Dr. B.R.

Ambedkar University Delhi

School of Business, Public Policy & Social Entrepreneurship

MBA 2nd Year

Project Report on
Financial Derivatives of Malaysia
Submitted To:
Ms. Shivali Veen
Submitted By:
Parul Sharma
Enrollment No:
S223F0033
Introduction to Financial Derivatives
Derivatives are financial instruments that derive their value from the value of an underlying
physical commodity or financial asset. As a result, their value is derived from the price of the
underlying instrument — crude palm oil futures are based on the price of palm oil traded in the
commodities market, whereas stock index options are based on the Kuala Lumpur Composite
Index.

Derivative items have been around for a long time. There are records of forward contracts on
olive presses in Greece in the sixth century BC, and forward contracts on rice crops in 18th
century Japan. Equity options were first traded on the London Stock Exchange more than a
century ago.

However, the last 30 years have seen the most interesting rise in derivatives. In the early 1970s,
the usage of derivatives to limit financial risk skyrocketed in reaction to heightened risk in
financial markets caused by growing inflation, greater interest rate volatility, floating exchange
rates, and oil price shocks. In 1972, the Chicago Mercantile Exchange offered the first financial
derivatives product, a currency futures contract. In 1975, the Chicago Board of Trade offered the
first interest rate futures contract. The Chicago Board Options market, the world's first
formalised options market, established in 1973.

Financial derivatives based on stock index futures and interest rate futures are now extensively
available in several countries, including Malaysia, where stock index futures and interest rate
futures are well established. CFDs are leveraged derivatives products that track the price
movement of an underlying item. CFDs can be exchange traded or traded over-the-counter.
CFDs first appeared in the 1970s as a way for institutions to have equity exposure at a low cost.
They were first made available to individual clients in the United Kingdom in the late 1990s and
have since gained in popularity as a trading and hedging instrument in Australia, portions of
Europe and Asia, and Canada. London, Australia, and Europe are currently the world's three
largest CFD trading hubs. Depending on the location, some CFD providers also provide futures,
OTC spot FX options, and other products regarded more speculative and less regulated, such as
spread-betting and binary options.

Purpose of Derivatives:
Derivatives offer a way for market participants, such as commodity producers and financial
product traders, to avoid uncertainties or detrimental price changes in the underlying market. The
derivatives market puts buyers and sellers together in one area, where they agree on a price at
which commodities and financial instruments will change hands at specified future periods,
thereby limiting their exposure to price change. As a result, the major function of derivatives is
to manage price risk. Derivatives are an effective risk management tool for individuals who want
to limit their exposure to price changes in physical commodities or financial instruments.
Corporations, governments, financial institutions, and investors are all concerned about price risk
management. Futures, options, and other derivatives give financial market participants a way to
manage (i.e. hedge) this risk. Derivatives are also employed by professional traders, known as
speculators, who attempt to benefit by properly anticipating price movements. Though
sometimes vilified and misunderstood, the presence of speculators is critical to the market's
operation because it allows risk to be moved from those attempting to avoid it to those willing to
embrace it in the expectation of profit.

Types of Derivatives:
Derivatives are made out of existing debt and equity instruments, commodities, and even foreign
currencies. The types of derivatives that can be created are numerous, but they all fall into a few
categories: futures, forwards, swaps, options, and CFDs. However, in the next modules, we limit
ourselves to futures, options, and CFDs and do not discuss other types of derivative products.

i) Futures

Futures contracts are legally binding agreements signed on a derivatives exchange's trading floor
or through an electronic screen dealing system to purchase or sell something in the future.
That'something' could be gold or tin, cocoa or palm oil, a foreign currency, stock market indexes,
or interest rates. The commodity, quantity, quality, and time of delivery or cash settlement are all
specified in each contract. A futures contract's buyer and seller agree on a price today for a
product that will be delivered and paid for in the future. That is why it is referred to as a futures
contract. In most cases, the underlying security is not actually delivered. Instead, the contracts
are terminated by opposing transactions before the delivery date. A trader who has purchased a
futures contract will close out by selling the same quantity and type of contract that he
purchased. Delivery is not always achievable since contracts are framed in terms of a notional
(i.e. hypothetical) security rather than an actual security. When these contracts mature, the profit
or loss on the contract is computed as the difference between the agreed-upon price of the
underlying instrument and the price on the delivery date. The parties then settle their differences
in cash.

