LV Thạc sỹ_The development of forwards and futures market in Vietnam

NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM *********************************** BACHELOR’S THESIS IN FINANCE THE DEVELOPMENT OF FORWARDS AND FUTURES MARKET IN VIETNAM TABLE OF CONTENTS NATIONAL ECONOMICS UNIVERSITY TABLE OF CONTENTS LIST OF TABLES AND CHARTS .5 ABSTRACT CHAPTER I INTRODUCTION 1.1 Background .7 1.2 Aims and objectives 1.3 Scope of research CHAPTER II LITERATURE REVIEW CHAPTER III 13 RESEARCH METHODOLOGY .13 3.1 Methods of collection of data 13 3.2 Research process 13 CHAPTER IV 16 THEORETICAL BACKGROUND 16 4.1 Financial derivatives .16 4.1.1 Definition .16 4.1.2 Users and use of financial derivatives 17 4.2 Four types of financial derivatives products 18 4.2.1 Forwards 18 4.2.3 Options 21 4.2.4 Swaps .23 4.3 Financial derivatives market 24 4.3.1 Definition of financial derivatives market 24 (Source: en.wikipedia.org) 26 4.3.2 Derivatives trading in financial derivatives markets .26 4.4 Global derivatives market 26 4.4.1 Overview 26 4.4.2 Korean futures market 27 4.4.3 China futures market .29 4.4.4 Singapore futures market 29 4.4.5 Conclusion .31 CHAPTER V .31 CURRENT SITUATION OF FORWARDS AND FUTURES MARKET IN VIETNAM 31 5.1 Background of Vietnam economy and its legal framework 31 5.1.1 Review of the economy in Vietnam 31 5.1.2 Legal framework for forwards and futures market in Vietnam 33 5.2 Current situation of forwards and futures market in Vietnam 34 5.2.1 Participants 35 5.2.2 Performance of forwards market 37 5.3 Existing issues in the forwards market in Vietnam 40 CHAPTER VI 42 RECOMMENDATION 42 CONCLUSION 45 REFERENCES .46 INSTRUCTOR’S COMMENTS 47 ABBREVIATIONS ACB A Chau Commercial Bank BIDV Bank for investment and development of Vietnam GDP Gross domestic products OTC Over – the – counter SBV State Bank of Vietnam LIST OF TABLES AND CHARTS LIST OF TABLES Table 4.1: Differences between derivatives exchange and OTC LIST OF CHARTS Chart 4.1: The payoff of long and short forwards Chart 4.2: The payoff and profit of call and put options Chart 5.1: Participants in the futures and forwards market Chart 5.2: Transaction values of derivatives instruments in Eximbank Chart 5.3: Transaction values of derivatives instruments in Sacombank Chart 5.4: Transaction values of derivatives instruments in ACB ABSTRACT Since the global crisis in 2007-2008, economists have argued about reasons of the economic downturn, including the usage of financial derivatives The using of financial derivatives, especially forwards and futures contracts is controversial even in developed countries such as the United States or Europe How to apply these two instruments in an emerging market like Vietnam and reduce the risk coming along with them are questions which are not easy to answer Keeping that in mind, I have chosen the topic “The development of forwards and futures market in Vietnam” In Vietnam, the market for financial derivatives instruments was officially established since 1997 However, the market has not been in high demand as expected, due to unfair trading, the lack of transparency and the high cost for derivatives transactions… In order to improve the financial derivatives market, several recommendations are made, namely comprehensive policy framework, IT infrastructure and human resources This study is conducted in order to give more information about forwards and futures contracts and strengthen the trading activities of derivatives instruments in Vietnam Hopefully the research will provide useful knowledge about these two concepts and raising appropriate solutions for the development of forwards and futures market in Vietnam CHAPTER I INTRODUCTION 1.1 Background A strong financial system is a pre-requisite for a country to achieve sustainable economic development In the case of Hong Kong and Singapore, the sound financial system is the driving force for the economy and protects it from fluctuations of other economic factors Vietnam’s financial system is still in its early stage, therefore, easily affected by changes of market factors such as interest rates and exchange rates With a view to improving and modernizing the financial system, developing an efficient derivatives market has been in discussion for many years, especially since the global financial crisis in 2007 Until now, Vietnam is still not having an official derivatives exchange and lacking many supporting conditions to build up this market Firstly, the study was aimed at understanding financial derivatives instruments and their roles in the economic However, due to time and experience constraint, this study focuses only on forwards and futures contracts They have appeared in Vietnam market in recent years Moreover, the understanding of investors about these contracts is limited The research will identify characteristics of forwards and futures contracts which are currently being used in Vietnam Then, current situation of forwards and futures