The Muamalat Newsletter Vol.1 2023

FEM Newsletter | June 2023 14 lend further support to our consensus of ballooning foreign currency derivative hedging practices. Why Foreign Currency Derivative Hedging is Called for in Malaysian Financial Landscape Foreign currency derivative hedging is crucial in Malaysian financial landscape given the country’s status as a developing country with open economic policy. Thus, it is natural for the country to be exposed to numerous market shocks and potential market adverse movements. The main reason why foreign currency derivative hedging has come a long way to be a fashionable tool in the risk management framework is due to its ability to enable the holder additional strategic option in reacting to any outcome of the market. While we may not be able to control the amount or level of risk and uncertainties in the market, hedging enables the firms to control how they expect to be affected by such risk and uncertainties. Thus, it sits well with the nature of the Malaysian market that is often affected by the currency movements that does not only affect the Ringgit but also other currencies in the region. In addition, the economic expansion that the government of Malaysia has been planning on also implicitly exposes the market to currency exposure. With this, foreign currency derivative hedging seeks to reduce the currency exposure without affecting the overall investment and economic activities. What We Miss Out from Not Utilising Foreign Currency Derivative Hedging Like it or hate it, any investment and trades will incur exposure to currency movements. While existing hedging strategies such as natural hedging (matching negatively correlated investments) and operational hedging (diversification of operations) have worked so far to mitigate the risk arising from currency exposure, the modern financial market has evolved to be more complex and requires more extensive risk alleviation tools. Abandoning the foreign currency derivative hedging for natural hedging would seem outright inappropriate as the strategy could be inadequate to closely scrutinise the robust and intricate currency movements nowadays. In addition, depending solely on operational hedging would be detrimental as it requires large start-up cost and mass operation expenses. The multinational firms must also face other additional issues such as agency issues and diversification width which could eventually trigger much larger costs – and loses. With this, foreign currency derivative hedging is deemed as appropriate for the current market needs and characteristics. What Shall We Do Now? Consideration of the crucial importance of foreign currency derivative hedging and its wide expansion potential, it would be timely and apt for all parties to put more concern on this risk management segment. Harnessing financial literacy and awareness among the market practitioners and academics could work wonders on the advancement of the practice. While we may have come a long way to achieve this point of considerable hedging practice, we also have a far long and promising way ahead to inculcate on the promising derivative hedging industry. After all, we all strive to the same investment goal; maximising profit while minimising risk. we all strive to the same investment goal; maximising profit while minimising risk. “ “ Author’s email: wan.nurhanan@usim.edu.my