short position, thereby closing out their futures position and fulfilling contract obligations.
A position can also be settled by a method called „exchange of physicals‟ where a party finds another one with an opposite position, delivering the good and settling
1.5.1.4 Differences between Forward Contracts and Futures Contracts
Forward and futures contracts share similarities, as both involve a predetermined price and future date for buying or selling an asset However, their differences arise from unique characteristics, as highlighted in the table below.
Table 1.1: Differences between Forward Contracts and Futures Contracts
Differences Forward Contracts Futures Contracts Structure Tailored to customers‟ needs Standardized
Purpose Normally used for hedging Normally used for speculation
Negotiated directly between parties Quoted and traded on the
Not regulated Regulated by the
Risk High counterparty risk Low counterparty risk
Maturity is generally the day on which the commodity is delivered
Maturity may not necessarily be the day on which the commodity is delivered
Depending on the transaction and the requirements of the contracting parties
Market Primary and secondary Primary
An option is a contractual agreement that grants the option holder the right, without any obligation, to engage in a specified transaction with the option issuer under defined terms.
Risks Associate with the Use of Derivatives Instruments
Market risk refers to the unfavorable fluctuations in the value of financial instruments or portfolios caused by changes in market conditions, including interest rates, inflation, equity, currency, and property values In the context of derivative instruments, market risk pertains to changes in the market values of the contracts rather than the notional amounts outlined in the agreements Additionally, market risk includes basic risk, which occurs when the correlation between two assets intended to hedge each other deteriorates or fails.
In addition to market risk, derivatives carry counterparty credit risk, which arises when one party defaults, leading to replacement risk for the non-defaulting party This replacement risk can be further categorized into specific components.
Mark – to – market exposure: The close out process may lead to noticeable mark-to-market exposure on the underlying contract
Liquidity risk: Sourcing ample liquidity in the market (notional/maturity) to replace the required position that has been closed out due to the counterparty‟s default
Operational risk involves effectively managing the close-out of a portfolio, notifying counterparties of default events, replacing transactions in the market, ensuring accurate margining, addressing ongoing valuation disputes, and fulfilling required intra-day settlements.
Legal risk arises when a transaction cannot be completed due to legal obstacles, including insufficient documentation, regulatory restrictions on certain counterparties, and the non-enforceability of bilateral and multilateral closeout netting and collateral agreements during bankruptcy.
Collateral risk arises when posted collaterals, such as ten-year government bonds, may necessitate reinvestment into new assets upon default Additionally, there is a danger that haircuts on the collateral may be inadequate or that the collateral is overly correlated with the counterparty's risk.
Settlement risk refers to the intra-day exposure to a counterparty that occurs during cash flow transfers under derivative transactions or when returning collateral amounts after payments, particularly in contracts like cross-currency swaps and option purchases.
Operations and systems risk primarily affects exchange-traded markets, encompassing the potential for human error or fraud, as well as the risk of system failures that may inadequately record, monitor, or account for transactions and positions.
CURRENT BACKGROUND OF DERIVATIVES
The History of Derivatives Markets
Derivatives trading has a long history, with evidence indicating that agreements for commercial transactions and rights to participate in trade have existed for centuries.
Thales of Miletus, an ancient Greek philosopher, is recognized as the pioneer of derivative contracts, having negotiated call options on oil presses during winter for the upcoming spring olive harvest In 1688, De la Vega noted that options and futures, referred to as “time bargains,” began trading on the Amsterdam Bourse shortly after its establishment.
Futures contracts for rice were traded in Japan as early as the 17th and 18th centuries, with the first futures market, the Dojama Rice Exchange, opening in Osaka on September 24, 1730 This market was established in a district of Osaka, where the Edo government compensated samurai with rice In 1730, a significant drop in rice prices resulted in a sharp decrease in the monetary value derived from rice.
To address the situation, the samurai devised a rice trading method that allowed them to secure transactions at current prices for future dates, protecting them against potential price declines.