market in Vietnam is also analyzed Finally, the study will suggest some recommendations for the development of forwards and futures market in Vietnam 1.2 Aims and objectives The aim of this research is to add one useful reference for further study and research about market of financial derivatives in Vietnam The objectives of the study are as follows • Providing theoretical understandings of the forwards and futures markets • Analyzing the current situation of the forwards and futures market in Vietnam • Suggesting recommendations for the development of forwards and futures market in Vietnam 1.3 Scope of research The research focuses on the forwards and futures market in Vietnam Due to the limit of time, it can not provide a deep analysis about all the aspects involved The research choose commercial banks in Vietnam to analyze the current situation of the market since it is not difficult to collect data of these banks, and it provides the quantitative evidences for the research CHAPTER II LITERATURE REVIEW The emergence of the market for derivatives products, most notably forwards, futures and options, can be traced back to the willingness of riskaverse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices By their very nature, the financial markets are marked by a very high degree of volatility Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices As instruments of risk management, these generally not influence the fluctuations in the underlying asset prices However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors Derivative products initially emerged, as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products In recent years, the market for financial derivatives has grown tremendously both in term of variety of instruments available, their complexity and also turnover The development of derivatives market has been a subject of enthusiasm of research in the field of finance There are many empirical findings for the roles of derivatives trading Below are some reviews of literature of them In the paper titled “Chapter for Asian Financial Market Development”, Fratzscher O (2006) analyzed the benefits and driving factors of Asian financial market, as well as developed a roadmap for further sound development of derivative markets Asian derivative markets today account for one third of worldwide foreign exchange and over 40% of equity derivatives trading Korea is hosting the world’s largest derivatives exchange, India has the world’s fastest growing exchange, whereas Thailand and the Philippines not yet have an established derivatives exchange Derivatives products have made Asian capital markets more competitive and also have significant benefits, for example as hedging tools for commodity producers and as cheaper financing tools for corporations Derivative markets have grown especially fast across Asia over the past decade and have created many benefits for the region, but lessons can also be learned from some high-profile failures Successful development of derivative markets must build on a foundation of solid product design, strong regulation, and sound market infrastructure In “Asian Derivative Markets: Research Issues”, Shamsher M and Taufiq H (2007) examined the status of selected commodity and financial derivatives markets in Asia: India, Korea, Hong-Kong, China, Malaysia, Japan, Singapore They suggested that the more industrial/advanced economies have developed liquid commodities markets, and few of them have also developed active financial derivative markets But for most of the 19 or so emerging markets in Asia, the development of derivative markets is still at an early stage For instance, in Malaysia, since 1990 the government changed the direction of the country’s economic policy from agriculture based economy to industrial economy As a result, most commodity investor lost their interest on futures market Most of commodity futures could not survive Among the reasons cited 10 5.1.2 Legal framework for forwards and futures market in Vietnam Below are the legal documents related to forwards and futures trading in Vietnam: • 17/1998/QD-NHNN: stated that commercial banks could add the trading instruments of forwards contracts with foreign currencies as the underlying assets However, the customers were limited as export and import companies only • 65/1999/QD-NHNN: the degree changed the appropriate rule to calculate and evaluate foreign-currencies buying and selling rates of financial institutions and banks According to the regulation, the rate for the transaction of foreign exchange forwards is calculated as followed: - For transactions between VND and USD, the maximum rate cannot exceed the ceiling spot rate plus the allowed percentage applying for each specific forward contract (The ceiling spot rate equals the spot rate plus 0.1%) - For transactions regarding other currencies, General Director of the financial institutions has the right to decide the rate Nonetheless, the