NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM ***************************** BACHELOR’S THESIS IN FINANCE STRENGTHENING THE DEVELOPMENT OF FINANCIAL DERIVATIVES MARKET IN VIETNAM Student’s name : … Hanoi, TABLE OF CONTENTS NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM CHAPTER CONCLUSION 51 ABSTRACT Since the global crisis in 2007-2008, economists have argued about reasons of the economic downturn, including the usage of financial derivatives The using of financial derivatives is controversial even in developed countries such as the US or Europe Therefore, it is easy to understand that applying derivatives instrument, especially financial derivatives is facing many in emerging countries such as Vietnam However, financial derivatives already have a long development process in the world and they are proved to be effective and beneficial for financial institutions, investors and the economy as a whole Therefore, the question is not about applying the instruments or not but how to apply and reduce the risk coming along Having a thorough understanding about financial derivatives is a compulsory stage which will build up the development of these instruments in the financial market of Vietnam The research has three main parts, including: - Theoretical background on financial derivatives market - Current situation of financial derivatives market in Vietnam - Recommendations for the development of financial derivatives market in Vietnam ABBREVIATION ACB A Chau Commercial Bank BIDV Bank of Investment and Development of Vietnam SBV State Bank of Vietnam VND Vietnam Dong LIST OF TABLES NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM CHAPTER CONCLUSION 51 LIST OF CHART NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM CHAPTER CONCLUSION 51 CHAPTER 1: INTRODUCTION 1.1 RATIONALE Strong financial system is a compulsory factor in order for a country to achieve sustainably economic development In the case of Hong Kong and Singapore, stable financial system is the key to push the economy and protect it from fluctuations of global events In Vietnam, the financial system is still in weak form Uncertainties of the economy such as changes of interest rates, exchange rates, gold prices…can easily affect our banking system and then, manufacturers Under pressure of improving and modernizing financial activities, developing a derivatives market is in discussion for many times, especially after the global financial crisis in 2007 However, until now, Vietnam is still not having an official derivatives market and lacking many supporting conditionsfactors to build up this market Initially, the research was aimed at understanding derivatives instruments, its their role in the financial and economic system However, because of time constraint, this study focuses only on financial derivatives instruments They are now already established as products of some commercial banks in Vietnam Nonetheless, the understanding of organizations and individuals about their characteristics and usefulness is still limited and the application is still having shortcomings is problematic The research will identify characteristics and usefulness of financial derivatives instruments which are currently in use in Vietnam market Moreover, the situation of derivatives trading in Vietnam also is analyzed Finally, the recommendations will be concluded with some references from other markets such as China and Korea 1.2 RESEARCH OBJECTIVES The study aims at adding one useful reference for further study and research about the market of financial derivatives market in Vietnam There are three main objectives for the research, including as below: The research will have to provide readers a thorough view about the bellowed aspects: - Providing Fundamental Basic but full understandings of the financial derivatives market and its related contents - Analyzing the Ccurrent situation of the development of the financial derivatives market in Vietnam - Suggesting rRecommendations for the strong and sustainable development of Vietnam’s financial derivatives market 1.3 RESEARCH METHODOLOGY The study mostly uses the secondary sources of data and information Tha is to say That means the research contains references from some published books, articles, and news… Moreover, there are also information and data coming from Vietnam commercial banks’ financial statements The data is useful to analysis the current situation of the financial derivatives market in Vietnam 1.4 SCOPE OF RESEARCH The research focuses on the financial derivatives market in Vietnam Nonetheless, because of time constraints, it can not provide a detailed and deep analysis about all the aspects involving The research targets Vietnam commercial banks to mostly investigate the current situation of the market since it is not difficult to collect the data of these banks; and it provides the quantitative evidences for the research CHAPTER 2: THEORETICAL BACKGROUND ON FINANCIAL DERIVATIVES MARKET 2.1 Financial Derivatives 2.1.1Definition A derivative is a contract with seller and buyer The value of each contract depends on the price of other assets that we call “underlying assets” which are subject to changing market prices Unlike debt instruments, no principal amount is advanced to be repaid and no investment income accrues Derivatives are also totally different from securities They are financial instruments that are mainly used to protect against and manage risks, and very often also serve arbitrage or investment purposes, providing various advantages compared to securities Moreover, the time between entering into the contract and the ultimate fulfillment or termination of the contract, can be very long- in some cases more than ten years While Whereas, transactions of securities are fulfilled within a few days Derivatives come in many varieties and can be differentiated by how they are traded, the underlying they refer to, and the product type: - Type of derivative and market place: Derivatives contracts could be traded on the counter (OTC) with mostly individually customized contracts or on exchange with standardized contracts - - Type of underlying