Business Times

Derivatives? Fine but do it properly with ethics
Point of View

By Upul Arunajith

Recently Sri Lanka’s Securities and Exchange Commission (SEC) organized a regional derivatives conference. I see this as a step in the right direction fulfilling a long felt need for the country to move forward.

Inovation
Given our educated work force, and the strategic location in the outset we should strive to make Sri Lanka a financial hub among the SAARC member nations. We have the suitable conditions to make it happen. The future economy is all about innovation. A departure from our age old thinking and cookie cutter approach is a pre-requisite to the successful implementation of derivatives.

The end of war does not necessarily guarantee the success or the viability of this proposition. While this would create a suitable condition for international players to take somewhat of an optimistic look at Sri Lankan capital markets, there remains many deficiencies in our capital market that would shun the international investment leaders.

Foreign investors
Despite all the media hype given to sensational investment guru, Jim Roger’s recent visit, that would most likely remain a mere visit! Sri Lanka, in the past has had many such visits from a cross section of industry leaders. Regrettably, they did not progress into any tangible business ventures. Recently we had some patriotic Sri Lankan expatriats with access to investment dollars and novel ideas to propel the post war Sri Lanka to greater heights but to their utter frustration all what they saw was the system asking them to give all their money for “development” but no concrete plan for “such development” discussed or when querried no satisfactory answers provided by the panel. These are inherrent systemic problems in our country.

The entire world knows that. Unless we re-invent ourselves and rebrand Sri Lanka and come out with a clean slate there will be the vultures out there who will devour our small capital markets when we introduce derivatives. This we saw first-hand with the Ceylon Petroleum Corporation (CPC) crude oil hedging project when the CPC was given a one-sided derivative strategy that was heavily skewed towards the banks.

Financial crisis
Derivatives in the past has been used with various degrees of success. There are the success stories and then there are the horror stories. The recent financial crisis that had a domino effect in the global financial market is due misuse of derivatives. In particular these were the over leveraged Credit Default Swaps (CDS) that the sellers/buyer failed to track and properly manage the exposures. Orange county, once a rich county in sunny California went bankrupt with the misuse of derivatives.

Sri Lanka with an annual GDP approximately of $40 billion must be extremely careful when trying to dabble in these derivatives instruments. One wrong deal will wipe out the entire market as in the case of the Barrings Bank or the BT Bank. Derivatives are an integral part of any vibrant capital market and I am a strong advocate of the proposition to introduce derivatives, but must approached in increments.

Product mix
Sri Lanka is a small player yet primitive in its capital markets though we have a stock exchange which is almost 150 years old. In order to get into derivatives and get international players to come to Sri Lanka we must have a proper product mix. We must have the derivatives contracts properly approved by the authorities.

There has to be the proper liquidity in the market. There must be proper trading ethics and proper checks and balances in place for the international players to have confidence in our proposed derivatives operations. Without focusing on the preliminaries, if we were to take the plunge in a haphazard manner we will see a repeat performance of the CPC crude oil hedging fiasco.

(The writer is a derivation market specialist based in Canada and can be reached at uarunajith@can.rogers)

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