ii) Options:

An option is a contract between two parties in which one party (the buyer) has the right but not
the duty to buy or sell a defined asset from the other party (the seller) at a specified price and on
or before a stated date. As a result, the seller of the option has a contingent liability or obligation
that is activated if the buyer exercises that right. Options allow the option buyer to receive
insurance against risk in the underlying markets while still taking benefit of beneficial price
moves. They are distinct from futures contracts, which can be viewed of as a price-setting
mechanism, and options, which are a facility for price insurance that can be abandoned at a
relatively cheap cost if they are no longer required.
 iii) Contracts for difference:

A CFD's pricing is identical to that of its underlying asset. CFDs can generally be settled
physically or by cash, but CFDs offered in Malaysia must be cash settled. CFD margin
requirements are often lower than for stocks and equivalent to traditional futures trading (albeit
with lower minimum contract sizes), making CFDs a suitable trading and hedging tool. CFDs
allow traders and investors to hedge or invest in the price movements of many asset classes such
as stocks, indices, currencies, commodities, and interest rates. CFD positions can be opened on
the long or short side. Going long means entering a new market position by buying, whereas
going short means entering a new market position by selling.

Exchange-Traded vs Over-the-Counter Derivatives

Derivatives are classed based on the market in which they are traded. Markets are classified into
two types:

• Exchange-traded markets based on a formalised exchange

• OTC markets – those that exist outside of a structured exchange

iv) Exchange-Traded Derivatives

A derivatives exchange is a market area where derivatives are created and traded. The trading
environment is provided by the exchange. They act as communication hubs, centralising orders
from numerous buyers and sellers and transmitting price information. Futures and options are the
most frequent types of derivatives traded on an exchange. The characteristics of exchange-traded
derivatives are discussed further below.

 Trading Methods:

Derivatives trading on certain exchanges is based on an open outcry method on a physical

trading floor, where dealers transact trades using a combination of hand signals and speech.
However, with the introduction of computerised trading, most exchanges no longer utilise open
outcry trading, and all transactions are now handled electronically by computer. Bursa Malaysia
Derivatives Berhad employs a screen-based dealing system for all of its products, including the
FTSE Bursa Malaysia KLCI Futures, Option on FTSE Bursa Malaysia KLCI Futures, and
Option on FTSE Bursa Malaysia KLCI Futures. Crude Palm Oil Futures Contract, Crude Palm
Kernel Oil Futures Contract, USD Denominated RBD Palm Olein Futures, USD Denominated
Crude Palm Oil Futures Contract, Option on Ringgit Malaysia Denominated Crude Palm Oil
Futures, Tin Futures Contract, Gold Futures Contract, 3 month KLIBOR Futures Contract, 3-
Year MGS Futures Contract, 5-Year MGS Futures Contract, 10-Year MGS Futures and Single
Stock Futures.

 Contracts have standard features:

Contracts posted on exchanges are highly standardised in terms of the nature and maturity of the
'underlying' instrument, that is, the commodity or security on which the contract is based.
Because there is no need for conversations or debates to set the contract parameters — the only
thing left to negotiate is the price — this standardisation makes it simple for market players to
deal in these instruments. This, in turn, encourages higher liquidity because only a narrow range
of contracts are exchanged at any given moment. In the derivatives market, liquidity refers to a
contract's ability to be bought or sold quickly and easily with little or no affect on price.

 Secondary Trading:

Deals can also be easily unwound prior to the maturity date due to standardisation - participants
simply do a reverse transaction. For example, if a trader sells a number of crude palm oil futures
contracts, the position can be closed by purchasing the same number of contracts. This simplicity
of entering and exiting positions boosts liquidity even further.

 Clearing house:

Transactions are cleared through a dedicated clearing house affiliated with the exchange (but not
necessarily owned by it). The clearing house keeps track of open vacancies and registers
contracts. It streamlines and nets the gathering and distribution of margins and variation
gains/losses. It also oversees contract closure, whether by physical delivery or payment of
settlement amounts.

