Financial market development

Financial Market Development

Objective of Financial Market Development

Financial market is a crucial component in the economic system. It is the engine that drives the economy, being a platform where surplus units meet deficit units and negotiate various kinds of financial agreement. The objective of financial market development is, therefore, to enhance the capability of the financial market to act efficiently as an intermediary. An efficient financial market is one with proper depth and breadth, that is on the supply side, there is a wide range of financial instruments, offering choices of issuers, credit risks, and etc. to satisfy all classes of asset demand. On the demand side, there has to be sizable investment demand from various types of investors, with different risk-return appetites. Also, a good diversity among issuers and investors usually brings about a good mix of market views, leading to an active exchange of financial assets. A highly liquid financial market as such is able to accommodate large and varied issuance of financial instruments with minimum price effect. Here, financial instruments can be quickly exchanged at reasonable cost. Efficient clearing and settlement system is a key supporting factor that helps lower transaction cost.

A liquid financial market also enables central bank to efficiently conduct its day-to-day operations to attain its interest rate target.

Structure of Thai Financial Markets

Financial market consists of (1) foreign exchange market (2) money market (3) debt market and (4) derivatives market. These markets are highly related to one another.

1. Foreign exchange market is basically an Over the Counter (OTC) market in which commercial banks who have FX licenses from the BOT are the major players.

Currently, FX businesses in Thailand are under the Exchange Control Act B.E. 2485 (1942) and Ministerial Regulation No. 13 B.E. 2497 (1954). These laws set out the principles of controls under which Notifications of the Ministry of Finance and Notices of the Competent Officer were issued.

Basically, there are four main types of FX transactions, i.e., spot, outright forward, FX swap, and FX derivatives. Uses of FX swap is widely popular and related to other money market instruments such as interbank and repo, as all are short-term instruments.

Since 2 July 1997, Thailand has adopted a managed float exchange rate system where Thai baht exchange rate is primarily determined by demand and supply in the FX market.

2. Money market is a market for short-term borrowing and lending, within 1 year horizon, mainly for the purpose of liquidity management. Most of the money market transactions are unsecured interbank borrowing (clean loan), trading of short-term papers (such as Treasury Bills, BOT securities, Promissory Note, and Bills of Exchange), and Repurchase Agreement or Repo transactions. There are two types of Repo transactions; one that is between the BOT and its PDs called “Bilateral Repo”, and one between market participants called “Private Repo”. In 2004, the BOT introduced to the market a short-term interbank borrowing reference yield curve called “BIBOR” (Bangkok Interbank Offered Rates). This BIBOR curve is meant to be a reference for money market transactions as well as a reference floating rate for floating rate paper. Besides commercial banks, major players in money market include financial institutions, large corporates, and large state owned enterprises.

3. Debt market is a market for trading debt instruments. The underlying debt instruments are longer than 1 year.

Bond or debt issuers offer their new debt issuance in the primary market while the resale of the debt instruments will be done in the secondary market.

Issuers of debt securities can be public and private sector in either local currency or foreign currency. Features of debt range from a fixed rate bond, a floating rate bond and index-linked bond or an inflation-linked bond.

Compared with other markets, players in the debt market are relatively diverse, ranging from financial institutions, large entities to corporates, and individuals (retail investors). Moreover, in recent years, the government and the BOT introduced saving bonds designated to retail investors and non-profit organizations. The subscription of the saving bonds through commercial banks’ branches ensures better access and wider distribution to the public.

4. Derivatives market is a market for trading complex financial instruments, the value of which is derived from value of underlying assets. The underlying assets could be a certain type of financial instruments (for example, bond or equity), or a certain type of commodities, and so on, as agreed to each other. Financial derivatives is generally used as a tool to hedge or manage a certain type of risks, namely, interest rate risk, exchange rate risk, price risk of financial products or commodities. In general, derivatives can be traded in forms of futures contract or options contract.