assets: Underlying assets include financial assets and commodity asset Respectively with each kind of underlying assets, there are financial derivatives and commodity derivatives - Type of products: The four main types are forwards, futures, options and swaps Financial derivatives are financial instruments that are linked to a specific financial instrument or indicator or commodity price such as stock price, foreign currencies, and interest rate, gold prices… through which specific financial risks can be traded in financial markets in their own right Because of the research scope, the study is only focused on financial derivatives, but not commodity derivatives 2.1.2 Uses and users of financial derivatives Financial derivatives can be used with different objectives: Risk management or Hedging: derivatives are a tool for companies and other uses to reduce risks Financial derivatives help to eliminate uncertainty by exchanging market risks, commonly known as hedging Firms and financial institutions use financial derivatives to protect themselves against changes in exchange rates, interest rates, securities prices…These users would be called hedgers Investment: Derivatives can serve as investment vehicles Derivatives are an alternative for investors to investing directly in assets without buying and holding the asset itself 10 Reduced transaction costs: sometimes derivatives provide a lower cost way to effect a particular financial transaction The total transaction cost of buying a derivatives contract on a major European stock index is about 60 percent lower than that of buying a portfolio of underlying assets Speculation: Derivatives also allow investors to take positions against the market if they expect the underlying asset to fall in value Typically, investors would enter into financial derivatives contract to sell an asset that they believe is overvalued, at a specified future point in time and to buy an asset that they believe is undervalued Such strategies reduce the risk of assets becoming excessively under- or overvalued Because financial derivatives are new in the investment world and it is not easy to understand the characteristics and strategy to use derivatives, these contracts are mainly designed for professional users Moreover, some financial constraints, for example: the cost or the floor value of a contract would explain for the fact that the lead the instruments are more appropriate for professional users 2.1.3Benefits and risks of financial derivatives 2.1.3.1 Benefits: Financial derivatives instruments are innovative and effective financial products which are proved to have many advantages, including: - Providinge risk protection with minimal upfront investment and capital consumption - Allowing investors to trade on future price expectations - Havinge very low total transaction costs compared to investing directly in the underlying assets - Allowing fast product innovation because new contracts can be introduced rapidly - Getting Can be tailored to the specific needs of any user 2.1.3.2 Risks: 45 Another remarkable outcome of SBV is that the authority has issued accounting guidelines for financial derivatives contracts and a system for reporting financial statements of financial institutions The move obviously contributes to the transparency of the market and motivates customers 3.4.1.2 Providers for financial derivatives instruments At this time, there are more and more financial institutions involving in providing financial derivatives instruments to the customers Most large commercial banks in Vietnam such as Agribank, BIDV, Techcombank, Vietinbank, Eximbank… have already listed these products in their business activities Moreover, there are involvement of other financial institutions and organizations from both inside and outside Vietnam The agreement with the World Trade Organization is also attracting more foreign banks to business in Vietnam, especially introduce new financial derivatives instruments to the young market Consequently, the fair competition of many suppliers will lead to a healthy derivatives market 3.4.1.3 Financial derivatives products in the market The first financial derivatives transaction in Vietnam market was traded between SBV and commercial banks After that, SBV allowed commercial banks and qualified financial institutions to bring financial derivatives instruments into their daily operations Throughout this process, new financial derivatives products has been designed and traded in the market Until now, there are all types of basic financial derivatives tools trading in Vietnam market including forwards, futures, swaps and options contracts 3.4.2 Existing issues in the development of financial derivatives market in Vietnam 3.4.2.1 Existing issues At a very young stage, Vietnam financial derivatives market can not avoid some shortcomings which are barriers for the market’s development Identifying the mistakes is as important as suggesting solutions The analysis below points out these shortcomings with the hope to improve them in the future: 46 There is limited number of financial derivatives products; only traditional instruments are being traded and no swaps contract for VND At this time, the financial derivatives market in Vietnam contains trading activities of all four traditional instruments However, there are more focusing on forwards and swaps That means the development of options is not the concern of financial institutions It can be explained by the complexity of options and the abandon of the State bank of Vietnam One critical issue is that the State Bank of Vietnam not allowing for commercial banks, except HSBC to applying swaps contracts for Vietnam Dong The restriction will decrease the demand for derivatives instruments and limit the benefits of the products as an effective hedging tool The lack of an official public exchange is also one reason that affects the development of financial derivatives market negatively Having a public exchange for derivatives instruments will increase the liquidity of the market and attract more interest from customers both individually and institutionally However, the