Hungry for derivatives - JPS finance chief, NCB banker pitch for a deeper foreign exchange market
Jamaica Public Service Company, JPS, wants the regulatory authorities to pursue a wider range of hedging mechanisms beyond the options currently available, according to the power utility’s Chief Financial Officer, Vernon Douglas.
The energy official also knocked the central bank, while speaking on its home turf, for not being proactive in the development of a currency derivatives market, saying the “role of the Bank of Jamaica is too limited”.
Speaking Wednesday at the Foreign Exchange Market Development Symposium, staged by the Ministry of Finance at the Bank of Jamaica in Kingston, Douglas asserted: “Something is wrong and we need to face it. The issue we have is the level of volatility taking place. To what extent and over what period of time is this acceptable?”
He noted that as Jamaica moves towards the inflation-targeting regime to deliver low, stable and predictable inflation, a clearer foreign exchange policy on intervention is needed to address some of these risks.
JPS, which as operator of the national electricity grid faces a large foreign exchange bill to pay for the fuel it purchases for its power plants, sees the need for comprehensive market development in forwards, futures, options, cross-currency swaps.
“We have to have that, and we have to have it fast. The BOJ is thinking about them now, but having implemented inflation targeting, they have to move fast,” Douglas said.
JPS says on its website that it needs approximately 20,000 barrels of oil each day. Its fuel bill is a major component of its cost of sales, which amounted to US$619.5 million in 2018.
Douglas’ presentation followed that of Peter Higgins, assistant general manager of foreign exchange trading at National Commercial Bank, who, citing central bank data collated between September 2018 and June 2019, said there were about 80 forward contracts valued at some US$400 million in that period.
Comparatively, he said, foreign currency trades are estimated at US$10 billion annually.
Forward contracts provide a guarantee of supply, he said, but the market is beset with challenges, among them: large corporations and government agencies are not interested, believing that if they might lose funds; pricing for contracts is supposed to be based on interest differentials, but most dealers will add a premium because they believe the market is not liquid enough and they may have to source forex when required; and no standard master agreement, which means agreements for forward contracts vary from bank to bank, sometimes requiring expensive legal advice to interpret.
The banker added that there was also a need for the development and structuring of more hedging products.
Douglas said he agreed with Higgins that the BOJ should participate in offering forward contracts. He cited as problematic the existence of “cowboy premiums”, saying that in shopping around earlier for US$80 million, he noted that nobody could him tell the basis on which they were pricing the currency. “It was anybody’s guess,” he said.
He also urged the BOJ to consider the experiences of Thailand, where that government, which also transitioned to an inflation-targeting regime, has come up with a strategy to address volatility in the foreign exchange market.
“The question is, what is considered to be too volatile?” said Douglas. “I think what I am hearing from my fellow corporate is that they think a movement between $131 and $138 in 15 days is too volatile, especially with the lack of applicable financial instruments,” he said.