WHEN it comes to investment, the first thing that springs to mind is the stock market, bonds and unit trust.
However, the financial market has grown more complicated in recent years, especially with the introduction of derivative instruments offering new ways of investment.
Derivatives are financial instruments that derive their value from another asset or any underlying variable.
Derivatives trading has grown in popularity particularly in developed markets, creating depth in their financial market that changes the playing field.
One of the factors why investors shy away from derivatives trading is that some are hard to understand and that derivatives have no intrinsic value as their value comes only from underlying assets, which is more vulnerable to market swings.
The advantages of trading in derivatives include lower cost, hedging tools and asset diversification.
According to Hong Kong-based Perfect Hexagon Ltd, the main challenges in the South-East Asian derivatives market are lack of expertise and awareness.
“The misconception about the derivatives market is partly due to the stigma of the instrument being a speculative domain, much like a ‘casino’, whereby only those who gamble participate, as compared to western regions which are used for hedging, ” Perfect Hexagon chief executive officer Sim Tze Jye told StarBizWeek.
Sim reckons that there should be more promotions on South-East Asian derivatives as there is a lack of participants to create volume in the market.
“Without prominent branding, market awareness will be limited to almost zero, eventually resulting in low trade volumes and hence making it harder to attract new traders as this vicious cycle continues perpetually, ” he said.
Derivatives market only gained prominence in South-East Asia around the 1990s, in comparison with developed countries that have long been taking the lead in the derivatives market.
Perfect Hexagon which specialises in commodities trading including derivatives recently partnered with Bursa Malaysia to boost the local derivatives market by becoming an active liquidity provider on Bursa Malaysia Derivatives (BMD).
“Perfect Hexagon will be working hand-in-hand with Bursa Derivatives to grow the commodity derivatives trading market, ” said Perfect Hexagon Commodity and Investment Bank Limited chairman Tan Sri Koo Yuen Kim.
Bursa Malaysia Derivatives Bhd chairman Datuk Muhamad Umar Swift said Perfect Hexagon will be one of the market makers for BMD.
“Market makers play an essential role in the exchange ecosystem towards providing and enhancing the liquidity in the market.
“As we all know, liquidity is crucial for market participants to effectively execute their risk management strategy, ” he said.
He pointed out that a market maker would have to buy and sell at publicly-quoted prices on the exchange to ensure a smooth flow of orders between buyers and sellers.
In addition to market making, Muhamad Umar said Perfect Hexagon also received approval and has successfully registered as an Associate Participant of BMD effective May 13,2020. There are currently 23 Associate Participants approved by BMD.
Muhamad Umar elaborated that BMD operates a well-regulated, most liquid and successful crude palm oil futures (FCPO) contract in the world, positioning Malaysia as the global price benchmark for the crude palm oil market.
In 2019, about 268 million metric tonnes of palm oil underlying for FCPO was traded, representing 3.5 times of world production, demonstrating the extensive usage of FCPO globally.
The use of derivatives to hedge risk and improve returns has been applied for a very long time, and it is especially popular in trading metals and other commodities.
One of the main purposes of commodity futures trading is hedging. For instance, a manufacturer faced with the volatility of raw material prices is protected by futures contracts.
Meanwhile, some investors use commodity futures as a vehicle for investment in commodities without holding the actual assets.
It is worth noting that commodity futures markets are often much smaller than forex, options and money markets instruments. As such, they are not liquid enough to attract investors and large transactions.
Muhamad Umar said the derivatives market provides risk management solutions to various market participants, allowing users to hedge their exposures against price fluctuations.
“We are continuously developing, enhancing and broadening our product offerings to cater to the growing needs of the industry, ” he said.
Perfect Hexagon Ltd chairman Datuk Tan Jyh Yaong said the current global economic trends have changed the entire commodity trading landscape, and China has transformed itself from a growing economy into a dominant global market.
“Perfect Hexagon will step up efforts to develop regional cooperation in commodity trading with more domestic strategic partners.
“We accepted the invitation of Bursa Malaysia to become an Associate Participant, hoping to take this opportunity to enhance commodity trade between Malaysia and China, ” he said.
Perfect Hexagon is a recognised leader in commodity trading in Hong Kong, China, Singapore, Thailand and Malaysia.
Sim said that Perfect Hexagon is aiming to redefine the commodity market environment in Malaysia, and targeting the three main markets: precious metals, London Metal Exchange and palm oil products.
“Therefore, products in Bursa Malaysia Derivatives like gold, tin, CPO and palm olein do fit within these criteria, ” he said.
He stressed that Perfect Hexagon is not a derivatives platform provider, but a supply chain solutions provider for the commodity market.
“In short, we are the software and derivatives platform providers are the hardware. We see ourselves as the software that can be put in any hardware, and through our partnership with CGS-CIMB, we look forward to a more sophisticated and effective integration of software and hardware, ” he said.
Among the key advantages that Perfect Hexagon is providing include cross-market hedging directly through separate derivatives platform providers, reducing forex losses from settlement and more effective cross region fund transfer.
“Our international business networks further reduce dependency on a single market client exposure which other platform providers are constrained to and this enables us to tap into international markets for alternative liquidity support, ” Sim added.