Banks in Singapore are stubbornly against adopting domestically set reference rates for derivative contracts in the Indonesia rupiah, despite preparing to drop their own rate fixing for the Malaysian ringgit and Vietnamese dong. Traders in non-deliverable forwards (NDFs) distrust onshore prices for the rupiah, fearing that a lack of liquidity in Indonesian currency markets and the central bank's heavy-handed intervention distorts pricing.
"NDFs are priced off the fixing," said one trader. "They have to make sure that the local fixing is reflective of market-traded prices." Singapore and Hong Kong are the regional centres for trading NDFs, derivatives that allow speculation in or hedging of emerging market currencies that cannot be traded directly or freely due to exchange controls.
Singapore banks, under pressure from regulators, are soon expected to abandon their process of fixing a daily reference rate for Malaysia's ringgit, following probes into manipulation of the spot price used for settling such contracts. Malaysia had been pushing since last year for traders in Singapore to accept an onshore rate for trading the currency.
Policymakers in Jakarta share their Malaysian counterparts concerns about the impact of offshore speculation on their spot currency markets, but the city-state's banks are loath to make a similar switch to accept a reference rate set by Bank Indonesia. The Indonesian central bank, which last month reminded local banks they were banned from trading in NDF rupiah, has said it will create a new reference rate, based on market prices, in April.
But market participants say traders in rupiah NDF markets, hedge funds, portfolio investors and even blatant speculators would be exposed to big risks if their contracts were settled on the basis of a highly unpredictable rupiah rate. "There has been some talk of tight dollar liquidity onshore occasionally, and this could be an issue that may complicate offshore from using onshore rates," said Gundy Cahyadi, a strategist with OCBC Bank in Singapore.
NDF traders in Singapore said they would wait and watch as Indonesia rolls out its new onshore reference rate, but would stick with the offshore fixing for their contracts for now. If Singapore's banking association is forced to abandon the setting of a rupiah benchmark and there is no credible onshore rate, NDF players may move operations to a new destination, such as Hong Kong, traders say.
Average daily volumes in rupiah NDFs are $500-$700 million, about half the volume of the offshore trade in China's yuan, according to estimates by HSBC. "It's not impossible that the market will just shift elsewhere," said Cahyadi. The rupiah, easily Asia's most volatile currency, is a favourite with foreigners seeking high yields. With more than 33 percent of Indonesian government bonds held by foreigners, Indonesian authorities are well aware of the need to attract investment and keep the currency stable.
Through 2012, as fickle global economic conditions and a worsening current account deficit back home put downward pressure on the rupiah, Indonesia's central bank stood resolutely behind its currency, using a mix of moral suasion, regulations and intervention to staunch volatility. Implied volatility priced into rupiah options fell sharply as a result, with one-month volatility now down to 5.5 percent, a third of levels in mid-2012.
There were unintended consequences too of Bank Indonesia's tactics, which included heavy policing of the quotes Indonesian banks gave for the rupiah and a strict rationing of scarce US dollars. Often, offshore markets would quote the rupiah 1 to 2 percent weaker than the onshore market. Fixings, the reference rates for rupiah, also diverged, with dollar rates set by the ABS often 50 to 150 rupiah higher than those quoted by Bank Indonesia.
Typically, NDF contracts are net-settled in dollars. A trader who'd bought a one-year contract a year ago would compare the contracted rate with the spot fixing rate, and pay or receive the difference. If they started settling offshore contracts against an onshore reference rate which is determined by a very different set of flows and factors, traders would be exposed to the risk of rupiah levels moving in a direction quite different from offshore prices.
Traders simply are not willing to stomach that risk. Even Bank Indonesia's latest proposal, that of creating another onshore rupiah benchmark that is based on market prices, isn't assuaging those concerns. "Dollar/rupiah fixing rates onshore are not always at the market rate," said one analyst, who declined to be named. "The fixing cannot be arbitrary. That would disadvantage the NDF trader, exposing them to basis risk."
The changes to the way currency contracts in the Malaysian ringgit are settled comes after months of investigations and a review of the way Singapore-based banks set daily reference rates for currencies such as the ringgit, Indonesian rupiah, Thai baht and Vietnamese dong.
The reviews were ordered by Singapore's banking association and triggered by a global scandal over bankers rigging benchmark lending rates such as the London Interbank Offered Rate, or Libor. The probes uncovered attempts by traders to manipulate Singapore's rate fixings for certain currencies, fuelling the ire of central bankers in Malaysia and Indonesia who say Singapore's NDF market undermines currency controls that they use to contain the pace of foreign money flows.
The Association of Banks in Singapore (ABS), which is leading the effort to improve the process, is expected to adopt a plan that would end the daily publication of a ringgit spot price for settling forward derivative contracts, a person with direct knowledge of the plans told Reuters last week.
Singapore media reported that banks in the city-state would also stop setting the reference rate for the thinly-traded Vietnamese dong NDF, though it's unclear what would replace that. Traders in offshore ringgit markets appear apathetic to the prospect of switching from a ABS-determined reference rate to one determined by domestic Malaysian banks. After all, switching to an onshore rate, which is the underlying value on which derivatives are priced, will eliminate the risk of divergence between the onshore and offshore rates.