The Chicago Board of Trade in the United States, which was opened in 1848 with 82 members, is the first formalized futures exchange market in the world
At the beginning, only forward contracts were bought and sold on the exchange
In 1851, the first futures contract for 3,000 bushels of corn was traded, set for delivery in June at a price one cent below the March price However, it wasn't until 1864 that futures contracts were formally established and traded The trading of listed stock options began in April 1973 on the Chicago Board Options Exchange (CBOE), followed by the introduction of stock call options in 1975 and put options in 1977 by other exchanges.
The derivative products were mostly originated from the US exchanges Futures contracts on equity indices were first released on 24 th February 1982 when
In April 1982, the Kansas City Board of Trade introduced futures contracts based on Value Line indices, while the Chicago Mercantile Exchange launched S&P 500 futures on April 21 of the same year By 1986, S&P 500 futures had gained immense popularity, achieving a remarkable transaction volume of 19.5 million contracts Additionally, in May 1982, the New York Futures Exchange began trading futures on aggregate NYSE indices, further expanding the derivatives market.
In July 1984, the Chicago Stock Exchange began trading various futures contracts on key markets, specifically the Major Market Index (MMI) Currently, five U.S exchanges facilitate the trading of options on over 1,000 stocks.
In later years, derivatives respectively appear in other major markets such as Australia, Canada, Japan, Singapore, United Kingdom, and Hong Kong and so on
How big the derivatives markets really are is still unrevealed partly because trading is worldwide in scope and regulatory responsibility is fragmented
Table 2.1: Top 10 Derivatives Exchanges Ranked by the Number of Contracts
2 CME Group (includes CBOT and Nymex) 1,284 1,571 22.4%
8 Nasdaq OMX Group (includes all EU and US markets) 405 508 25.3%
Source: Future Industry Association, FIA Volume Webinar 9/2010
In 2010, the top derivatives exchanges based on the number of contracts traded were detailed in Table 2.1, highlighting the rankings from both 2009 and 2010 Notably, the top four exchanges—Korea Exchange, CME Group, Eurex, and NYSE Euronext—maintained their positions from the previous year However, significant shifts occurred in the rankings of the next four exchanges, with NSE rising from 8th place in 2009 to 5th in 2010, followed by BM&Fbovespa, CBOE, and Nasdaq Meanwhile, the Shanghai Futures Exchange and Russian Trading Systems Stock Exchange retained their positions at the bottom of the list for both years.
The Development of ETD Markets
2.2.1 The Development of Futures ETD Markets
Figure 2.1: Futures ETD Markets Categorized by Regions
Unit: in Billions of U.S Dollar
(Source: The Bank for International Settlements; www.bis.org)
Figure 2.1 illustrates the value of futures derivatives transactions in exchange-traded markets across various global regions from 1998 to 2014 During this 17-year period, North America and Europe consistently recorded the highest transaction values, while Asia, the Pacific, and other markets followed in value.
Dec.1998 Dec.2001 Dec.2004 Dec.2007 Dec.2008 Dec.2009 Dec.2010 Dec.2011 Dec.2012 Dec.2013 Dec.2014
North America Europe Asia and Pacific Other Markets
The value of transactions in all regions followed upward trends from 1998 to
2007 before declining in 2008 The following years saw the recover of derivatives market in North America and other regions whereas the figure of the other two areas fluctuated
Figure 2.2: Futures ETD Markets Categorized by Types of Derivatives
Unit: in Billions of U.S Dollar
(Source: The Bank for International Settlements; www.bis.org)
Figure 2.2 illustrates the notional outstanding amounts of three derivative types—interest rate, currency, and equity index—traded in ETD markets from 1998 to 2014 Interest rate derivatives emerged as the most prevalent, consistently outpacing the outstanding figures of the other derivatives by a factor of 13 to 25 times throughout this period.
