Framework derivatives presentation (THỊ TRƯỜNG PHÁI SINH SLIDE)

Conference on Derivatives Markets for Viet Nam Framework Presentation Robert H Singletary VIE-026 Introduction The State Securities Commission of Viet Nam is conducting a program to support the creation of a derivatives market for the country This Conference is designed to engage industry and international specialists to share the SSC’s progress to date and gather information to better guide the Commission’s policy and regulatory decisions The Threshold Questions What is the industry demand for derivatives? Should the SSC’s goal be to develop standardized derivatives or tailored derivatives (OTC derivatives), or both? What type of derivatives should be developed? (options / futures) (cash-settled / physically delivered) The Threshold Questions (continued) What types of underlying assets will be allowed? Which securities should be the underlying asset? Who will be the infrastructure institutions:  Trading mechanisms  Intermediaries  Purchasers and sellers  Clearance and settlement The Threshold Questions (continued) What systemic protections are envisioned for default by purchasers and sellers? What systemic protections are envisioned to prevent manipulation of the market for the underlying asset and/or the derivatives market? The Answers to these Threshold Questions Will Drive the Architectural Choices for the Derivatives Markets What does the industry want (need)? View: The derivatives market architecture and products should be “demand-driven” The SSC, in its role as market designer, wants to understand what this market needs today, and what the needs may be over the near-term horizon However, systemic safeguards and investor protections must be built in Standardized, OTC derivatives or both? JPMorgan $45.74 Closing Price Mar 14, 2011 Calls Maturities Apr Exercise Price May Jun Sep 43 3.30 3.75 4.06 5.05 44 2.60 3.17 3.65 4.60 45 1.95 2.57 3.00 4.02 46 1.39 1.98 2.43 3.50 47 92 1.46 1.93 2.99 48 59 1.15 1.54 2.45 49 37 80 1.13 2.15 Standardized, OTC derivatives or both? In-Country OTC Derivatives Practices Today VN has an OTC forwards market already The maturities are short The underlying assets are bonds or currency This is an institutional investor market Preliminary View: The SSC should not attempt to force the institutional OTC activity onto a standardized, organized market What types of derivatives? Price of the Underlying Asset Economic Outcomes for Futures and Options Holders Contract Price Market Price Time Expiration Date What types of derivatives? Standardized Futures Contracts Present more systemic risk (default risk) because both parties are compelled to perform on expiration date Standardized Options Contracts Present less systemic risk (default risk) because the parties must perform only if the price movement is favorable to the holder Otherwise , the option expires worthless 10 Who will be the infrastructure institutions Exchanges? Institutional Investors The Trading Market for Derivatives Sellers Buyers Trading Mechanism Sellers Clearance and Settlement Buyers Retail Investors Central Counterparty? Intermediaries 19 Who will be the infrastructure institutions Exchanges? Market for the Derivative Investors CCP Sellers Trading Mechanism Buyers Intermediaries Pricing Market for the Underlying Asset Investors Sellers Trading Mechanism Buyers Clearance and Settlement Clearance and Settlement Process Intermediaries 20 Who will be the infrastructure institutions Exchanges? Information flow and IT linkages are necessary to allow: Efficient pricing of the derivatives Market surveillance Will the same exchange that trades the underlying asset be allowed to trade the derivative on it? What happens when the underlying asset is traded offexchange? 21 Who will be the infrastructure institutions Exchanges? Preliminary View: Side-by-Side trading should be allowed first Cross trading will depend on IT linkages and surveillance issues View: Trading of derivatives on assets that are trade offexchange should not be allowed 22 Who will be the infrastructure institutions Intermediaries? Intermediaries: Will all licensed securities companies be allowed to intermediate? (Issues of expertise and capital) Preliminary View: Because SCs should be required to stand behind the trades of their clients, only those with sufficient capital should be authorized 23 Who will be the infrastructure institutions – Purchasers and Sellers? Purchasers and sellers:  Will purchasers / sellers be limited to VN entities only?  What is the impact of the foreign ownership restrictions?  Will purchasers / sellers be restricted to sophisticated investors only? 24 Who will be the infrastructure institutions – Purchasers and Sellers? Preliminary View: The use of cash-settled derivatives solves the foreign ownership limit problem Also true for derivatives on indices or ETFs that contain stocks that have reached the ownership limit Preliminary View: Physically delivered derivatives can be used for debt instruments Preliminary View: Participation in the derivatives markets should not be limited 25 Who will be the infrastructure institutions – Clearance and Settlement? Clearance and Settlement:  Will the system contain a “central counterparty”?  Will there be a default guarantee fund?  Will the securities companies be required to guarantee the performance of their customers? 26 Who will be the infrastructure institutions – Clearance and Settlement? Clearance and Settlement:  Who will record position ownership?  Will this be a tier or tier record-keeping system?  Who has the expertise, operational capacity a risk management systems to serve this function? 27 What protections are envisioned for default risk? View: VN should use a Central Counterparty View: VN should use a guarantee fund View: Securities companies should be required to stand behind the trades of their customers Preliminary View: A 1-tier system (where the CCP can see the customer who holds the position) is preferable 28 What protections are envisioned for default risk? Default risk protections:  “Margin” deposits (pre-pay and/or pre-deliver in full adversely affects the economics of derivatives)  Securities company guarantees (this impacts capital requirements)  Guarantee fund (must be used as last resort, not as “slush fund” 29 What protections are envisioned for market manipulation? Market for the Derivative Investors Sellers Exchange Buyers Central Counterparty Securities Companies Pricing Market for the Underlying Security Investors Sellers Exchange Buyers Securities Companies VSD 30 What protections are envisioned for market manipulation? Preliminary View: VN should use position limits Preliminary View: VN should use exercise limits Preliminary View: VN should only allow derivatives on exchange traded assets 31 Conclusions Summary of Threshold Decisions 1.Determining industry demand and the ability of the design to meet it 2.Choosing Standardized, OTC, or both 3.Determining options versus futures, cash-settled versus physical delivery (and perhaps differentiating between underlying asset) 4.Determining the eligible underlying assets 32 Conclusions Summary of Threshold Decisions (continued) 5.Determining eligibility criteria for intermediaries 6.Selecting trading mechanisms 7.Determining whether there shall be a central counterparty and record-keeping system 8.Determining protections against default risk 9.Determining protections against market manipulation 33 ... is the industry demand for derivatives? Should the SSC’s goal be to develop standardized derivatives or tailored derivatives (OTC derivatives) , or both? What type of derivatives should be developed?... and/or the derivatives market? The Answers to these Threshold Questions Will Drive the Architectural Choices for the Derivatives Markets What does the industry want (need)? View: The derivatives. .. 47 92 1.46 1.93 2.99 48 59 1.15 1.54 2.45 49 37 80 1.13 2.15 Standardized, OTC derivatives or both? In-Country OTC Derivatives Practices Today VN has an OTC forwards market already The maturities