Reforms in the financial markets play a pivotal role in enhancing the development of the capital market that, in turn could lead to the further strengthen the domestic economy
One such reform or enhancement is the introduction of the short-term Peso Interest Rate Swap (Peso IRS) instrument and the repurchase agreement (repo) for government securities, a collaboration between the Bankers Association of the Philippines (BAP) and the Bangko Sentral ng Pilipinas (BSP).
Both the BAP hierarchy and BSP Governor Eli M. Remolona are captivated by these reform initiatives for financial instrument trading, which will give the market a wider range of product lines apart from the usual straightforward instruments such as bonds, equity, futures, and bills of exchange.
Financial instruments 101: peso swap is a simple but powerful derivative. It involves the exchange of interest and sometimes principal in one currency for the same value in another.
In this particular case, the enhanced Peso IRS overnight reference rate (ORR) is anchored on the variable overnight reverse repurchase rate (ORRP) of the BSP that is set on a daily basis.
Repo, meanwhile, is a financial transaction that takes place on an overnight basis, wherein a dealer offers a security like government IOUs –Treasury bills or Treasury bonds to an interested party and buys the securities back at a slightly higher price to earn profits.
Paul Raymond A. Favila, chair of the open market operations committee of the Bankers Association of the Philippines (BAP) at the media launch of these instruments, said both are “tools that will benefit the banking clients to better manage their risks and exposures and eventually grow our market.”
The Citibank country head admitted that these financial instruments have yet to be adopted as the “key element to the formal launching of the Peso IRS is the publication by ISDA of the ORR.”
Nope, Virginia ISDA is not a fish. It’s an acronym, short for International Swaps and Derivatives Association. It is an association, whose members are mainly banks, that helps to improve the market for privately negotiated Over-the-Counter (OTC) derivatives by identifying and reducing risks in a specific, particular market.
Peso IRS is a simple derivative. Designed to improve the benchmarks with an end in view of putting in place a smoother yield curve, the appeal of the peso swap allows one to choose between a peso and a dollar liability, whichever he desires.
Another inherent beauty of the instrument is the option, which gives the contracting party an alternative to select his desired risk, given the underlying currency he prefers to take.
This swap facility would lead to better pricing of loans and ultimately redounds to the benefit of the borrowing public as interest rate payments on borrowed funds become more acceptable and/or affordable.
BAP officials expect that ISDA’s recognition of the ORR as the benchmark for the Peso IRS will be handed down within the next month. “At that point, the market can start using the ORR to engage in swap activity,” Mr. Paul Raymond explained.
Repo is another market reform-enhancing initiative. Its usage is expected to have a knock-on effect on better pricing of interest rates for the borrowing public and their loans.
Currently, the repo market’s potential remains capped because trading is limited.
As a consequence, trading volume of government bonds is a bit lackluster and this has a cascading effect on how banks price loans to their clients.
This is because the BSP “tags” securities to banks that place cash with it via the central bank’s reverse repo window. And as such, these securities, such as bonds, cannot be traded with other interested market participants for repo.
The situation and the condition will soon change, altogether as these securities can now be freely traded, in line with global standards. Ergo, by expanding more activity within market participants, prices would, eventually, arrive at a price point that ideally reflects their financial needs.
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