In 2007, there was a significant surge in the trading volume of various derivatives, followed by sharp declines in interest rate and equity index derivatives, while currency derivatives saw a more moderate decrease After experiencing fluctuations, the futures exchange-traded derivatives (ETD) market began a stable recovery in 2012 By 2014, the notional outstanding amounts for interest rate, currency, and equity index derivatives had increased approximately 3, 7.8, and 5.4 times, respectively, compared to 1998 levels.
Dec.1998 Dec.2001 Dec.2004 Dec.2007 Dec.2008 Dec.2009 Dec.2010 Dec.2011 Dec.2012 Dec.2013 Dec.2014
Currency Interest rate Equity index
2.2.2 The Development of Options ETD Markets
Figure 2.3: Options ETD Markets Categorized by Regions
Unit: in Billions of U.S Dollar
(Source: The Bank for International Settlements; www.bis.org)
Figure 2.3 illustrates the value of options derivatives transactions in ETD markets globally from 1998 to 2014, revealing that North America and Europe consistently led in transaction value, while Asia, the Pacific, and other regions exhibited significantly lower figures during this timeframe.
From 1998 to 2007, the value of transactions in North American and European derivatives markets saw significant growth, but volatility followed in the subsequent years In North America, transaction values rebounded dramatically, rising from approximately $12.3 trillion in 2012 to over $28.3 trillion by 2014 Conversely, Europe experienced a notable decline in 2014, with transaction values halving compared to 2013.
Dec.1998 Dec.2001 Dec.2004 Dec.2007 Dec.2008 Dec.2009 Dec.2010 Dec.2011 Dec.2012 Dec.2013 Dec.2014
North America Europe Asia and Pacific Other Markets
Figure 2.4: Options ETD Markets Categorized by Types of Derivatives
Unit: in Billions of U.S Dollar
(Source: The Bank for International Settlements; www.bis.org)
Between 1998 and 2014, interest rate derivatives dominated the notional outstanding value in option exchange-traded derivatives markets, consistently representing over 80% of the total market value The period from 1998 to 2007 saw an upward trend in trading volumes across all derivative types, but this was followed by a sharp decline in 2008, leading to fluctuations in trading figures in subsequent years.
Dec.1998 Dec.2001 Dec.2004 Dec.2007 Dec.2008 Dec.2009 Dec.2010 Dec.2011 Dec.2012 Dec.2013 Dec.2014
Currency Interest rate Equity index
The Development of OTC Markets
Unit: in Billions of U.S Dollar
(Source: The Bank for International Settlements; www.bis.org)
Between 1998 and 2014, the OTC derivatives market experienced significant growth, as depicted in Figure 2.5 This rapid expansion persisted for over a decade, only facing a slowdown during the financial crisis of 2007 and 2008.
Interest rate contracts have seen remarkable growth, with transaction values soaring to nearly $400 trillion in 2007, an eightfold increase from 1998 Following this surge, the growth rate stabilized, and by June 2014, the value of interest rate derivatives had more than tripled, reaching approximately $560 trillion.
The others also witnessed substaintial growth over the period however the value of each was lower than 100,000 billion dollars
Dec 1998 Dec 2001 Dec 2004 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013 Jun 2014
Interest Rate Contracts FX Contracts Equity – linked ContractsCommodity Contracts Credit Default Swaps
CURRENT BACKGROUND OF DERIVATIVES
Situation of Derivatives Market
Vietnam has officially established commodity derivatives markets under the Ministry of Industry and Trade and currency derivatives markets managed by the State Bank of Vietnam, supported by a basic legal framework Despite notable achievements in the stock market over the past 13 years, the absence of a derivatives market limits risk management options for investors The Vietnamese stock market remains in its early stages, characterized by a lack of diversified investment tools and significant untapped potential compared to regional and global counterparts.
As of now, Vietnam lacks an official centralized derivatives market, but non-stock derivative instruments like commodities and currencies have emerged The Buon Ma Thuot Coffee Exchange Center, established in 2006, primarily facilitates the trading of coffee through spot and futures contracts In early 2011, the Vietnam Commodity Exchange (VNX) was created to manage the trading of futures contracts based on various underlying assets, including coffee, steel, and rubber.