market is still in need of a public exchange after more than 10 years of development That explains for the small-value transactions in the market and the not popular of the instruments for investors There is lacking of applying international standards in financial derivatives instruments Because of the lack of an official public exchange, all financial derivatives trading activities in the market are managed as on-the-counter exchange All transactions are tailor-made based on the discussion between commercial banks and their customers In this case, the gap in understanding of the two parties will lead to a transaction with many holes and shortcomings The cost for financial derivatives transactions is too high Therefore, the profits of commercial banks from derivatives activities are negligible In addition, it increases the expense of customers in demand of using financial derivatives instruments Therefore, it will obstruct the interest of customers towards derivatives products 47 The financial derivatives market does not attract attention from customers, especially organizational customers This means regulatory authorities and financial institutions including commercial banks need to invest more in educating the customers 3.4.2.2 Reasons of the issues - Incomplete legal framework: in fact, there is no legal document regulating the activities of all financial derivatives instruments in Vietnam at this time All documents in use to regulate the market are guideline documents only which can be adjusted quickly but lack of consistency and legitimacy A detailed legal framework is a compulsory factor to build up a strong market for any kind of products Therefore, SBV and other regulatory authorities need to give more concerns for this issue - Foreign exchange regulating system is not effective: the demand for exchanging foreign currencies is always increasing However, there are two markets for customers to their transactions There are official market and “black” market That means the foreign exchange regulating system in Vietnam is not effective and customers have choices since there is a gap between the exchange rates in the two markets Usually, the unofficial is more convenient for customers to come and the transactions Thereby, it is not adequate demand for commercial banks to include foreign exchange derivatives in their products - Arguable definitions of the financial derivatives market After more than ten years of applying derivatives instruments into the market, SBV, regulatory authorities and even researchers are still arguing about the definitions of the financial derivatives market and other terms - Lack of transparency: the financial markets in Vietnam is lacking of transparency since there is no requirement for stating details about trading activities regarding financial derivatives instruments - Lack of understanding about the instruments: financial derivatives are still vague terms with many investors and even financial institutions in Vietnam 48 Therefore, the trading activities of these instruments is not effective and active as expected - Lack of liquidity: the lacking of liquidity of the market reduces the incentives of investors to be involved in the financial derivatives market - High cost: the high cost to applying financial derivatives in banking activities is one of many reasons that reduce the concentration of commercial banks for the potential products Moreover, because commercial banks charge investors high fees to compensate the banks’ losses, it will make the investors less motivated to use financial derivatives 3.5 Recommendations for the development of financial derivatives market in Vietnam There are some positive s ignals that an exchange or OTC market is planned to established in 2014 It will be a strong support for the development of financial derivatives From now on to this time, SBV and other regulatory authorities need to affiliate with commercial banks to prepare the below fundamental factors: 3.5.1 Regulation about exchange rate limitations This regulation aims at managing the market so that it will be a fair playground for investors Since derivative products can be used in both risk-hedging and speculating, it will provide some “big” investors the opportunities to “beat” the market They can that by setting the too high or too low prices The action will make the fluctuation of exchange rates is unreasonable and cause troubles for other investors and the market itself Vietnam can apply options with conditions The conditions are the exchange rate limitations with floor and ceiling rates If the exchange rate is exceeded the ceiling rate or below the floor, the options are expired 3.5.2 Requirements about capital and collateral in trading financial derivatives market 49 After the collapse of Enron, economists have been discussing about the collateral requirements for derivatives contracts Derivatives contracts need collateral or deposit condition in order to motivate the investors follow the contracts Moreover, the bank should consider the capital capability of the investor before doing any transaction to decrease default risks in the system 3.5.3 Requirements about re- insurance in international markets The requirements ensure that the commercial bank will not have to face risk if the transaction is traded in international markets Vietnam commercial bank should only act as an intermediary between two partners, collecting fees from the domestic buyers and buy in the international market Moreover, Vietnam regulators and supervisors should apply the global standard contracts or forms in trading financial derivatives instruments The step will enhance the development of the market and reduce risks for the commercial banks 3.5.4 Open- markets for all financial institutions that are trading financial derivatives instruments SBV should open doors for all financial institutions that want to involve in trading the instruments The action will increase the competition in the market and strengthen the capability of these institutions However, finding the appropriate system to supervise these institutions should be considered first and need more investment