October 2014

Hong Kong’s protest – a driving factor in the growth of SME exchange derivatives market
On September 24th, a peaceful march by students in Hong Kong, protesting China’s decision to vet candidates for its 2017 election, sparked a pro-democracy demonstration which sent Asian markets into a tailspin. The repercussions of this event redirected market participants’ focus onto risk mitigation and the potential cultural change within the SME exchange derivatives market.

Albeit its peaceful nature, investor wariness over the protests caused broad sell offs across the region. Hong Kong’s Hang Seng Index dropped nearly one percent overnight, as tens of thousands of protestors bourgeoned into a vigil, barricading central parts of the city.

The Hong Kong dollar (HKD) immediately followed suit, tumbling to a six-month low against the US dollar by the sixth day of the protest. Similarly, currency slumps were felt across Asia.

Investors and speculators recoiled to the safe haven of the greenback, causing the Malaysian Ringgit and Japanese Yen to reach their lowest levels since April 2014 and August 2008, respectively.

Amid the mounting political risks and escalating currency volatilities, underlying dangers of currency exposure have caused market participants to revisit foreign exchange hedging options.

Since the Asian Financial Crisis, companies in the region have started to embrace the significance of hedging and responded positively to its utilisation. However, certain segments have gained more traction than others.

In East’s latest Asia Business Foreign Exchange Report, figures showed that engagement with FX Forwards and FX Options only corresponded to 26.8 percent and 23.9 percent of SMEs respectively.

Such disparity polarised to that of upper corporate and institutional enterprises; which begs the question – why are SMEs less inclined to invest in foreign exchange strategies?

Historically, the majority of SMEs have solely been reactive to foreign exchange movements.
Anecdotal evidence indicates that most business owners have adopted the mentality of “hoping for the best” when it came to currency risk mitigation. They merely adjusted their strategies post impact in accordance to the degree of variance the volatility has caused.

Furthermore, SMEs have not been able to grasp FX hedging’s effect on the maintenance of a sustainable operational profitability. Due to the almost ancillary impact of currency risk on daily transactions, they do not classify it as on par with receivables and notes – a business risk that should be managed in order to achieve healthy margins and stable cash flows.

It is also not plausible for SMEs to attain the same magnitude of financial sophistication as their larger counterparts. The lack of an entrenched derivatives culture in the SME segment can be drawn from their ambivalence towards products on offer, a consensus outcome that appears throughout several East research programs.

Consequently, such scenarios also represent a strategy evaluation opportunity for FX solution providers.

The establishment of a symbiotic relationship where customers consider their bankers as a source of knowledge and advice should be at the forefront of all strategic objectives. The result will often lead to higher customer satisfaction rates, which in turn will increase the banks’ wallet share.

For example, Singapore has the most sophisticated SME cohort in terms of FX strategies. The derivatives penetration rate in Singapore is 31.5 percent for FX Options and 33.2 percent for FX Forwards.

This is almost double that of the Philippines. Unsurprisingly, Singapore also enjoys the best customer satisfaction rating, scoring the highest in the region at 1.25 and eclipsing the Philippines’ rating of 1.53.

Despite the turmoil, Hong Kong’s ongoing protests may have inadvertently provided a much needed wake up call for banks seeking to penetrate the elusive SME exchange derivatives market.

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