Source: BURSA MALAYSIA | Published: October 2023
Financial instruments known as derivatives derive their value from an underlying physical good or financial instrument. As a result, the price of the instrument on which they are based, such as the Kuala Lumpur Composite Index (KLCI) for stock index options and the price of palm oil sold on the commodities market for crude palm oil futures, determines the price of the derivative.
Early in the 1970s, as a result of the heightened risk in the financial markets brought on by growing inflation, greater interest rate volatility, floating exchange rates, and oil price shocks, the use of derivatives to limit financial risk skyrocketed. In many nations, like Malaysia, where stock index futures futures are now well-established, financial derivatives based on asset prices, currency values, and interest rates are now readily available. Their main benefit to investors is leverage, which increases prospective profits (though this applies to losses as well). Derivatives may also be less susceptible to market manipulation. Additionally, short positions allow traders in derivatives to generate returns and profit from both bullish and bearish market patterns.
Types of Derivatives in Malaysia
Derivatives can be classified into two main types: Exchange-Traded Derivatives (ETD) and Over-The-Counter (OTC).
Exchange-Traded Derivatives (ETD) are contracts that are traded on derivatives exchanges. These contracts are standardized as defined by the exchange, and the derivatives exchange acts as the counter-party to all contracts. ETD include options and futures contracts on various underlying assets such as financial instruments, equities, and commodities.
On the other hand, Over-The-Counter (OTC) derivatives are privately negotiated contracts that are traded directly between two parties. The OTC market is the largest market for derivatives, providing flexibility in terms of contract specifications and customization to meet the specific needs of the parties involved.
Financial derivatives are based on underlying assets such as bonds, and they include futures contracts for government securities of different maturities (e.g., three-, five-, and 10-year bonds) as well as short-term interest rate instruments traded on the money market. Commodity derivatives in Malaysia derive their value from agricultural items and precious metals like crude palm oil and gold. Crude palm oil futures, in particular,are one of the most actively traded derivatives in Malaysia.
Derivatives offer investors the opportunity to maximize the return potential from a small initial capital by prudently using leverage and short positioning. However, it's worth noting that while many investors in Malaysia choose to invest in shares, the adoption of derivatives has not yet been widespread.
The rapid growth of the derivatives market has been fueled by the development of new valuation methodologies. Today, derivatives play a significant role in modern finance, providing risk management tools and investment opportunities in various asset classes.
Market Liberalisation and More Clarity
With a population of over 32 million, Malaysia is a country with an upper middle-income economy. Demand for high-quality goods and services is rising as the country's middle class becomes more prosperous.
The country's sophisticated infrastructure, an English-speaking business and consumer environment, a solid legal system, and the ability to repatriate capital and earnings are all advantages for foreign exporters aiming to increase their market share in Malaysia. According to the World Bank's Ease of Conducting Business 2021 Report, Malaysia is generally regarded as an easy and cost-competitive market for doing business.
Looking back on the 1997–1999 Asian financial crisis, Malaysia forbids trading in the offshore ringgit, including on the non–deliverable forward market and for futures. This was done to stop speculation and capital outflows from domestic financial markets.
However, BNM has liberalised its foreign exchange rules, enabling non-resident treasury centres to hedge on behalf of their associated firms. With a single registration with BNM, the central bank now also gives non-resident treasury centres outside of Malaysia the ability to hedge on behalf of their linked firms there as well as abroad using a licensed onshore bank or appointed overseas office (AOO).
Changes to Bursa Malaysia Derivatives Berhad (BMD) and Bursa Malaysia Derivatives Clearing (BMDC) include removing the requirement that trading participants maintain a voice logger for client orders and allowing registered representatives to advise clients and conduct transactions outside of the company's physical location. Other changes include the introduction of various non-face-to-face methods to verify a client's identity when opening an account.
Bursa Malaysia also removed the restriction that prevented holders of dual licenses from engaging in proprietary day trading, giving holders of dual licenses who deal in both securities and derivatives more flexibility.
The local bourse has improved the governance structure for participants in trading and clearing in BMDC and BMD.
This contains brand-new specifications for internal audit and risk management procedures, such as mandating that the appropriate committees supervise them and requiring the registration of a head of dealing at a trading participant's front office. Regardless of market action, savvy investors might want to think about increasing prospective gains by taking advantage of the leverage effect provided by derivatives. Considering the many changes that have taken place in the Malaysian derivatives space, a more informed choice may be required.
One of the largest bourses in ASEAN, Bursa Malaysia operates and regulates a fully integrated exchange offering a comprehensive range of exchange-related facilities.
Learn more at: https://bursaacademy.bursamarketplace.com/en/home
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