in research 3.5.5 Open-markets for financial derivatives trading VND Having a derivatives instrument to hedge the risk of using VND is importantly necessary for Vietnam manufacturers and investors The State Bank of Vietnam should consider improving the mechanism of effectively using the VND-based derivative products instead of abandoning and limiting their trading 3.5.6 Requirements about financial statements 50 In order to improve transparency of the market, SBV should issue requirements and guideline documents for commercial banks to apply in their financial statements The financial statements should provide more information about financial derivatives –related- activities in these banks Moreover, the report should also contains some financial calculation to show the situation of the trading derivatives activities in the banks 3.5.7 Using an industry-standard transaction for derivatives trading Applying an international standard transaction such as the industry-standard International Swaps and Derivatives Association (ISDA) documents is a feasible solution for the development of financial derivative market in Vietnam The application will make the trading simpler for all parties involving Moreover, the international standard documents are helping investors avoiding unfair conditions in purchasing and using financial derivatives products 3.5.8 Improving the current accounting system The current accounting system is also needed to apply international standards in order to improve the transparency 3.5.9 Increasing the liquidity of the system As mentioned in the failure lesson of China, the liquidity of the financial market is the fundamental condition to develop financial derivatives instruments Unfortunately, the liquidity management in Vietnam market is always one biggest issue In order to reinforcement the market and develop financial derivatives products, there are many things need to to improve the liquidity of the whole system 3.5.10 Recruitment and Educating people One more critical factor that influences the development of the financial derivatives market is human resources Both regulatory authorities and commercial banks need to recruit right people who understand thoroughly characteristics of financial derivatives instruments and the derivatives market to manage the new and complex activities 51 Last but not least, policy makers should concern more on educating investors The customers need to know about the benefits of using derivatives and how to apply it effectively CHAPTER CONCLUSION 52 Financial derivatives and financial derivatives market are two new concepts in Vietnam Even in the world, there are many arguments about using the products The complex nature of derivatives instruments make them difficult for all participants involving, including regulatory authorities, financial institutions and end-users of the products However, understanding thoroughly about the instruments is essential since they are considered as very effective hedging and investing tools for their users In Vietnam, the market for financial derivatives instruments was established since 1997 However, the market has not been popular used as expected The situation is a result of many different reasons which will need many adjustments and solutions to improve The responsibility is put heavily under policy- makers’ shoulders and the State Bank of Vietnam as more specific They should keep in mind that development a strong financial market for derivatives product will contribute greatly for a more sustainable economy There are many lessons in other countries which can be used in building the market system in Vietnam Also, there are experiences of Vietnam itself in applying financial derivatives products Learning by other nations’ lessons and our own experiences is a good way to improve the current situation of financial derivatives market in Vietnam The study is conducted in order to give more information about financial derivatives market and strengthen the trading activities of derivatives instruments in Vietnam Hopefully, the research is providing useful knowledge about derivatives concepts and raising appropriate solutions for the development of financial derivatives market in Vietnam However, because of the limited knowledge of the writer and the time constraints, there are many issues that were not mentioned in this paper such as the opinion of investors was not analyzed That should be a direction for the improvement of the research REFERENCES Vietnamese: Cơng trình nghiên cứu khoa học 2011, Phát triển thị trường tài phái sinh nhằm hồn thiện hệ thống tài góp phần ổn định kinh tế vĩ mô Việt Nam Đại học Kinh tế Quốc dân Phan Thị Thu Hà (2007) Ngân hàng thương mại Nhà xuất Đại học Kinh tế quốc dân, Hà Nội Tô Ngọc Hưng (1993) Tiền tệ, Ngân hàng Thị trường Tài Nhà xuất Khoa học kỹ thuật, Hà Nội English: Deutsche Borse Group (2010) The Global Derivatives Market-An Introduction White Paper Oliver Fratzscher (2006) Chapter for Asian Financial Market Development The World Bank Shamsher M and Taufiq H (2007) Asian Derivative Markets: Research Issues Magazine - Brent McClintock (1996) International Financial Instability and the Financial Derivatives Market, Journal of Economic Issues - Shamsher M and Taufiq H (2007) Asian Derivative Markets: Research Issues, The International Journal of Banking and Finance, Vol Website: - Websites of commercial banks in Vietnam, such as of HSBC, ACB, BIDV, Sacombank… - Website of the State Bank of Vietnam COMMENTS INTERSHIP REPORT ASSESSMENT Signature of supervisor ... support the development of financial derivatives in Vietnam 3.1.2 Development of financial derivatives market in Vietnam Financial derivatives market in Vietnam has its first development since 1997... stock indexes Therefore, the State Bank of Vietnam is now in charged of regulating the financial derivatives market The State Bank of Vietnam regulates the financial derivatives market by announcing... other financial institutions such as Vietnam Petrolimex Financial Company, Vietnam Energy Financial Company… in Vietnam which are also involving in the financial derivatives market They act as the