Over the Counter Derivatives:

Swaps, forward rate agreements, options on physical assets, and CFDs are the most regularly
traded over-the-counter (OTC) instruments. Compare the characteristics of exchange-traded
derivatives described above to those of the OTC markets listed below:

 Trading Method:

In general, OTC derivatives are exchanged bilaterally between both counterparties, as opposed to
exchange traded derivatives, which are traded on a controlled market. It should be noted,
however, that as part of the G20 OTC derivatives reform, there is a request to move OTC
derivative trade to an organised trading platform.

 Tailor-made Contracts:

Most OTC instruments do not have typical contracts in terms of amount, delivery date, or
duration until maturity. The counterparties negotiate the specifics of each transaction. This lack
of standardisation offers advantages in that the specifications can be tailored more precisely to
the demands of the parties.

 Little Secondary Trading:

Because each contract is unique, there is substantially less secondary trading of contracts and
much lower liquidity for most OTC products due to a lack of standardisation. It is also more
difficult to manage positions because contracts are typically not onsold to third parties. Contracts
can only be unwound before to maturity if the original counterparty agrees to a reverse
transaction, in which case the two offsetting gross contracts can be netted out. In the absence of
this, an offsetting transaction with another counterparty can be completed, but in most situations,
these two offsetting transactions will not be able to be netted.

No Clearing House:

For OTC derivatives, there is no centralised clearing house. As a result, OTC transactions carry a
higher credit risk because the counterparty is directly exposed, there is no deposit or margin
system, and there is no guarantee fund. Traders manage this risk by assessing the
creditworthiness of counterparties and establishing exposure limits. A broker is usually involved
in an OTC derivatives transaction. If a broker is involved in the transaction, the broker will
operate as an intermediary, aligning the needs of the buyer with the needs of the seller at a price
that is acceptable to both sides. Once agreed upon, the buyer and seller would settle the trade
directly with each other, with the broker normally charging only a commission during trade
settlement. In the absence of a broker, the buyer would seek out its own seller, communicate its
requirements, negotiate and agree on a price, and pay the sale directly with the seller. However,
as a result of the G20 OTC derivatives reform, there is a gradual drive to require OTC
derivatives to be cleared by a clearing house.

CFDs, while often traded over-the-counter, share several characteristics with exchange traded
derivatives. A CFD with an exchange traded security as its underlying would most likely have
identical, uniform characteristics and be actively traded.

Derivatives Markets in Malaysia

Malaysia's derivatives market began in July 1980, with the founding of the Kuala Lumpur
Commodity Exchange (KLCE). Crude Palm Oil Futures was the first futures contract traded on
KLCE. This contract is still being traded today. The KLCE has the infrastructure and ability to
allow for financial futures trading; however, establishing a subsidiary was required because
dealing in financial futures fell under distinct authorities.
As a result, on August 19, 1992, the KLCE established a wholly owned subsidiary called the
Kuala Lumpur Futures Market Sdn Bhd (KLFM), which was eventually renamed Malaysia
Monetary Exchange Bhd (MME) in mid-1995. The foundation and operation of MME as a
futures and options exchange corporation was approved by the Minister of Finance on 7 May
1996, and the three-month KLIBOR futures contract was introduced on 28 May 1996. In
preparation for the merger with the Malaysian Monetary Exchange, the KLCE was renamed the
Commodity and Monetary Exchange of Malaysia (COMMEX) on November 9, 1998. The
merger occurred on December 7, 1998. In the wake of increased volatility in the financial
markets, an International Monetary Fund visibility assessment for Bank Negara Malaysia in
1990 underlined the need for some type of financial risk management instrument. This research
resulted in a series of regulatory infrastructure modifications to allow for the introduction of
financial derivatives. As a result of these reforms, Malaysia's first financial derivatives exchange,
the Kuala Lumpur Options and Financial Futures Exchange (KLOFFE), was founded. On 11
December 1995, KLOFFE was licenced as a futures and options exchange, and stock index
futures and options were initially traded on 15 December 1995 and 1 December 2000,
respectively. KLOFFE and COMMEX combined on June 11, 2001, to become the Malaysia
Derivatives Exchange Berhad (MDEX), in accordance with the Securities Commission
Malaysia's Capital Market Masterplan. MDEX was renamed Bursa Malaysia Derivatives Berhad
on April 20, 2004.

