OTC derivatives gathering steam

In keeping with growing demand for complex financial products, domestic financial institutions are all set to expand their product line. Financial derivatives are the first stop along the road to developing sophisticated financial instruments. So far, these hedging instruments are strange to local businesses and investors, but the addition of newer players- Authorized Derivative Dealer (ADD) - in the market will help buttress the development of OTC derivatives market. Recently, the State Bank of Pakistan (SBP) has issued ADD license to Faysal Bank Limited to conduct financial derivative business, bringing the total number of ADD dealers to six in the industry. The remaining five ADDs are Citibank, Deutsche Bank, Habib Bank Limited, Standard Chartered Bank (Pakistan) Limited and United Bank Limited. In light of policy guidelines issued by SBP, the main products currently being offered by ADDs are Rupee Forward Rate Agreement, Cross Currency Swaps, Interest Rate Swaps and Foreign Exchange Options on a third currency. With the country wrestling with a slower economic growth rate, the popularity of such complex products is growing in dribs and drabs. As of 1HCY11, the size of the derivates market was close to Rs200 billion, with cross currency swaps accounting for nearly 70 percent of the total derivatives portfolio of banks. Taking cue from the developed worlds experience with derivatives products, and given that the local OTC market is in a revolutionary phase, the local banking sectors seem prudent in adopting risk management practices and compliance procedures. "Foreign banks have a luxury to import expertise, we need to work harder to develop and setup systems and procedures", said a local banker, adding that development of infrastructure required quality human resources. The industry is currently offering a narrow range of products, but once these existing instruments are up and running, it will develop a good base to roll out more complex derivative instruments in the future. The key stumbling blocks currently being faced by the industry are the low market awareness, low liquidity in the interbank market and illiquid market for certain underlying instruments. With local market standing many years behind the global financial market, there will be a gradual development in demand for such complex products. However, the banking industry has asserted the need to improve coordination among existing banks to share their capacities and resources, to help OTC derivatives market grow to its full potential.