Currency options may increase Singapore dollar volatility
Currency options may increase Singapore dollar volatility
SINGAPORE (Dow Jones): The Monetary Authority of Singapore's
move last week to loosen rules on onshore currency options
trading may be a signal that it's prepared to let the local
dollar fluctuate more widely - if not exactly wildly, analysts
say.
To attract more interest in Singapore dollar options, used to
hedge positions, the authorities will need to allow sufficient
volatility in the underlying instrument - in this case the
Singapore currency.
"When you introduce options, you need to allow greater
volatility," says Jimmy Koh, the head of treasury research at UOB
Group. "They will probably need to widen the Singapore dollar
trading band."
Last week, the Monetary Authority of Singapore, the republic's
de facto central bank, announced it would allow banks to transact
Singapore dollar-denominated currency options with other banks
and financial institutions it now regulates.
The move, which came into effect Dec. 6, was aimed at
facilitating the use of currency options as hedging instruments.
A currency option is a contract between a buyer and seller which
gives the buyer the right, but not the obligation, to trade a
specific amount of currency at a predetermined price and within a
predetermined period of time, regardless of the market price of
the currency.
Allowing interbank trading in Singapore dollar options was
part of a package of measures unveiled last week designed to
increase foreign investment in the domestic capital market.
"It makes the whole process of price-making more efficient,"
says a currency options specialist at a U.S. bank. "There was a
fair amount of options trading going on between customers and
banks, but having an interbank market now makes the whole process
more efficient."
Last week, the MAS also announced that it would allow banks to
lend local dollars to nonresidents for investment purposes in
Singapore. Banks can also extend Singapore dollar credit
facilities to nonresidents to fund offshore activities as long as
the Singapore dollar proceeds are converted into foreign
currency.
The change effectively widens the use of the Singapore dollar,
the control of which the MAS has long been reluctant to give up.
It uses the currency, not interest rates, as its primary monetary
policy tool. The movement of the Singapore dollar is guided
within an undisclosed trading band against a basket of currencies
of the country's major trading partners.
The Singapore dollar trades within very narrow daily ranges on
average, as the MAS regularly steps into the market to smooth out
volatile trading. In the last 10 trading days, for instance, the
Singapore dollar fluctuated within an average 60-pip daily range.
Even with the introduction of an onshore currency options
market, important restrictions will remain, ensuring that the
authority retains the ability to keep a tight grip on the
Singapore dollar if it so chooses. For example, restrictions
disallow the development of an offshore options market - which
would potentially pose a challenge to the authority's control in
the event of speculative attacks against the local dollar.
Still, the move to allow an onshore market for options was
somewhat revolutionary, some said.
"I was a little bit surprised. It (allowing currency options
trading) happened quite suddenly," says a European bank options
desk head. "Their main concern was that in opening up the market,
it would create more volatility in the spot."
Koh at UOB Group adds the MAS didn't have much of a choice.
"If you want to fire up the domestic debt market, you need to
provide an environment for people to hedge their positions."
The MAS has been trying hard to develop various segments of
the financial sector, including the debt market, as a way of
shifting focus from foreign exchange trading, a previously strong
money earner but which is fast losing importance to the more
exotic areas of derivatives.
The impact of currency options on Singapore dollar spot
trading has been muted so far. Interest in Singapore dollar-
denominated currency options has slackened off following an
initial exuberance, as year-end lethargy saps life out of Asian
currency options markets, dealers say.
"Hedging activity is pretty much on the low side. It's not
only in Sing dollar that volume's low," said a U.S. bank dealer.
"There's hardly anything done in the baht now."
Daily trading volume in Singapore dollar options has been
halved to about $20 million to $30 million a day, from a "decent"
volume of around $60 million at its debut, as the authority's
consent triggered an initial flurry of excitement, dealers say.
In comparison, daily trading volume in the Taiwan dollar
options averages about $70 million to $80 million, while Thai
baht options have been barely traded ever since the Thai
authorities clamped down on speculative trading in the currency a
few weeks ago, dealers say.
Experts say they expect trading volumes in Singapore dollar
options to improve next year. Although only about half of the
banks in Singapore have participated in this market, more are
expected to join the bandwagon, dealers say.