Structure of the Malaysian Derivatives Market

Relevance of Derivatives to the Capital Market

The Malaysian government is dedicated to supporting the development of an efficient capital
market to support the country's financial system and economic development. Indeed, the
government's goal of obtaining developed-country status by 2020 necessitates a fast developing
capital market. The capital market helps the economic development process by mobilising long-
term cash from the investing public to fund public development programmes and private
projects. It also encourages private enterprise by making it easier to raise financing for corporate
investment and expansion. The development of the derivatives market is critical to the expansion
of Malaysia's capital market. Derivatives offer hedging and asset allocation services, allowing
investors to hold greater debt and equity positions and, as a result, improve the liquidity of the
underlying markets. Given the government's privatisation ambitions, which would entail a large-
scale mobilisation of cash, capital market liquidity is critical. An active derivatives market that
supplements the capital market will allow investors to hedge or alter their positions, making
them more inclined to take greater positions and therefore fueling Malaysia's economic
development.

Participants in the Malaysian Derivatives Market

The Malaysian derivatives market has a varied set of participants. They are as follows:

 The regulator — which authorises the market's existence

 The derivatives exchange — which provides trading facilities
 The clearing house — which clears and processes trades and assumes counterparty risk
 Intermediaries such as holders of a Capital Markets Services Licence (CMSL) who carry
on the business of dealing in derivatives, holders of a CMSL who carry on the business of
fund management,
  Holders of a CMSL who carry on the regulated activity of investment advice — who
advise and/or trade in the market Exchange traded derivatives are affected.

Participants in the Malaysian Derivatives Market

Regulator
Securities
Commission
Malaysia

Exchange Clearing House

Bursa Bursa Malaysia
Malaysia Derivatives
ClearingBerhad
Derivatives
Berhad Derivatives
Market

Users/Clients
Intermediaries
Hedgers,
Holders of
Speculators,
CMSL
Arbitrageurs

The Derivatives Exchange:

Bursa Malaysia Derivatives Berhad:

The Kuala Lumpur Commodity market (KLCE), Malaysia's first futures market, was founded in
July 1980 with only one commodity, crude palm oil futures. Other commodity futures contracts
soon followed, including a rubber futures contract in 1983 (dubbed "RSS 1 Rubber futures") and
a second rubber futures contract in 1986 (dubbed "SMR 20 Rubber futures"). Tin futures were
introduced in 1987, followed by cocoa futures in 1988, palm olein futures in 1990, and crude
palm kernel futures in 1992. The crude palm oil futures contract is currently operational. The
KLCE has the infrastructure and ability to allow for financial futures trading; however,
establishing a subsidiary was required because dealing in financial futures fell under distinct
authorities. As a result, on August 19, 1992, the KLCE created a fully owned subsidiary called
the Kuala Lumpur Futures Market Sdn Bhd (KLFM), which was later renamed Malaysia
Monetary Exchange (MME) in mid-1995 with the assistance of government authorities. The
Minister of Finance approved the foundation and operation of MME as a futures and options
exchange corporation on May 7, 1996, and the three-month KLIBOR Futures were introduced on
May 28, 1996. In preparation for the merger with the Malaysian Monetary Exchange (MME), the
KLCE was renamed the Commodity and Monetary Exchange (COMMEX) of Malaysia on
November 9. The merger occurred on December 7, 1998. Malaysia's first financial derivatives
market, the Kuala Lumpur Options and Financial Futures market (KLOFFE), was created in
December 1995. Stock index futures and options were originally traded on KLOFFE on
December 15, 1995, and December 1, 2000, respectively. KLOFFE and COMMEX combined on
June 11, 2001, to become the Malaysia Derivatives Exchange Berhad (MDEX), in accordance
with the Securities Commission Malaysia's Capital Market Masterplan.

Kuala Lumpur Stock Exchange Berhad (KLSE Berhad) took over as MDEX's holding company
on January 5, 2004. This was one of the consequences of the demutualisation process, which also
saw the Kuala Lumpur Stock Exchange (KLSE) transform from a company limited by guarantee
to a public company limited by shares. Following that, on 20 April 2004, KLSE Berhad and
MDEX were renamed Bursa Malaysia Berhad and Bursa Malaysia Derivatives Berhad,
respectively.