In 1999, the currency market introduced forwards as the initial derivatives instrument for USD/VND contracts between commercial banks and import-export enterprises Today, the State Bank of Vietnam has expanded the use of currency derivatives, allowing both domestic and foreign banks to utilize various instruments, including swaps and options.
Although a formal securities derivatives market and legal regulations are lacking, various informal derivatives have emerged spontaneously Amid rapid market growth, several securities companies have introduced stock-based options contracts, with the underlying assets chosen based on customer demand and market liquidity These options are traded over-the-counter (OTC), where securities companies serve as option sellers, engaging directly with customers, collecting premium fees, and fulfilling their contractual obligations.
Hoang Linh Hong ATCA – K14 primarily serves individual investors with significant underlying asset holdings Due to the nature of these transactions, which are often conducted in various forms to evade regulatory oversight, there is a lack of official statistics The State Securities Commission (SSC) has issued a warning to halt unauthorized derivative trading in these stock markets immediately.
The State Securities Commission (SSC) has issued warning dispatches to specific companies, including Vang The Gioi (VTG) and Vndirect Securities Company In 2010, VTG introduced a new product resembling futures contracts based on the Vietnam stock index (VTG – VN index) Similarly, Vndirect Securities Company offered "investment contracts" in late 2010 that exhibited fundamental characteristics of option contracts.
The introduction of new products by VTG and VNDirect aimed to satisfy investor demand, expand product offerings, and mitigate price fluctuation risks; however, these products faced legal risks due to the absence of a protective legal framework.
In addition to the previously mentioned products, similar options have been traded on websites like http://www.sanotc.com and http://www.quyenmua.com, primarily involving shares from the OTC market.
The emergence of derivative products in the free market has demonstrated strong investor interest in these innovative instruments However, their spontaneous nature requires effective regulatory oversight, leading to significant risks This highlights the urgent need for robust legal frameworks from the government to establish a derivatives market anchored in underlying stock assets.
Prime Minister Nguyen Tan Dung has endorsed the initiative to establish and develop a derivatives market in Vietnam, aiming to create a centralized and unified market governed by state regulations, rather than allowing for a spontaneous and unregulated market formation.
Building and developing derivatives market in Vietnam has 3 phases from simple to complex, ensuring the ability to manage and monitor risks in the market
Table 3.1: Roadmap for Development of Derivatives Market in Vietnam
1 2013 – 2015 Build a legal framework, complete technical infrastructure to operate the derivatives market
Allow and organize trading of derivative securities based on the underlying stocks (stock indices, government bonds and shares)
Develop unified derivatives market based on the underlying assets in accordance with international practices
The derivatives market initiative seeks to establish a comprehensive derivatives market to enhance the overall structure of securities markets This development will support the sustainable growth of underlying markets, such as equities and bonds, while also bolstering the stock market's significance within the broader financial landscape.
Evaluation of Derivatives Market
Securities Law No 70/2006/QH11, enacted on June 29, 2006, and amended by Securities Law No 62/2010/QH12 on December 6, 2010, primarily governs the activities of the primary stock market Although derivatives securities are referenced in the definitions of "securities, call options, put options, and futures" in Article 6 of the original law and Article 1 of the amended law, the lack of detailed guidance in sub-law documents has resulted in a legal vacuum for trading derivatives Consequently, recent spontaneous derivatives transactions in the free market are deemed illegal and strictly prohibited.
The absence of regulations in the derivatives market leads to a significant gap in accounting standards and tax frameworks Currently, there are no established guidelines for recognizing and valuing financial instruments, especially derivatives This lack of clarity impacts the accurate determination of their value in financial reporting.
Hoang Linh Hong ATCA – K14 emphasizes the significance of financial performance and risk management for businesses Additionally, the lack of sufficient and accurate information hampers authorities' ability to effectively supervise the market and monitor enterprise activities.
