The State Securities Commission is pushing ahead with its efforts to build up the country’s fledgling derivatives market, despite concerns about possible negative impacts on the domestic economy.

The market watchdog (SSC) discussed its plans last Thursday in a Hanoi-based conference, attended by Luxembourg’s development co-operation agency Lux-Development.

At the conference the SCC said derivatives were risky by nature and it wanted “strict regulations” from the start to minimise possible damage to the local market.

According to the plan outlined by the commission, all derivatives instruments will be traded on government exchanges. Over-the-counter derivatives, which are practically a direct negotiation contract between parties, will be introduced at a later date.

To begin with, the underlying assets for derivatives will be the stock index, and the derivatives will be futures, theoretically the derivatives of lowest risk.

Given that Vietnam’s securities market is at its very early stages of development, onshore bonds were actually “illiquid” because of small trading volume.

In terms of settlement methods for derivatives, the SSC preferred cash settlement thanks to its simplicity. Physical delivery, meanwhile, would likely generate investors’ manipulative acts, which was currently “very popular in the local market,” stated the commission.

Moreover, physical delivery would lead to problems when it came to ratios of foreign ownership, currently capped at 49 per cent.

Therefore, stock index futures settled by cash will be the first derivative developed by the market watchdog.

“We will go step by step from the simple [type of derivative] to the complicated,” said Ta Thanh Binh, deputy head of the SSC’s Market Development Department.

But a bigger problem is the absence of infrastructure to deal with derivatives.

While derivatives investors usually use high leverage, meaning they borrow a great deal of money from brokerage firms via margin trading accounts, authorities in Vietnam are only this year beginning to build a legal framework for leverage and margin trading.

The current technologies of local exchanges and clearing house are considered insufficient to handle derivatives transactions.

In fact, demand for derivatives in Vietnam is very low. The nation has almost no derivatives at the moment, according to Lux-Development report.

Investors have only low awareness of derivatives as an instrument to hedge risks, despite the nation’s market being very vulnerable to global risks. Otherwise, local investors are all interested in speculation and have only basic knowledge of investment tools.

Dan Svensson, director for Dragon Capital Markets, said the the financial risk culture [in Vietnam] was still in its infancy. He said Vietnam needed a minimum 15 years to build up its derivatives market from the current base.

The SSC’s plan is part of a 20-year market development project. The comission expects to incorporate the “most basic issues” related to derivatives in the nation’s securities law in 2014.

Vietnam Investment Review - April 19, 2011