Membership in the Derivatives Exchange the following classes of Bursa Malaysia Derivatives
Exchange Berhad participants:

(a) Trading Participants

(b) Local Participants

(c) Associate Participants

(d) Any additional type of participantship that the derivatives exchange may develop from time
to time

Trading Participants:

Trading Participantship should be firms incorporated under the firms Act 2016 and established
particularly to carry out the regulated activity of dealing in derivatives, as well as companies
licenced under the Capital Markets and Services Act 2007 (CMSA). A Trading Participant's
minimum issued and paid-up capital is now RM5 million, and this amount is established by
Bursa Malaysia Derivatives Berhad in conjunction with the Securities Commission Malaysia.
The minimum financial requirements are subject to change. Clearing Participants and Non-
Clearing Participants are the two types of trading participants.

Local Participants:

Individuals who want to trade on their own behalf might use the Local Participant option. These
people are not permitted to trade on behalf of customers. Local Participants are not required to be
licenced under the CMSA because they are not considered industry middlemen. They must,
however, be registered with the derivatives exchange. Local Participants can use the trading
facility of Bursa Malaysia Derivatives Berhad to execute their own trades, which will then be
cleared through any of the Clearing Participants.

Associate Participants:
Associate Participants must be corporations that do not conduct regulated derivatives
transactions in Malaysia. Associate Participants, on the other hand, must be a Clearing
Participant or be nominated by a Nominating Participant for the clearing of their contracts.

The Clearing House:

The existence of an effective and financially sound clearing house is a requirement for the
successful operation of any derivatives market. Clearing houses ensure the underlying financial
integrity of the derivatives market by allowing players to transact freely with one another without
regard for credit risk. This section explains how they do it.

Functions of the Clearing House:

 Register all Trades

When a transaction is completed, a record is sent to the clearing house. The clearing house
processes the deal, and later that day, a statement summarising the trades registered in the
clearing participant's name is issued.

 Novation

The nexus between the two original contracting parties is severed after the futures
contract/option is recorded by the clearing house (in the names of the two clearing participants).
The clearing house then acts as both a buyer and a seller to the clearing participant acting as a
buyer. As a result, the identity of the other party to a futures contract is no longer relevant, nor
are parties to an initial contract need to return to each other in order to complete or unwind the
contract. One of the unique aspects of the exchange-traded derivatives market is this function,
known as novation. The clearing house becomes the seller to every buyer and the buyer to every
seller as a result of novation. Because it can guarantee the performance of all contracts, the
clearing house removes credit risk among clearing participants. The following diagrams depict
the process of novation:

Transacting a Trade on the Derivatives Exchange:

The Clearing House is interposed between Buyer and Seller

It should be noted that the clearing house does not guarantee the clearing participants' clients.
Contracts exchanged by a participant on behalf of a client, as previously stated, are registered by
the clearing house under the participant's name rather than the client's name.

Risk Management:

The clearing house's role is to provide efficient settlement and risk management facilities that
protect clearing participants' and their clients' interests. To ensure that it can absorb the risk of its
participants if they default, the clearing house must efficiently assess, monitor, and manage risk
in order to safeguard its participants in the case of uncertain market conditions.

Through its risk management policies and processes, the clearing house safeguards financial
integrity. These include:

a) ensuring that the clearing participant has the capability and meets the minimal standard of
participation; and

b) daily margining and settlement system criteria.

c) financial oversight; and

d) security deposit and clearing fund.

Participant Standards

The first stage in ensuring financial integrity is to evaluate each possible clearing participant's
creditworthiness and ability. Clearing participants are subject to severe financial and operational
standards imposed by the clearing house. Each potential clearing participant is evaluated based
on operational efficiency, specifically the accurate and timely accounting of its transactions. It
must have experienced management and competent and qualified staff to carry out its tasks.
Clearing participants must also meet the minimum financial requirements for assets, capital, and
participation payments.

Margining and Settlement

A margin, or deposit, is required to be paid to the clearing house for each futures or options trade
in the market. The collection of margins on all positions held by clearing participants is critical
to the clearing house's operation in safeguarding itself against losses caused by a clearing
participant's default. The margin level is evaluated on a daily basis and may be changed to reflect
changes in price volatility, underlying asset price movements, and other variables. When the
contract is settled, whether by delivery or by an opposite transaction in the derivatives market,
the margin is refunded. The margin functions more like a performance bond than a deposit on the
contract being exchanged. In addition to the initial margins necessary to open contracts, any
market price moves must be compensated daily by additional margins known as variation
gains/losses or daily settlement. If a trader purchases a contract and the price falls later, the trader
must pay additional funds to cover the present unrealized loss. If a contract is sold on the
derivatives market and the price rises, the trader will be in a similar position. The clearing
house's risk exposure is theoretically confined to a single day's price change. The variation
margins mechanism, in which the seller or buyer gradually pays this debit amount, successfully
keeps the participants at current market values. This guarantees that the buyer or seller has paid
in full or has settled-to-market.

