fter years of stagnation, Sri Lanka for the first time will open up its derivatives market particularly for foreign exchange, before the end of this year, according to a top official of the Sri Lanka Forex Association (SLFA).

The move will see the introduction of variety of derivative instruments for foreign exchange market participants, importers and exporters to safeguard themselves from the risks arising from forex fluctuations.

“Within this year, as the Sri Lanka forex association, we are planning to get into the derivative market,” said SLFA President P.A. Lionel.

Both Bloomberg and Reuters will provide Sri Lanka with the necessary platforms and the infrastructure to start some of these derivate products.

The only derivate instrument available in Sri Lanka to hedge the traders’ foreign exchange risks are ‘Forward Rate Agreements’ (FRA) offered by the banks.
According to Lionel, Sri Lanka’s derivatives market did not take off mainly due to restrictive rules by the regulators, the lack of dialogue between the stakeholders and the 30-year old conflict.

“We have started a campaign on this. We have requested the Central Bank also to be lenient on the rules and they have released a revised set of guidelines.
 So, from the regulator’s side, risk management side and the banks’ side – all are now having a single forum. After the war ended,  we accelerated our effort (on developing the market),” he remarked.

According to forex dealers, the traditional forex risk hedging mechanism, FRA is a plain vanilla product where the trader must agree to buy or sell foreign currency at a given forward foreign exchange rate on a future date.

While this provides certainty to the importer and the exporter of their payable and the receivable, the instrument does not provide flexibility for the trader to benefit from the actual movement of the foreign exchange rate.

Derivative instruments are relatively new to the Sri Lankan market though they are very popular financial instruments in developed financial markets.

Derivative instruments range from basic FRAs to futures to options to swaps to swaption. While most of these instruments can be purchased as over-the –counter products, they can also be tailored based on the different requirements of counter parties/traders.

Derivative instruments are primarily designed to hedge foreign exchange risk, interest rate risk, commodity price risk etc.

Derivatives are widely used by financial institutions, corporate, hedge funds and individuals, to hedge their exposure to minimize adverse financial consequences on their asset portfolios caused by market factor volatilities