The recent deployment of derivative products by securities companies highlights the growing demand for innovative trading options beyond traditional stocks and bonds This shift indicates that a segment of the market is prepared to engage with more sophisticated financial instruments However, recent transactions by some firms have led to a lack of awareness about these products among investors, introducing potential risks to the market Additionally, spontaneous trading activities targeting financially strong customers have created imbalances among investors and fostered distrust in regulatory authorities.
The Necessary of the Derivatives SecurititesDevelopment in Vietnam
Derivatives markets have evolved significantly over the years, initially designed for risk hedging, and have now become essential tools in the market economy Their appeal is further enhanced by the potential for high financial leverage, making derivatives increasingly attractive to investors.
Since its inception in 2000 with the launch of the HOSE, the Vietnam stock market has experienced 13 years of significant growth and development, solidifying its crucial role and influence within the economy.
In 2007, Vietnam's stock market experienced significant growth, with stock capitalization reaching 43% of GDP and the VN-Index peaking at 1,170 points on March 19 However, the market remains nascent, primarily trading in stocks, bonds, and investment fund certificates, and lacks a diverse range of investment instruments This highlights the urgent need to develop new investment options, such as derivatives, to enhance market sophistication and meet evolving investor demands.
First, the development of derivative instruments is inevitable to the growth of the financial markets It reflects the deeper and broader market and shows the trend of international integration
Derivatives play a crucial role in diversifying investment instruments, attracting both foreign and domestic capital While the stock market offers profitable opportunities, it also comes with a high level of risk Therefore, derivative securities are vital for investors seeking effective risk hedging strategies.
The growing demand for more complex and appealing trading products reflects an enhanced understanding among investors after a period of active trading This shift indicates that investors are increasingly interested in exploring innovative investment options.
In fact, some form of derivatives such as forwards, options and some other contracts have been in used in recent time
Derivatives securities serve dual purposes: investment and risk hedging In Vietnam, during the market growth phase from 2007 to early 2008, these products emerged spontaneously to satisfy high demand However, during economic crises, their primary role shifts to minimizing market risks The State Securities Commission (SSC) acknowledges the importance of developing derivatives to fulfill investor needs As part of the "Vietnamese Capital Market Development" initiative, the SSC partnered with the Ho Chi Minh Stock Exchange (HOSE) to conduct the first workshop in December 2010 and collaborated with the Luxembourg Development Agency for a second workshop in April 2011 in Hanoi These events attracted significant participation from market players, research institutions, and regulatory bodies, highlighting the strong interest in establishing an official Exchange-Traded Derivatives (ETD) market in line with international standards.
Finally, the initial conditions for the formation ofsecurities derivatives market has come into existence as follow:
Underlying markets including stock market and bond market have been operated effectively Mechanism, transaction methods and system of stock index have been efficiently applied;
Derivative securities are legally defined in the Securities Law, providing a solid foundation for the establishment of a derivatives market The Securities and Exchange Commission (SSC) is currently conducting research and preparing a decree to regulate derivatives and related financial instruments.
Evaluation of the Possibility of Developing Securities Derivatives Market
Depository, registry and clearing systems have thriven and accumulated valuable experiences Simultaneously, payment system serving the market is on the process of completing;
SSC has entered into a contract with Korea Exchange to implement Package Solution Design (package 04), which provides a technology transfer system for the entire derivatives market This advanced system is anticipated to be operational soon.
In short, building and developing the securities derivatives market in Vietnam is essential in the recent time
3.4 Evaluation of the Possibility of Developing Securities Derivatives Market in Vietnam
The government has planned to develop securities derivatives market in Decision
No 252/QD-TTg dated 01/03/2012 on approving the development strategy for the stock market in 2011 – 2020
Securities Law is an important legal basis for building a legal framework to guide the organization and operation of security derivatives market
Margin trading in securities transactions is permitted under Circular No 74/2011/TT-BTC and the Regulations on margin trading of securities, as outlined in Decision No 637/QD-UBCK issued on August 30, 2011.