Financial Monitoring Programme:

The clearing house has a financial monitoring plan as part of its risk management measures. The
scheme includes:

a) monthly financial reporting by clearing participants;

b) clearing house audits and examinations; and

c) information sharing between the clearing house and the derivatives exchange.

d) monitoring clearing players' positions in relation to intraday price fluctuations and economic
events.

Security Deposit and Clearing Fund:

The clearing house has access to contingency funds that it maintains through security deposits
and contributions to the clearing fund. Security deposits and clearing fund contributions may be
used if the clearing house's margins are insufficient to cover losses incurred by its participants.

Intermediaries in the Derivatives Market

Intermediaries in the derivatives market are those who trade or advise the investing public on
trading. They serve as'middlemen' between the derivatives exchange and the users of the
derivatives exchange's products. The CMSA classifies intermediaries principally participating in
the derivatives market into the following licencing categories:
Holders of a CMSL who Carry on the Business of Dealing in Derivatives:

Holders of a CMSL that engage in the regulated activity of dealing in derivatives are companies
that participate in a derivatives exchange by trading on the exchange and agreeing to be bound
by its rules. CMSL holders have the ability to trade on behalf of others. Their primary
responsibilities include:

a) representing their clients in market orders;

b) collecting margins from clients;

c) providing basic accounting records and transaction papers to clients; and

d) advising and recommending trading programmes to clients.

Due to the nature of the derivatives market's evolution, these CMSL holders are required to
execute all orders for dealing in futures and options contracts on the derivatives exchange.

Holders of a CMSL who Carry on the Business of Fund Management:

Companies that manage a portfolio of securities and/or derivatives are CMSL holders who
conduct fund management activity. The funds operate similarly to unit trusts, allowing small
investors to pool their resources for management by CMSL holders. Holders of a CMSL who
carry out the business of fund management must be corporations, and their employees or agents
who interact directly with their clients are known as fund management holders of a CMSL.

Holders of a CMSL who Carry on the Regulated Activity of Investment Advice:

CMSL holders who engage in the regulated practice of investment advisory provide advice and
analysis to customers who want to participate in the securities and derivatives markets. Holders
of a CMSL who engage in the regulated activity of investment advising but do not engage in the
business of derivatives trading face less stringent duties than holders of a CMSL who engage in
the business of derivatives trading. The key reason for this is that they do not deal with their
clients' money or property when trading derivatives. As a result, they are not required to retain
segregated client accounts and, unless the Securities Commission Malaysia rules differently, they
are not required to keep statutory accounting records under the CMSA (save for the provision in
section 92). They do, however, have a legislative need to keep accounting records under the
Companies Act 2016.

Representatives:
Representatives are individuals who deal directly with clients of a CMSL holder who is engaged
in the business of dealing in derivatives, a CMSL holder who is engaged in the business of fund
management, or a CMSL holder who is engaged in the regulated activity of investment advice. A
representative effectively operates on the principal's behalf in connection with the principal's
business. They must know their clientele well as CMSRL agents or holders. They must be aware
of the following:
  integrity reputation
 financial capacity
 trading objectives

Holders of a CMSRL who conduct derivatives business, in particular, will frequently be required
to:

a) supply the proper documents for new accounts;

b) explain trading rules and procedures to clients;

c) keep clients informed of prices and market conditions;

d) enter orders received from clients;

e) report executions; and

f) explain the risks involved when dealing in futures and options.

Because representatives' work requires personal skills, the most significant requirement for
licencing individuals as representatives is the existence of the necessary knowledge and personal
capabilities.
They are subject to the requirements stipulated in the CMSA for the conduct of the business of
trading in derivatives, fund management, and acting as an adviser because they represent their
respective holders of a CMSL. They are primarily responsible for the professional image and
reputation of the entity they represent as representatives.