maximum fee of forward contracts with one to six months period is 0.05% of the transactional value but can not exceeded one million VND • 1198/2001/QD-NHNN: the degree fixed and changed some contents with the previous degree (65/1999/QD-NHNN) The forwards period was expanded from 1-6 months to 7-180 days Beside, the forward rates were 33 stated more clearly About VND-USD transactions, the highest rate of each period did not exceed the ceiling spot rate add the written percentage of the ceiling spot rate, as below: - 0.40% of ceiling spot rate for the 7-30 day period - 1.50% of ceiling spot rate for the 31-120 day period - 2.35% of ceiling spot rate for the 121-180 day period • 1133/QD-NHNN: extended the scope of participants including commercial banks, other financial institutions and enterprises/companies • 1452/2004/QD-NHNN replaced 17/1998/QD-NHNN: gave permissions for all financial institutions to practice foreign exchange activities Their customers were expanded to all individuals and organizations Moreover, the period fluctuated from days-1 years for forwards contracts • 7404/NHNN-KTTC: The State Bank of Vietnam issued the accounting system guideline of the derivatives transaction • 16/2007/QD-NHNN: The State Bank of Vietnam issued the financial reporting system in the derivatives transactions 5.2 Current situation of forwards and futures market in Vietnam Derivatives market in Vietnam was established since 1998, when the State Bank of Vietnam allowed forwards contracts trading Because of the new market and the complicated nature of the products, the application of derivative is facing many difficulties and limitations Because futures contracts can only be traded in an exchange market with standardized characteristics, so they are not being 34 traded in Vietnam at the moment So from now on, we will only analyze the performance of forwards market in Vietnam This market has many characteristics of an OTC market Forwards contracts transactions are mostly traded privately between financial institutions and their customers throughout many discussions and processes 5.2.1 Participants Chart 5.1: Participants in the futures and forwards market • Regulatory authorities 35 In Vietnam, the underlying assets for forwards contracts are currencies and interest rate, and gold prices Therefore, the State Bank of Vietnam is in charged of regulating the forwards market The State Bank of Vietnam regulates the market by announcing the guideline documents about practicing forwards contracts in the market It also works with others departments such as Foreign Exchange Management… to solve with the current situation of the market After the financial crisis began in the United States, the State Bank of Vietnam and many other state banks in Asia countries such as China, Malaysia… have restricted the market The commercial bank must have an good proposal and development plan in order to have the permission of SBV to practice forwards instruments in Vietnam • Financial institutions - Commercial banks: They make money by collecting customers’ fees or benefit from the foreign exchange bid-ask spread The banks have important roles in educating investors and supporting technically, especially in the early stage of the market - Other financial institutions: Beside banks, there are other financial institutions such as Vietnam Petrolimex Financial Company, Vietnam Energy Financial Company… which participates in the forwards market They have the same roles as the commercial banks: provide forwards contracts for customers and hedge their risk or speculate by being customers of commercial banks However, they just contribute a small part in the market 36 • Investors In Vietnam, the main purpose of investors is that they can control their risk and limit their losses Because of the lack of understanding and the complex nature of the transactions, most of investors trading in the market are organizations (especially organizations doing business in export and import), not individuals 5.2.2 Performance of forwards market According to legal documents, swap contracts are the first derivatives instrument which was allowed to trade in Vietnam However, because the swaps were only traded between SBV and commercial banks, it took longer for this type of contract being traded in the market The first derivatives instrument in the market is forwards contracts, firstly in 1998 Because of its flexibility and usefulness, it quickly became the most common derivatives instrument in Vietnam market, even until now The underlying assets mainly are interest rates and currencies and gold Forwards contracts using foreign currencies as their underlying asset are used mostly The reason is the large demand of the customers (most of them are exporting/importing companies) Some large commercial banks, for example BIDV and Vietcombank even provide forwards contracts for other banks and financial institutions Forwards contracts with interest rates