Bank Negara Governor Hits Out at NDF Market, MYR at Year’s Low

The Malaysian Ringgit is approaching its lowest trading
level against the US dollar since the Asian crisis in 1998 when the country was
prompted to introduce capital controls.

In an attempt to stem the outflow of MYR, the country’s
central bank, Bank Negara, last week issued a warning regarding offshore NDF
trading – a move widely seen as a reintroduction of capital controls – by
sending letters to compliance heads at onshore and offshore banks demanding
they commit to ceasing offshore trade of MYR NDFs.

The NDF market has grown as investors and traders seek a way
around Malaysia’s strict regulatory regime and has led MYR weakness in recent
months. On Monday morning in Malaysia, USD/MYR was trading at 4.4300, its
highest level since September 2015, which was in turn the highest level since
the introduction of capital controls in 1998.

In a speech on Friday night, Bank Negara governor, Datuk Muhammad bin Ibrahim, said
conditions in the ringgit FX market have been “uniquely challenging”, adding, “At
the end of 2014, the situation appeared rather benign. The ringgit was stable,
market liquidity was good, trading activity was healthy with market volumes
averaging $11.8 billion daily while the volume for USD/MYR pair averaged $8.3
billion in 2014.

subsequent period however, precipitated by the weakening external conditions,
falling oil prices and domestic uncertainties have laid bare these notions,” he
continued. “Volume and liquidity declined, bid-offer spreads widened and at
times, there were one-way markets which exacerbated any movements. Given these
developments, 2015 was a year where our actions were primarily geared towards
stabilising the markets. While this was clearly achieved, it was not without
cost; a reduction in foreign exchange reserves, a markedly less liquid and
volatile foreign exchange market, and a weaker currency.

“In the
midst of this, an important observation that became increasingly evident is the
continued vulnerability of our markets to the arbitrary and unpredictable
devices of the offshore markets,” he added ominously.

in the offshore market, in particular the ringgit NDF market, have brought on “observable
adverse impacts” to the onshore market, the governor said, adding, “To our
disappointment, onshore players had become followers rather than leaders in
determining domestic market rates.”

He noted
that, taking the lead from the NDF market, the ringgit exchange rate has been
volatile since last year, peaking at 23.1% for its one-month historical
volatility and is the highest among regional currencies for this year. Of late,
it has been trending down, but the average volatility remains high at 10.1%
compared to its 5-year average of 8.2%.

On a day-to-day
basis, the governor noted the ringgit has also been volatile, particularly
prior to the USD/MYR fixing time even though it can be quiet throughout the
rest of the day. “As trade related FX transactions are done throughout the day,
it is highly perplexing as to why trading activities and observed volatility
have to be concentrated just prior to the fixing time,” he observed. “The only
plausible reason for the above phenomena is that it emanates from the fixing
orders from non-resident financial institutions (NRFI), the transactions of
which are driven by NDF market activities. As NDF is settled using fixing rate,
NRFI have been using fixing orders to square their offshore NDF positions.

“As a
consequence of such speculative activities, the ringgit fixing rate has
significantly diverged from the onshore traded ringgit prices,” he continued. “The
ringgit fixing rate was clearly out of sync with real trades and investment
activities done throughout the day.”

governor argued that the impact of NDF market volatility has been “clearly
pervasive” in the onshore market and that “several” FX traders in the domestic
market were seen to be looking towards the NDF market to provide cues in
determining the opening market price for ringgit. “And this behaviour
continues throughout the day in the pricing of the ringgit,” the governor said.
“Unfortunately, our media and public were also drawn into taking the lead from
these offshore rates as well. The sum effect of these behaviours is that we
inadvertently imported the NDF volatility into the onshore market.”

governor cited a Federal Reserve Bank of New York paper in May 2005, that
estimated 60 to 80 percent of NDF volume is generated by speculative interest
globally and argued that because of this, NDF markets tend to promote herd
behaviour which compounds the lack of two-way market liquidity. “Prices may
move rapidly in one direction or another driven purely by fickle sentiment, as
well as leveraged positions taken on by the speculators, making them inherently
unsuitable to represent an efficient and objective price discovery process for
the ringgit,” he warned. “Compounding this further, the offshore NDF markets
are highly opaque and information on these markets can only be gleaned through
the BIS’ triennial survey and other sources such as through mandatory reporting
of derivatives and swap data repositories on US financial institutions.

“Because of
the estimated volume and its opaqueness, the NDF market clearly has the
potential to undermine the integrity and financial stability of the onshore
market,’ he stated.

Noting that
the central bank had instigated several measures to combat the influence of the
NDF market, the governor then went on to discuss last week’s new measures,
although he argued they were not capital controls. He prefaced his comments
with, “Let me make it doubly clear on this. Onshore banks are reminded against
quoting onshore ringgit opening price referencing to the offshore prices.
Markets should not price ringgit excessively or out of sync with the underlying

He added, “We
have also reminded onshore banks to avoid dealing in FX with non-resident banks
suspected of engaging in NDF speculative activities except for those that
provide confirmation of their non-involvement in the offshore ringgit NDF
market. This week has seen many noises surrounding these measures. There is no
new policy on capital flows.

“There is
no proxy capital control either. In fact, Malaysia’s current account
remains free with free mobility of inflows and outflows of capital for
investments,” he continued. “The market remains open to all market participants
and we shall ensure the necessary liquidity to the market.

essence, the measures that were instituted over the past week are consistent
with our long standing policy of non-internationalisation of the ringgit and
one that we expect banks to fully adhere to without exception,” he stressed. “We
do not recognise or condone the non-deliverable ringgit offshore market. Those
who engage in NDF or NDF-related transactions are doing so at their own peril.”

accepting that the measures identified last week are “challenging” to some, the
governor reiterated his belief that they were not new. “We need to remove the
negative influence of the NDF activities that impacts the smooth functioning
and stability of the onshore financial market. We need to protect the interest
of genuine investors and businesses, irrespective of whether they are foreign
or domestic. Only through a concerted effort by all the stakeholders of the
ringgit market, can this objective be achieved. We need to remember, that
integrity and proper functioning of our financial market is in the interest of
every market participant, and all of us have a role to play towards achieving
this objective.”



Colin Lambert

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