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Monday 20 December 2004 (08 Dhul Qa`dah 1425) c
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Muhammad Aftab, Arab News c
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ISLAMABAD, 20 December 2004 ² ×akistani banks have launched financial derivatives business in a market that is
expanding and introducing new products and financing modes. The State Bank of ×akistan (SB×) has allowed commercial
banks and development finance institutions (DFIs) to start financial derivatives business (FDB), for which it has just
announced the financial derivatives business regulations (FDBR) for the first time.

The regulatory framework for the FDB lays down the essential risk management standards and operational arrangements for
this business. The regulations revolve round the fact that FDB involves a high level of inherent risks. The SB× said, ³ now
banks and DFIs that want to undertake derivatives transactions will be required to get approval from SB× to work as
authorized derivatives dealer (ADD) or non-market maker financial institution (NMI) status.´ They will be allowed to undertake
derivative business within the FDBR framework. Non-ADDs or non-NMIs will have to obtain specific approval from SB× for
such transactions.

SB× had, previously, selectively allowed over the counter (OTî) financial derivatives in ×akistan, under which banks are
permitted to undertake interest rate swaps (IRS), foreign currency (FX) options and forward rate agreements (FRA) with
SB× s approval.

However, such prior approval will no longer be required for the IRS, FX Operations and FRAs, once SB× grants a bank or a
DFI is granted an ADD or NMI status. These moves will bring ×akistani financial markets at part with advanced countries in
providing a variety of financial products.

The FDB initiatives has been unveiled as OTî financial derivatives have globally seen a major growth in the last 10 years,
c because these are a good mode to hedge risks and make profit. FDB and the forex market in ×akistan are being developed
simultaneously to establish a mechanism to hedge risks to the stakeholders.

ADDs and NMIs will be allowed to undertake derivatives transactions in forex under the guidelines laid down by SB×. FX
options dealings are allowed in G-7 currencies only. No entity will offer any ×akistan rupee/US dollar, or other currency
options unless SB× specifically allows. There is no restriction on the minimum or maximum size of the notional principal
amounts of forex options. The maximum tenor of the option may not exceed one year, but for longer tenors, separate
approval will be required from the relevant approving authority. All forex options will be covered by ADD or NMI on a back-to-
back basis and financial institutions will not be allowed to carry any market risk in this connection. All exposure should be
covered on a back-to-back basis from a foreign bank or their foreign branches. In order to cover long or short FX position
ADDs may purchase FX options with a maximum maturity of six months. The banks may enter into packaged products,
involving cost reduction structures for customers, provided the structure does not involve customers receiving a premium.

The banks are allowed to quote option premium in US dollars or in the currency of the underlying option and can remit abroad
the premium required to cover the transaction on a back-to-back basis. Hedges entered against a particular exposure for a
given time period should not exceed the total principal or duration of the underlying exposure. Option contracts can be settled
on maturity by delivery on spot or by net cash settlement. Option can be booked against all existing FX exposures arising out
of trade transactions and loan exposures.

In cases where exposures are against ×
R, the customer can either run dollar/rupee exposure or cover this separately in the
interbank forward market. Interest rates swaps will be allowed in fixed to floating or floating to floating modes of exchanges of
interest rates. This creation of a formal derivatives market will enormously help businesses that need to hedge interest rate
and currency risks, speed up transactions, standardize contracts, and provide banks with a framework to expand the range of
their products.

S×B has provided two safety features in derivatives: Back-to-back coverage, and the facility to be used only against existing
risk² and not to take speculative positions. The borrowers now have more instruments to choose from, for their risk-related
credits. As a significant expansion and modernization of industry is currently going on with increasing quantities of imported
plant and machinery, the volume of business facing these risks, has increased.

The new derivatives cater to this need. More companies are now asking banks for interest rate swaps for floating loans.
Banks will, in future, provide fixed rates and get floating rates. At the moment FX options are also being sought for hedging
 against exposure to euros, yen, US dollar and other currencies.

New products are being launched as the overall financial market is growing. The total bank deposits in ×akistan are an
equivalent of $33 billion. In addition, the state-operated National Savings Schemes (NSS) that provide far higher profits to
depositors and are an easy way for the government to raise non-inflationary funds, now total around the equivalent of $15
billion. The two together form 20 percent of the GD×.
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