as the underlying asset are also quite common in Vietnam but the transactional value is lesser than forwards that use currencies as underlying Techcombank is the most successful bank in using interest rates forwards Finally, gold underlying forwards contracts are used the least products among these three There are only some commercial 37 banks applied this kind of derivatives: Sacombank, ACB and Eximbank and their minimum transactional value is 10 ounces The USD/VND forwards rate is calculated based on the exchange spot rate in transaction day The rates between VND and other currencies or between other currencies are based on agreements between the commercial bank and its customers Normally, commercial banks require customers to have deposits, or collaterals or deposits in the bank, for example ACB requires its customers to deposit equals to 5% of the value of gold forwards contracts • Position of forwards contracts in comparison with other derivatives instruments Below are the transactional values of derivatives instruments in some commercial banks: Chart 5.2: Transaction values of derivatives instruments in Eximbank (Unit: million USD) 38 (Source:Eximbank’s financial statements ) Chart 5.3: Transaction values of derivatives instruments in Sacombank (Source:Sacombank’s financial statements) Chart 5.4: Transaction values of derivatives instruments in ACB (Source:ACB’s financial statements) 39 In the early of 2000, forwards contracts took a lead role in the financial derivatives market since the options contracts was very new with investors and the swaps contracts were only traded between commercial banks and SBV or between commercial banks However, since 2007, Vietnam market was influenced by global market, especially after the global financial crisis in United States The exchange rate and interest rate fluctuated dramatically and unpredictably These changes motivated the increase of other derivatives instruments like swaps and options As you can see on these charts above, forwards and swaps contracts are two derivatives instruments that were traded mostly Obviously the allocation of derivatives instruments depends on the strategy of each bank, but we can realize that the percentage of forwards contracts fluctuates strongly in 2007-2010 and mostly on a downtrend 5.3 Existing issues in the forwards market in Vietnam At a very young stage, Vietnam financial derivatives market can not avoid some weaknesses which discourage the market Identifying the mistakes is really important The analysis below points out these limitations with the hope to improve them in the near future: • The lack of an official public exchange It is the main reason that affects the development of futures market Without it, futures contracts can not be traded in Vietnam market Having a public exchange for derivatives instruments will also increase the liquidity of the market and attract more attention from customers both individually and institutionally • Unfair trading Because derivative products can be used in both risk hedging and speculating, it will provide some “big” investors the 40 opportunity to “defeat” the market They can that by setting the prices too high or too low This action will make the fluctuation of exchange rates and prices unreasonable and cause troubles for other investors and the market itself • The lack of applying international standards in forwards trading Because of the lack of an official public exchange, all forwards trading activities in the market are managed as OTC market All transactions conditions are tailor-made based on the discussion between commercial banks and their customers In this case, the gap in understanding of two trading parties will lead to a transaction with many holes and mistakes • The financial derivatives market does not attract attention from customers, especially organizational customers This means regulatory authorities and financial institutions including commercial banks need to invest more in educating the investors • The lack of transparency and liquidity The financial market in Vietnam is lacking of transparency as there is no requirements for stating details about trading activities related to derivatives instruments It is also lack of liquidity, which reduces the incentives of investors to participate in the derivatives market 41 CHAPTER VI RECOMMENDATION Based on some problems that I mentioned above, the author would like to give some suggestion in order to improve the forwards and futures market in Vietnam The recommendations are as follows: • Establish an official exchange market This will be a strong support for the development of derivatives market, especially for futures market Having a public exchange for derivatives instruments will increase the liquidity of the market and attract more interest from customers • Regulation about exchange rate limitations Vietnam regulatory authorities can set floor and ceiling rates for the exchange rates to avoid the