Decision No 252/QD-TTg, dated March 1, 2012, approved the development strategy for Vietnam's stock market for the period 2011-2020, aiming to restructure the organizational model into a single national stock exchange This initiative is designed to enhance the effectiveness of derivatives as a hedging tool for investors in the Vietnamese stock market.
Vietnam stock market is still regarded as an emerging market full of potential with rapid growth in comparison with other markets in region and around the
Hoang Linh Hong ATCA – K14 has gained significant attention as Vietnam's stock index soared by 35.5% in the first four months of 2012, making it the second highest globally, surpassed only by Egypt's EGX 30 By August 2013, this upward trend continued, highlighting Vietnam's growing prominence in the international stock market.
VN index growth of over 16% was considered to be one of the highest growth rates of 10 countries in the world
Vietnam has established a specific government bond market with different maturities The bond market has attracted a large number of banks with competitive interest rates
As of the end of 2011, Vietnam's stock market features a robust network of 105 securities companies, including major players like SSI, VCBS, and BVSC, which have extensive branches across various provinces and cities These firms possess significant financial resources and dominate a substantial share of the market Recent regulations on financial security, corporate governance, risk management, and early warning systems have been implemented Additionally, securities companies are undergoing restructuring to concentrate on larger firms that demonstrate strong financial capabilities and effective governance, positioning them as suitable candidates for the more demanding securities derivatives market.
Commercial banks play a crucial role in the bond market, serving as special members and significantly influencing trading dynamics In the first half of 2013, they represented nearly 90% of winning bids and 68.6% of the total government bond trading value Notably, these banks function as primary dealers, underscoring their importance in the market's operations.
Vietnam is set to establish securities companies and investment funds with 100% foreign capital, in line with its WTO commitments to open its financial market This development marks a significant advancement in the country's derivatives securities sector, which is gaining popularity globally.
In recent years, the implementation of commodity and currency derivatives transactions has increased significantly, particularly in banks, which has familiarized the market with essential concepts and trading methods VNX is actively introducing forward and futures contracts to support market participants and investors in adapting to derivatives trading on exchanges The spontaneous emergence of derivatives transactions in the stock market is seen as a preparatory phase for new markets and products, laying the groundwork for initial investments in Vietnam's securities derivatives market.
HOSE is acquiring an advanced technology system that ensures high integration and synchronization across trading, monitoring, clearing, and market information This new system will support transactions for a diverse range of products, including derivatives, and will be implemented across the entire stock market in Vietnam, benefiting HOSE, HNX, and VSD.
Current legal regulations regarding securities lack clear guidelines for the implementation, management, and supervision of securities derivatives transactions, posing challenges for their practical application However, this issue has been addressed with the government's issuance of a decree specifically focused on the securities derivatives market.
SSC only issues guidelines on margin trading Meanwhile short selling transactions are not permitted to apply as a basis for ensuring the implementation of derivative transactions
The legal provisions relating to securities derivatives such as regulations on tax and fee policy as well as accounting system have not been issue to support business and investors
The Vietnam stock market has been significantly affected by the global financial crisis and ongoing macroeconomic challenges, resulting in diminished investor confidence, poor market liquidity, and low transaction values Consequently, introducing a new product in the current environment may face obstacles due to unfavorable market conditions and difficulties in capturing investor interest.
Despite improvements in market inspection and supervision compared to the previous year, significant constraints remain This limitation poses challenges as the deployment of more complex security derivatives markets, which carry higher risk potential, continues to evolve.
In recent years, the stock market has experienced a significant decline, resulting in substantial revenue losses for securities firms Many companies now face the threat of mergers or bankruptcy, highlighting the financial limitations of 105 intermediary organizations within the market.
Securities companies are lacking of high quality workforce who have deep understanding about securities derivatives and risk management
Securities companies exhibit significant structural differentiation, with most operating on limited capital and experiencing uneven development This disparity presents challenges in identifying qualified firms to participate as members of the securities derivatives market.
