Derivatives instruments as a risk management tool

  • Markets
  • Saturday, 06 Jun 2020

Bursa Malaysia Derivatives Bhd (BMD) chairman Datuk Muhamad Umar Swift said that market and product awareness needs to be increased to encourage more institutional users to use derivatives instruments as a risk management tool.

WITH the financial market looking uncertain in the near term, analysts see derivatives instruments as useful for investors to manage their risk.

“By hedging with a derivatives contract, market participants can reduce uncertainty on the future price of a commodity, security or financial instrument, ” said CGS-CIMB futures Sdn Bhd head of futures broking David Tan.

He said derivatives contracts are one of the most popular asset classes being used to offset market risk exposure and protect themselves from market volatility.

In the commodity market, both consumers and producers of a commodity can use futures contracts to hedge without having to hold the physical commodity.

“Say a producer has been contracted to deliver physical crude palm oil (CPO) in six months’ time by December 2020 and wants to lock in the current CPO price at RM2,330 per tonne.

“To hedge against any fall in CPO prices until December 2020, the producer can sell his December 2020 CPO futures contract at the current price of RM2,330.

“If CPO prices fall to RM2,300 by December 2020, the lower physical sales price by RM30 would be offset by the gains of RM30 in the futures contract, ” Tan told StarBizWeek.

The same situation also applies to consumers who worry about the volatility of the commodity market. They can buy CPO futures at lower prices today that could offset higher CPO prices in the coming months, he added.

While it is apparent that derivatives markets provide a useful tool for hedging, especially in the commodity market, awareness level among investors on derivatives markets is still lacking.

Bursa Malaysia Derivatives Bhd (BMD) chairman Datuk Muhamad Umar Swift said that market and product awareness needs to be increased to encourage more institutional users to use derivatives instruments as a risk management tool.

“Continuous efforts are being made to engage with the industry and promote the use of derivatives products for risk management, ” he said.

For instance, BMD has been the host of Malaysia’s largest palm oil industry conference – the Palm and Lauric Oils Price Outlook Conference & Exhibition (POC) – for 30 years, as part of its promotional activity.

Muhammad Umar said that intense competition from foreign derivatives exchanges is also a challenge to grow the local market.

To further enhance the local market, he said BMD has been working to expand its international presence.

“We will further enhance our effort to promote our derivatives products to foreign proprietary trading firms, hedge funds and commercial firms, and introduce foreign futures brokers to Malaysian counterparts in our bid to forge new inter-broke relationships for potential business opportunities in the future.

“Our internationalisation effort includes market entry into Greater China through various collaborations with various parties, ” he said.

BMD recently partnered with Hong Kong-based Perfect Hexagon Ltd to be a market maker for commodity derivatives to enhance liquidity.

Perfect Hexagon also received approval and has successfully registered as an Associate Participant of BMD effective May 13,2020.

“As an Associate Participant of BMD, Perfect Hexagon will be providing liquidity to the Bursa platform through different products listed via our extensive experience and networks.

“In short, we play the role as a market maker in BMD, ” said Perfect Hexagon director and chief executive officer Sim Tze Jye.

Perfect Hexagon is a recognised leader in commodity trading globally.

“In our relentless pursuit to enhance our services to our clients in all continents, we began participating directly in key exchanges since 2016.

“Within a short time frame, we have been on board the Singapore Bullion Market Association (SBMA), Chicago Mercantile Exchange (CME) and London Metal Exchange (LME), Hong Kong Exchange (HKEX) in different products and type of memberships, ” Sim said.

On the difference between investing in derivatives and the stock market, Sim said derivatives instruments are an alternative asset class to invest in compared to stocks for diversification, as it offers direct exposure to asset prices, for example commodities. “Investors can look for arbitrage opportunities through gaps in the wide range of derivative products and markets.

“Most importantly, derivatives should be used as a risk managing tool for investors to hedge, ” he said.

He reckons that palm oil is one of the key products for the Malaysian derivatives market, as it is an alternative product to sunflower oil and soybean oil.

“We foresee it will perform better in the post Covid-19 pandemic environment as the food supply chain is one of the key industries being affected.

“Food production-related industry players will look more into palm oil supply due to easier access to goods, which will result in further growth in palm oil volume, ” Sim said.

“Now is the perfect time to enabling infrustructure and to be ready when the economy is in full swing again after the Covid-19 situation, ” he added. – By Intan Farhana Zainul

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