unfair trading that I mentioned above If the exchange rate is exceeded the ceiling rate or below the floor, the contracts are expired • Requirements about capital and collateral in trading forwards and futures contracts Derivatives contracts need collateral or deposits in order to motivate the investors follow the contracts Nonetheless, the bank should consider about the capital capacity of the investor before doing any transaction to decrease the default risk in the transaction 42 • Open-markets for all financial institutions that are trading forwards and futures contracts SBV should open doors for all financial institutions that want to involve in trading the derivatives instruments This action will increase the competition in the market and strengthen the capability of these institutions However, firstly we need to find an appropriate system to supervise all these institutions • Using an international standard transaction for derivatives trading Applying an international standard transaction is a possible solution for the development of forwards market in Vietnam This action will make the trading simpler for all parties involving Nonetheless, the international standard documents will help investors avoid unfair conditions in purchasing and practicing forwards and futures contracts • Recruitment and education Human resource is an important factor that influences the development of futures and forwards market Both regulatory authorities and commercial banks need to recruit right people who have broad knowledge about derivatives instruments and derivatives market Nonetheless, policy makers should concern more on educating investors The customer needs to know about the benefits and disadvantages of derivatives and how to apply it effectively • Increasing the liquidity of the system As mentioned in the failure lesson of China, the liquidity of the financial market is the compulsory factor to develop forwards and futures market Unfortunately, the liquidity management in Vietnam market is always one of the 43 biggest issues In order to develop the market, there are many things the government needs to to improve the liquidity of the whole system • Requirements about financial statements In order to improve transparency of the market, SBV should issue requirements and guideline documents for commercial banks to apply in their financial statements The financial statements should provide more information about trading activities related to financial derivatives Nonetheless, the report needs contain some financial calculation to show off the current situation of the trading derivatives activities in Vietnam market 44 CONCLUSION Forwards and futures are two new concepts in Vietnam Even in the world, there are many arguments about using them The complex nature of derivatives instruments make them difficult for all participants involving, including regulatory authorities, financial institutions and end-users of the products However, understanding thoroughly about these two instruments is essential since they are considered as very effective hedging and investing tools for their users In Vietnam, forwards contracts have been used since 1998 However, the market has not been popular as expected This is the results of many problems which need adjustments and solutions to improve The responsibility is put on policy-makers’ shoulders They should keep in mind that a strong derivatives market will contribute greatly for the economy There are many lessons in other countries which can be used in building the forwards and futures market system in Vietnam There are also the experiences of Vietnam itself in trading forwards contracts Combination of other nations’ lessons and our own experience will improve the current situation of forwards and futures market in Vietnam 45 REFERENCES Vietnamese • Phan Thị Thu Hà (2007) “Ngân hàng thương mại” – Nhà xuất đại học kinh tế quốc dân, Hà Nội • Tô Ngọc Hưng (1993) “Tiền tệ, Ngân hàng Thị trường tài chính” – Nhà xuất Khoa học kỹ thuật, Hà Nội English • Oliver Fratzscher (2006) “Chapter for Asian Financial Market Development” – White paper • Shamsher M and Taufiq H (2007) “Asian Derivative Markets: Research Issues” – The World Bank Website • Website of commercial banks in Vietnam, such as ACB, Sacombank, Eximbank… • Website of the State Bank of Vietnam 46 INSTRUCTOR’S COMMENTS 47 ... development of forwards and futures market in Vietnam? ?? In Vietnam, the market for financial derivatives instruments was officially established since 1997 However, the market has not been in high demand... objectives of the study are as follows • Providing theoretical understandings of the forwards and futures markets • Analyzing the current situation of the forwards and futures market in Vietnam. .. Suggesting recommendations for the development of forwards and futures market in Vietnam 1.3 Scope of research The research focuses on the forwards and futures market in Vietnam Due to the limit of