The participation of professional and institutional investors in Vietnam's stock market remains insufficient, which is critical for the growth and sustainability of the securities derivatives market Enhancing knowledge about derivatives among investors is challenging and time-consuming, as individual investors dominate the market landscape.
SUGGESTED SOLUTIONS TO DEVELOP
Legal Framework
Securities Law No 70/2006/QH11 and its amendment, Securities Law No 62/2010/QH12, acknowledge the existence of securities derivatives but lack comprehensive guidelines The drafting of the second-generation Securities Law aims to enhance regulations governing securities derivatives and their market This updated law will serve as the primary legal framework for the securities sector, specifically addressing the nuances of securities derivatives.
The Decree on derivative securities and the derivatives market in Vietnam is designed to adjust regulations regarding product types, trading organizations, and clearing systems This government decree will serve as a crucial legal framework for the operation of Vietnam's security derivatives market Key supplements to this decree are highlighted for consideration.
The general provisions on securities derivatives and security derivatives market: the scope, subjects of adjustment and relating terms;
Provisions on designing, listing and trading different types of derivatives;
Provisions on the derivative exchange – traded market (VDM); Vietnam Securities Depository – Central Counterparty Clearing House (VSD – CCP);
Regulation on trading members, clearing members; securities derivatives business operations; Regulation on escrow in case of investors or members do not or can not exercise their contractual obligations;
Regulation on the management, monitor, inspection and sanctioning disclosure and so on
Those will be important legal document to regulate the operation of security derivatives when no new regulations complement the new Securities Law to replace the existing Securities Law
4.1.3 The Circulars of the Ministry of Finance
The Ministry of Finance plans to release a circular aimed at regulating the securities derivatives market, focusing on trading, clearing, monitoring, business operations, tax regimes, and associated fees Additionally, the circular will include regulations for market inspections and measures for addressing violations.
4.1.4 Regulation of VDM and VSD
The Stock Exchange and the VSD will develop regulations in more detailed, concentrating on market participants and their activities in comparison to that approved and issued by the SSC.
Basis Securities Market
4.2.1 Improve the Quality of Listed Stocks
Enhancing the subsector securities system and improving the quality of listed companies can be achieved by developing a corporate governance handbook and promoting its adoption among these companies This initiative aims to gradually elevate the standards of listed securities.
4.2.2 Ensure Transparency of the Underlying Market
Member companies and securities firms must establish clear guidelines for information disclosure and ensure the quality of the published data Additionally, it is essential to enhance the surveillance systems for monitoring municipal activities and conduct regular performance assessments.
4.2.3 Boost the Attraction of Investors at Home and Abroad
To increase the number of investors in the market, it is essential to improve public understanding of investment strategies and educate individuals on avoiding crowd psychology, which can lead to detrimental market fluctuations.
In the first phase construction, the index serves as the underlying asset, which is crucial to the success of the market SE can build the system with categories of
Hoang Linh Hong ATCA – K14 focuses on market capitalization and industry dynamics, either independently or through collaborations with external partners It emphasizes the importance of a representative index that accurately reflects securities volatility and is well-recognized by the investing public.
Develop a single and unified stock exchange (Vietnam Stock Exchange) by merging HOSE and HNX;
Construct of the exchange for the stock market, bond market, the securities derivatives market of Vietnam Stock Exchange;
Establish an independent clearing company affiliated VSD to take the role of clearing for all securities derivative transactions on both OTC and ETD markets
4.2.6 Restructure the Securities Business Organizations
Restructure the number of brokers towards narrowing the quantity, processing and purifying some weak and inefficient securities companies;
Restructure the organizational structure of the securities companies in order to improve the operational quality, financial capacity, corporate governance and risk control ability;
Open financial services market under the integration roadmap committing with the WTO.
