It is usually the case that when a financial regulator introduces new rules or guidelines that it will make a big song and dance about the news, heralding whatever is being introduced as a 'new dawn in the development of the financial market'. You do not expect the regulators to be so modest that they make no public announcement whatsoever.
That, however, seems to be the approach of the Bank of Thailand (BOT) when it comes to publicizing the development of the country's credit derivatives market. We would not have known that commercial banks are now allowed to engage in credit default swap (CDS) transactions had one FinanceAsia reader not recently forwarded us the memo sent out by the central bank to the banks.
In the memo, the BOT says that with effect from May 2, credit default swaps are now allowed as part of its aim to "support the continuous development in the financial market and provide commercial banks with more risk management alternatives." The banks are allowed to conduct in CDS either as seller or purchaser with other financial institutions and can also sell them to non-financial customers with exposure to a particular asset.
There are certain criteria that parties must meet in order to do transactions; purchasers of a CDS must, for example, maintain a capital fund capable of absorbing the credit risk of the underlying asset. In addition, any transactions involving foreign institutions - including the Thai branches of foreign institutions - must be denominated in foreign currencies.
The underlying credit that the CDS is selling protection on must also be rated, in accordance with the Securities and Exchange Commission requirement that all debt instruments issued in the local market must have a rating by either TRIS or Fitch.
The CDS guidelines follow on from the BOT's decision in June 2002 to allow banks to sell credit-linked notes to financial institutions. It would be fair to say that the BOT is proceeding cautiously when it comes to credit derivative products.
"The BOT has brought in the CDS legislation to allow commercial banks and their customers to hedge their risk," explains Pises Sethsathira, a partner with Allen & Overy in Bangkok. "This is part of a step-by-step plan by the BOT to introduce credit derivative products into the market: we saw the introduction of credit-linked notes last year. The BOT is responding to demand from commercial banks that need these instruments. At the moment this is limited to certain instruments like CLNs and CDS and not products like total return swaps, which involve the total exchange of risk between two parties. That might be considered a stage too far at the current time."
Despite the lack of fanfare about the guidelines, Sethsathira is positive about the potential for the CDS market in Thailand. " I do think it has a lot of potential, especially because of the foreign banks," he says. "They have been very keen to enter into these transactions and obviously they have a lot of experience from their CDS activities in other markets. It is one of the reasons the BOT is allowing CDS transactions, in order to follow international trends. Our firm has been contacted by several foreign banks about doing CDS deals. As they seek to build up their businesses in Thailand again, products like CDS will be important in helping them to manage their credit risk."
One investment banker at a foreign bank's Bangkok office also welcomed the introduction of CDS, but was not overly optimistic about seeing significant volumes in the short-term.
"It is good to see that the BOT is more positive on credit derivatives than it used to be but I honestly don't expect to see the CDS market grow much at this time," the banker says. "CLNs are easy to do because they are a funded product, but as a bank we would have reservations about writing CDS. Local banks do not have great credit ratings so you would be very circumspect about guaranteeing a worse credit. We have had some requests from local banks but we have not yet shown a CDS price to them. We will be more willing to get involved when we see a real improvement on the ratings side."