Flow of Trading Procedure in Malaysia

Users of Derivatives — Clients

Participants in the derivatives markets are broadly classified as hedgers, speculators, or

arbitrageurs. They are futures and/or options contract holders, as well as clients of the
intermediaries mentioned in the previous section. However, as the following section will
demonstrate, these three types of users have quite different motivations for entering the
derivatives market.

 Hedgers:
Hedgers trade the underlying instrument and control price risk with futures and/or options. The
derivatives market serves as a price-setting mechanism, allowing hedgers to know in advance
what price they will pay to purchase or sell (or what interest rate they will borrow or lend). This
enables hedgers to plan for known costs and returns and establish a solid financial budget. The
derivatives market achieves its goal of fixing a price in advance by delivering profits or losses
that balance the underlying market's losses and gains. Thus, a more advantageous price in the
underlying market than that agreed upon in the futures contract is offset by futures losses, and an
unfavourable price movement in the underlying market is offset by futures losses.
 Speculators:
Speculators deal with fluctuations in projected price levels over time, and they typically do not
own or utilise the underlying instrument. They are motivated by the desire to profit from the
transaction and absorb hedgers' pricing risk. Simply put, speculators earn from derivatives
trading by purchasing contracts at a discount and selling them at a premium. Speculators are
significant market participants, providing liquidity and chances for ongoing trading. Trading
firms and professional market participants frequently engage in derivatives markets to profit
from anticipated changes in commodity prices.
 Arbitrageurs:
The simultaneous buying and sale of the same instrument in separate marketplaces in order to
profit from price differences is known as arbitrage. It is the ability to benefit from differences in
rates, prices, and/or circumstances between marketplaces. Arbitrageurs (those who arbitrage) can
profit from momentary pricing distortions or inconsistencies. Arbitrageurs, like speculators, play
a vital role in derivatives markets by providing liquidity and assuring the convergence of cash
and derivatives values around the contract's expiry date.

Regulation of the Derivatives Market

Previously, the regulatory framework for Malaysian derivatives markets was divided into two
sections: one for commodities futures and one for financial futures and options. Following an
amendment to the Futures Industry Act in April 1997, the Securities Commission Malaysia
assumed the position and function of the Commodity Trading Commission as commodity futures
regulator. As a result, the Securities Commission Malaysia currently regulates both financial and
commodities futures and options under the Futures Industry (Amendment and Consolidation)
Act 1997. The Futures Industry statute of 1993 and the Securities Industry Act of 1983 were
merged into a single statute, the CMSA, in September 2007.

Securities Commission Malaysia:

The Securities Commission Malaysia (SCM), which was founded on 1 March 1993 under the
Securities Commission Malaysia Act 1993 (SCA), is a statutory agency whose primary purpose
is to regulate Malaysian securities and derivatives markets. The SCA appoints nine
Commissioners, all of whom are appointed by the Minister of Finance. They are made up of the
Chairman, the Deputy Chief Executive, four members representing the government (traditionally
from the Ministries of Finance, Primary Industries, and Bank Negara), and three others
representing various professions in the private sector.

The Securities Commission Malaysia's management, on the other hand, is made up of full-time
personnel. The Securities Commission Malaysia's derivatives-related functions include:

a) advising the Minister on all derivatives-related topics; and

b) regulating all derivatives-related matters.

c) responsible for supervising and monitoring the activities of any exchange holding company,
derivatives clearing house, and central depository

d) take all reasonable measures to maintain the confidence of investors in the derivatives market
by ensuring adequate protection for such investors

e) promote and encourage proper conduct among exchange and clearing house participants,
depository participants, and all licenced or registered persons

Co-Regulation:

The Malaysian derivatives industry is regulated by co-regulation by the:

a) Securities Commission Malaysia, which administers the CMSA; and

b) derivatives exchange, which creates and implements a set of rules governing the trading of
goods offered on its markets.

c) clearing house, which makes and enforces its own rules.