Market Participants
It is necessary to develop high quality management staff Staff construction should be focused on professional and specialized training on derivatives market can be based on:
Basic knowledge of products and markets of securities derivatives including product types and models of market operation;
Intensive training on derivatives securities for the management staff who directly operate the market through legislation, regulations promulgated by the security derivatives exchange
The training would be undertaken by research and training center
Investors
The derivatives market is inherently complex and carries a higher level of risk compared to traditional markets like stocks and bonds, necessitating that investors possess a thorough understanding of derivatives and their associated risks before engaging in transactions Public education on investing is crucial, as evidenced by the experiences of various countries, and should be prioritized Additionally, securities firms must employ qualified professionals with expertise in derivatives and risk management to ensure informed trading practices Ultimately, enhancing investor knowledge is vital for the growth and sustainability of the securities derivatives market.
The education and training of public investment can be made through the following forms:
Build training programs on securities derivatives business: research and training centers will build the training course and offer formal certificates for the courses;
Organize trainings seminars for investors to introduce products and market of securities derivatives The detailed content of the seminar is posted on the official website of the management bodies;
Disclose information about product characteristics and regulations involving in securities derivatives;
Introduce securities derivatives to public investment through media such as newspapers and television;
Collaborate with securities firms to organize workshops and activities aimed at educating investors on securities derivatives transactions and the associated legal regulations.
Technological Infrastructure
4.5.1 Technical Infrastructure of the SEs, their Member Securities
The derivatives and securities markets are closely interconnected, where even minor fluctuations in one can significantly impact the other The risk of temporary trading suspensions due to technical infrastructure issues is substantial To enhance the capacity to meet the intricate demands of derivatives trading, it is essential to upgrade the technical infrastructure.
Clearing is a crucial phase in derivatives trading, making the establishment of a Central Counterparty (CCP) essential To ensure accuracy, minimize incidents, and maintain investor confidence, technological advancements in the clearing system must be prioritized.
Derivatives markets are crucial to the modern economy, significantly enhancing the development of financial markets The emergence and expansion of these markets are vital for investment, hedging, and arbitrage strategies As a result, derivatives have provided substantial benefits to investors, intermediaries, and the overall economy.
Trading derivatives has a rich history globally, with roots in commercial agreements dating back centuries In contrast, Vietnam's commodity and currency markets have only been established for 9 and 16 years, respectively The absence of a formal securities derivatives market and relevant legal regulations has led to the emergence of informal derivatives, highlighting the urgent need for government intervention to create a structured market based on stock underlying assets While there are foundational elements to develop the securities derivatives market, several challenges must be addressed to ensure its effective growth This study presents solutions aimed at fostering the development of Vietnam's securities derivatives market, requiring collaboration from the government, regulatory bodies, and society With the right efforts, there is a strong basis for optimism regarding the establishment of a robust and effective securities derivatives market that will significantly contribute to Vietnam's economic advancement.
LIST OF REFERENCES Books and Document
1 Hull J., Options, Futures and Other Derivatives, Upper Saddle River,
2 Andrew J.G.Cairns, Derivative Securities: Pricing and Hedging, Heriot-
3 Chicago Mercantile Exchange Group, An Introduction to Futures and Options, 2006;
4 Hull J., Introduction to Futures and Options Markets, Prentice Hall,
5 Kolb R.W., Futures, Options and Swaps, Oxford, Blackwell, 3rd Edition, 1999;
6 Poitras, Geoffrey, The Early History of Financial Economics,
7 Dimitris N., Introduction to Derivative Financial Instruments, McGRAW
8 Hull J., Fundamental of Futures and Options Markets, Upper Saddle
River, New Jersey, 4 th Edition, 2002;
9 Dr Nguyen Thanh Phuong, Giao Trinh Thi Truong Chung Khoan, Thoi
10 Securities Law No 70/2006/QH11 promulgated by the National Assembly, taking effect on January 01,2007;
11 Amended Securities Law No 62/2010/QH12 promulgated by the National Assembly, taking effect on July 01,2011;
12 Decision No 252/QD-TTg dated March 01, 2012 of the Prime Minister approvaing the plan on formation and development of Vietnam‟s derivative securities market;