Economy, Business And Markets

A Step Towards the Future

Business & Markets Desk
A Step Towards the FutureA Step Towards the Future

Iran Mercantile Exchange is about to offer currency futures for the first time to help Iranian companies and foreign investors hedge against the foreign exchange fluctuations of the Iranian currency rial.

IME has already drawn up contracts and is offering schedules for the prospective foreign exchange futures—a  futures contract to exchange one currency for another at a specified date in future at a price fixed on the purchase date, IME's chief executive Hamed Soltan-Nejad told Eqtesad Bartar website.

Soltan-Nejad did not specify the currencies that will be offered against the rial. However, it is safe to assume that rial futures against the euro and the US dollar will be the first to make a debut.

Trading of these currency derivatives will be 24/7, according to the executive, although spot trading is not in IME's plans for now.

"A foreign exchange futures market is the prerequisite for attracting foreign investment," said Soltan-Nejad.

> The Making of Change

The Tehran-based exchange is coordinating with the Central Bank of Iran, as the main authority overseeing Iran's foreign exchange market, for offering currency futures on the rial.

CBI Governor Valiollah Seif signaled earlier in the year that his bank is looking into foreign exchange futures as a tool for increasing transparency and liquidity in the foreign exchange market, and also for managing risk.

"Tehran Stock Exchange, over-the-counter market Iran Fara Bourse and IME had sent draft proposals for offering currency futures to the Securities and Exchange Organization in August," said Hassan Amiri, deputy head of SEO for supervision on exchange and issuers.

According to Soltan-Nejad, IME is the winner as it has the most experience in offering derivatives and the required structure in place.

Founded in 2006, IME trades in agricultural, industrial and petrochemical products in the spot and futures markets. It also offers futures on gold coins, instead of bullion.

"IME can offer derivatives on any financial instrument and has the legal framework to offer currency futures."

> Hedging Against Risk

Soltan-Nejad said the motive behind offering futures is to provide a shield against foreign exchange volatility.

Investors can use futures to hedge against foreign exchange risk. If an investor receives a cash flow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cash flow.

"Foreign investors have criticized the risk of investment in Iran as high, citing recent foreign exchange turmoil in the country. A foreign exchange futures market will provide a cover against this risk," said the executive.

In 2012, the rial lost around 70% of its value as sanctions against the central bank dried up its foreign exchange reserves. The CBI tried but failed to stop the rial's slide in the Iran's bureau de change-centered foreign exchange market. The rial recovered some of its lost ground later, but the chaos is still fresh in traders' minds.

> Speculation Is Key

Futures trading will provide more transparency, give the central bank a tool to manage exchange rates and provide the infrastructure for floating the rial when adequate trade volume is reached.

This is where speculators play their role. Currency futures can be used to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates. Speculation, in turn, raises trade volume on any financial asset and boosts liquidity.

As Iranian officials have historically been against speculation, they now need to change this attitude and understand the role of traders in the foreign exchange market's smooth operation.

To further increase liquidity and diversify tools for foreign exchange risk management, the exchange is likely to follow up futures with currency options and swaps in the near future.

> First Futures

Foreign exchange futures trading took off in the 70s when the Chicago Mercantile Exchange established the International Monetary Market and launched trading in seven currency futures on May 16, 1972. Today over $100 billion flows through IMM every day.

The market for currency futures has expanded into other financial centers, with Euronext.liffe, Tokyo Financial Exchange and Intercontinental Exchange having major stakes in the trade.

If the IME establishes connections with these exchanges and uses their training and expertise, currency futures trading will take off and become an indispensable part of Iran's financial system.

Furthermore, IME should adopt the maturity dates offered by IMM, namely the third Wednesday in March, June, September and December, as is conventional in currency futures around the world.

Offering foreign exchange futures is a somewhat small step for IME, but it’s a leap forward in Iran's initiative to open up its markets. Trading will probably be heavily regulated at first and there are many things that can go wrong. However, few would have thought it possible in Iran a few years ago.