TABB sponsored a webinar recently about Malaysian derivatives that unexpectedly made a point about how quickly fifteen years can slip by, and how the memories of investors retain the scar tissue from crises past.
After all, it was in July of 1997 that Thailand devalued the baht, setting off a region-wide series of crises that continued for more than a year. Immediately after Thailand’s action, some speculators saw Malaysia’s ringgit (MYR) as a target of opportunity.
The International Monetary Fund wanted the economies of the region to raise their rates, in order to make investments there more attractive to outsiders. Unfortunately, higher rates cause domestic difficulties, so Malaysian politicians quite sensibly resisted the idea.
By the end of 1997, ratings of Malaysian bonds had fallen to junk levels, and the Kuala Lumpur Stock Exchange composite index had taken its own fall, from roughly 1200 when the news from Thailand arrived to below 500 late that year. After a brief rally in the opening days of 1998 the fall resumed in earnest.
Why Cap Controls Can’t Last
The controls imposed in September 1998 in response to the continuing crisis prohibited transfers between domestic and foreign accounts, eliminated credit facilities for offshore parties, and prevented the repatriation of investments for one year. They also fixed the exchange rate of the ringgit to the U.S. dollar as 3.8:1.
A study by the Federal Reserve Bank of St. Louis said that the consensus of scholarship is that such controls “cannot indefinitely sustain inconsistent policies, and their effectiveness tends to erode over time as consumers and firms become better at evading the controls.”
One of the key purposes of such controls, after all, is to create two distinct interest rates: a high one for foreigners and a lower one for the local folk. This creates a risk-free “carry trade” for anyone clever enough to work around the restraints. And, given the usual combination of greed and ingenuity, somebody will.
The Malaysian moves, though draconian, were temporary both in intent and in the event. The controls began to be lifted in February 1999, when a system of taxation for repatriation replaced the original flat prohibition.
All this comes to mind because it came up at the webinar concerning the present and near future of the Malaysian derivatives scene. Matt Simon, of the TABB Group, served as presenter. The material he presented had first appeared in a recent TABB publication, Malaysian Derivatives Trading: Growth and Opportunities Abroad.
Bursa Malaysia Derivatives is, as you might guess, the derivatives subsidiary of Bursa Malaysia, one of the largest exchanges in Asia. In September 2009, the CME Group entered into a strategic alliance with BMD. What this means is that CME made a sizeable investment and that CME’s Globex has since become the international platform for BMD contracts, especially futures on crude palm oil (FCPO). These are the most successful and (no pun intended here) the most liquid crude palm oil contracts in the world.
Palm oil is a common cooking ingredient in much of the world, and is also used in soaps, lubricants, and fuels. Indeed, the Malaysian government has been doing what it can to encourage the use of palm oil as a biofuel stock.
BMD has plans for new products, including almost immediately a listing for options in crude palm oil futures. These OCPOs should begin trading July 16th.
Stigma and Optimism
After his own presentation, Simon introduced Azila Abdul Aziz, executive director of dealing, Kenanga Deutsche Futures, a joint venture between Kenanga Holdings and Deutsche Bank AG. In was in Simon’s exchange with Aziz that the issue of capital controls came to the fore. Assume that a foreign investor considers Malaysia a promising place to invest. Will this investor be confident that if he does so he’ll be in a position to repatriate at his own choosing?
Aziz clearly was of the opinion that the less said about the late 1990s unpleasantness, the better. Ever since then, she said, “the government has worked very hard to clear the stigma against Malaysia” that the cap controls had created. The regulators in place “promote open participation and ease of entry.”
She was happier talking about the U.S .Commodity Futures Trading Commission. At present, and despite the role of the CME Group, U.S. investors who want to trade in Malaysian derivatives must route their trades through an offshore institution, typically in London. But both Simon and Aziz expressed an expectation that the CFTC will act soon to make this unnecessary. “In the brokerage community we are very optimistic about it,”