In Thailand, Thailand Futures Exchange (TFEX), a subsidiary of the Stock Exchange of Thailand, was set up in 2004 to serve as an exchange for the trading of derivatives as governed by the Derivatives Act B.E. 2546 (2003). TFEX has launched SET 50 Index futures in 2006, and SET 50 Index option in October 2007 respectively. Further information about plans for forthcoming futures and options products can be found at http://www.tfex.co.th

As for agricultural products derivatives, the Agricultural Futures Exchange of Thailand (AFET) was established, under the provisions of the Agricultural Futures Trading Act B.E. 2542 (1999), to run the exclusive agricultural futures exchange in Thailand regulated by the Agricultural Futures Trading Commission. For more information, please see http://www.afet.or.th.

Meanwhile, investors in the Thai bond market may hedge their interest rate exposure by entering into an Interest Rate Swap agreement (IRS) to change a fixed-rate exposure into a floating rate exposure, or vice versa.

Nevertheless, it should be noted that there is a limited scope of risk management instruments overall in the Thai financial market. This encumbers the deepening of the financial market as many market participants may choose to sideline if they cannot efficiently execute all financial transactions needed to achieve desired risk-return profile. To enhance the efficiency and raise the risk transfer capacity in the Thai financial market, authorities and market participants need to put joint effort to remove obstacles to the development of the market for risk management, starting from improving relevant rules and regulations and educating all market participants about derivatives product complexity, management, and regulations.

5. Equity market is another channel of long-term funding for business units. Holders of equity securities possess ownership in the business similar to the issuer of the securities. Return would be in a form of dividend and capital gain. The equity market in Thailand is governed by the Office of Securities and Exchange Commission and the Stock Exchange of Thailand. Further information can be found at http://www.sec.or.th and http://www.set.or.th

By comparison, the Money market and FX market are the top two performers in terms of transaction volume (calculated from 2002 – 2007)

Table : Share of financial markets from 2002 – 2007 as measured by transaction volume (%)

	2002	2003	2004	2005	2006	2007
FX Market	44.2	47.8	27.1	28.4	29.6	21.3
Money Market¹	48.2	40.6	57.4	59.4	59.9	61.7
Bond Market	3.9	4.1	5.7	5.9	5.5	12.1
Derivatives Market	data base compilation in process
Equity Market (SET & MAI)	3.7	7.5	9.8	6.2	5.1	4.9
Total	100	100	100	100	100	100

Sources: BOT, SET, and ThaiBMA

1/ Inclusive of Interbank Clean Loan, BOT Repo, Private Repo, Bilateral Repo (during 2004-2007), and Sell and Buy Back transactions

Thai Financial Market Development :

Progress in the development of the Thai financial market has continued at steady pace. The task involves several entities in the public and private sectors, namely, the Public Debt Management Office (PDMO), the Fiscal Policy Office (FPO), the Revenue Department, the Office of Securitities and Exchange Commission (SEC), the Office of Insurance Commission (OIC), the Stock Exchange of Thailand (SET), the Thai Bond Market Association (ThaiBMA), the Thai Bankers’ Association (TBA), the Foreign Banks’ Association (FBA), the Federation of Accounting Profession (FAP), the Bank of Thailand (BOT), as well as academics and market professionals. The above mentioned authorities have successfully tackled many issues to build up market infrastructures and facilitate further market advancement as follows: the clearing and settlement system, the ease of some supervisory regulations, encouraging new type of transaction as determined by market needs, improving tax system and accounting standards, the preparation of Codes of Conduct and market practices, the establishment of market associations to gather and distribute market data as well as standardize market practices. Other than these, there are regular arrangements of training courses and market dialogues to exchange views and ideas.

These are mostly accomplished under the master plan or strategic action plan governed by a certain committee and a certain working group. There are also consultations on specific issues in order to understand the problems and come up with better solutions. The development goal is to raise the Thai financial market efficiency and potential so that the market will be able to adapt to changes, and compete at a global level.

On 25 March 2008, the government took another step forward along the passage of the Thai capital market development by appointing the Thai Capital Market Development Supervisory Committee, chaired by the Minister of Finance. The Thai Capital Market Development Supervisory Committee will be in charge of the formulation of Capital Market Development Plan and the assignment of responsible body.