Because the derivatives industry is at the forefront of financial innovation, the regulatory
framework must be adaptable enough to allow quick changes in business practices and the
economic utility of participants while also addressing regulatory concerns. As a result, the
CMSA's principal focus is on issues of investor protection and systemic stability. The rules of
the derivatives exchange and clearing house, on the other hand, are more commercial in nature
(but still regulatory in form). The rules are more flexible in that they can be altered with the
Securities Commission Malaysia's consent. In general, the Securities Commission Malaysia is
concerned with general policy formulation, licencing, product and market approval, and
prosecution, while the derivatives exchange and clearing house are responsible for day-to-day
market supervision, approval of entry into the industry, prudential controls, and participantship
regulatory responsibility. Placing the primary responsibility for the proper regulation of
derivatives activities on derivatives exchanges and clearing houses (commonly referred to as
frontline regulatory organisations) ensures that derivatives markets are free to operate with only
the minimal amount of regulation required to allow them to function in an efficient, competitive,
and orderly manner.

Development & Expansion of Listed derivatives in Malaysia:

Malaysia being one of the largest producers and exporters of palm oil, it is only natural that
BMD has built its palm oil futures franchise into a global market centre for crude palm oil
trading over the years. BMD is already successful in terms of growth, operating a liquid
commodities futures contract that remains relevant and is the 'go-to' exchange for players
wishing to reduce risk. Whether these participants hedge more or less depends on the underlying
commodity's supply and demand growth, as well as during moments of volatility that present
both significant dangers and large opportunities. Then there is increased demand due to
industrial use, as crude palm oil is increasingly being used as a 'green' supplement to fossil fuels,
creating demand for bio-fuel. Again, this is causing a need to hedge against price volatility,
which is increasing trading activity on these commodities markets.

The primary benefit of sponsored access to BMD is speed. Such ease of market access leverages
technology and draws liquidity, resulting in client diversification. On BMD, there is a growing
presence of high frequency trading (HFT) firms operating quantitative-based arbitrage strategies
and algorithmic tactics similar to those established for deep and active futures markets, with
greater sophistication to follow, which has helped enhance liquidity to the market. When
compared to the rest of the developed futures exchanges, HFT participation often accounts for
more than 60% of market volumes. Malaysian data for this area have caught up with other
developed exchanges in recent years, owing to volatility and a rising market.
When compared to products already available on global listed derivatives exchanges - which
include equity indexes, interest rates, currencies, and commodities - BMD markets (with the
exception of the yet-to-be-launched currency futures contract) offer product diversity. What can
be done to improve the liquidity of some of these inactive products is to attract and reward
primary liquidity providers, which is an opportunity in a less congested market.
Trading Session of Financial Derivatives in Malaysia

Market Indicators (As at 12 December 2023)

Market Data Overview (Sector wise : Bursa Indexes) As at 12 December 2023

Derivatives Market Statistics:

Bursa Malaysia Derivatives Trading Summary (As on 4th December 2023)

Conclusion:
In concluding our exploration into the realm of financial derivatives in Malaysia, it becomes
evident that these instruments play a pivotal role in shaping the nation's financial landscape.
Malaysia, as a burgeoning economy, has embraced financial derivatives as powerful tools for
risk management, speculation, and portfolio diversification. The journey through various types of
derivatives, including futures, options, and swaps, has illustrated their versatility and
applicability across diverse sectors. One of the key takeaways from this analysis is the integral
role that financial derivatives play in mitigating risks associated with fluctuating interest rates,
currency exchange rates, and commodity prices. This risk management function is crucial for
businesses and investors alike, fostering stability in the face of an ever-changing global
economic environment. Additionally, the active participation of both institutional and retail
investors in derivative markets reflects a growing awareness of these instruments and a
willingness to harness their potential for financial gain.

The regulatory framework governing financial derivatives in Malaysia has evolved to strike a
delicate balance between fostering innovation and ensuring market integrity. The regulatory
authorities have implemented measures to enhance transparency, mitigate systemic risks, and
safeguard the interests of market participants. The continuous efforts to refine and adapt
regulatory policies underscore Malaysia's commitment to maintaining a robust and resilient
financial system.
References:
https://www.sidc.com.my/wp-content/uploads/2019/06/17topic1.pdf

https://www.bursamalaysia.com/trade/market/derivatives_market

https://www.sc.com.my/api/documentms/download.ashx?id=985D39B2-D548-4E57-AE55-
B141159FD20A

https://www.bursamalaysia.com/sites/5d809dcf39fba22790cad230/assets/6576659bcd34aabb5e4
e5af8/TradingManual_v5.7_Final.pdf

https://www.kenangafutures.com.my/media/articles-publications/in-conversation-the-
astonishing-evolution-of-derivatives-trading-in-malaysia/