Last year, the surge of funds from Russian private and corporate clients into our banking system, which took place against the backdrop of unprecedented sanctions against the Russian financial sector, brought a pre-existing issue to the forefront with renewed urgency. This issue is the unfavourable conditions of foreign exchange transactions for clients of our banks and the lack of mechanisms to compensate for foreign exchange risks for the banks and their customers.
In any developed economy, businesses or individuals who transact or hold deposits in multiple currencies have access to tools that enable them to minimize currency risks and conduct currency exchange transactions at the best market rates. This is achievable because such countries have an exchange mechanism to determine exchange rates, as well as a mechanism to hedge currency risks by purchasing derivative financial instruments – primarily futures for currency pairs.
However, our country lacks such a mechanism. As long as our banks have access to the Russian spot and futures foreign exchange markets through Russian correspondents, they can conduct exchange transactions and hedge currency risks there (for instance, by purchasing ruble-dollar futures). The problem is that our banks» clients do not have this access (unless agreed upon with the bank treasury).
The second, more pressing issue is the escalating sanctions pressure on Russia. What if the Moscow Exchange ceases trading in currency pairs and futures (as it did in 2022) or our banks find themselves completely cut off from these mechanisms due to sanctions and pressure from correspondents? The Central Bank of Russia has already begun considering a scenario in which the Moscow Exchange cannot determine the ruble-to-US-dollar exchange rate, prompting consultations on the preparation of a replacement mechanism.
Kyrgyz professional stock market participants with access to foreign brokers can partially provide access to hedging currency futures traded on foreign exchanges (according to the law, our investment companies can execute client orders to purchase foreign securities and financial instruments; only public placements of foreign securities in Kyrgyzstan are prohibited without the approval of the State Financial Supervision Authority, and currency futures are not considered equity securities – they are ordinary derivative contracts).
However, this doesn’t fully address the issue. Firstly, high-quality foreign platforms that quote ruble-dollar, ruble-yuan, ruble-dirham, and so on, may not be available at some point. It is important to note that such platforms are not forex firms, which largely exist to deceive gamblers at exchange rates, essentially making them play not with the market, but with the company’s computer.
Since Kyrgyzstan became one of the regional financial centres last year due to shifting events, attracting non-sanctioned trade and investment activity from Russia, it is reasonable for the country to create its own foreign exchange market suitable for a regional financial centre.
In simpler terms, if a Kyrgyz bank client needs to efficiently exchange rubles for dollars, they currently can only do so by calling local banks, comparing conditions, and transferring their liquid funds to the chosen bank (by which time the rate and conditions may have changed). However, within the same banking system, there are companies that need to perform the reverse operation on the same day – exchanging dollars for rubles. Alternatively, some companies may be willing to conduct such an operation for speculative purposes if they find the rate agreeable. Establishing a market where the first company can directly transact with the second will allow them to save significantly on their settlements.
Contrary to the belief that banks will oppose the creation of such a mechanism (as it may infringe on their monopoly and high profits), I argue that banks will be among the first to participate in this market. For them, it is more profitable to have predictability in exchange rates and earn commissions as a percentage of the amount.
Developing such an autonomous mechanism amidst growing sanctions pressure on Russia is crucial for the stability of the national banking system.
Creating a pure currency exchange in Kyrgyzstan is currently challenging, as currency exchange operations are classified as exclusive banking activities. Therefore, a bank license may likely be required for its organization. In Russia, the Moscow Exchange is not a bank (in fact, it is an electronic «bulletin board»), but it has the National Clearing Centre (NCC), which holds the status of a non-bank credit organization — essentially a bank in our context. It is possible that the government will consider creating a Kyrgyz settlement centre for foreign exchange transactions based on a state or private bank later on.
Nonetheless, even with the current regulatory framework, it is feasible to use any stock exchange in the country to organize trading not in spot but in futures contracts with the underlying asset «currency.» According to the regulations on the types, conditions for the issuance and circulation of derivative securities, as well as the requirements for their underlying asset in the Kyrgyz Republic (approved by Government Decree No. 185 dated March 29, 2017), currency can be the underlying asset of contracts traded on stock exchanges, and it is not necessary to issue them in series, as «equity securities.»
How Government Decree No. 185 regulates transactions with currency contracts
1. The following concepts are used in this regulation:
underlying asset — standardized consignments of goods, securities, currency, and financial instruments;
futures — a contract for the purchase or sale of the underlying asset on a specified day at a fixed price.
option — a contract under which one party acquires the right to buy (call) or sell (put) a certain underlying asset at a fixed price, valid for the entire period specified in the contract, and the other party commits to ensuring the exercise of this right.
3. The procedure for conducting trades, the procedure for mutual settlements, and the provision of financial guarantees for derivative securities in the form of contracts are determined in accordance with the “Rules for Exchange Trading with Securities” approved by the Stock Exchange, after their agreement with the authorized state body for regulating the securities market.
33. The terms of over-the-counter option, forward, and futures contracts that are not securities are determined by the parties.
34. The terms and conditions of option, forward, and futures contracts concluded on the stock and commodity exchanges, which are not securities, are determined by the exchange, with the assignment of a unique number to the contract in the trading system of the exchange. Within 15 calendar days from the date of introducing a new contract into the trading system of the exchange, the exchange notifies the authorized state body for regulating the securities market in writing by sending the text of the main terms of the contract.
As such, the current regulatory framework allows the exchange to organize trading in currency derivatives (derivatives).
To commence trading in derivative contracts for currency, there is no need for regulatory reform. It is sufficient to develop intra-exchange rules, select software, and choose a reliable local bank for depositing collateral by bidders. The first exchange to offer this product will likely attract substantial liquidity and new entrants.
There is no need to wait until the possibilities of the Russian banking and clearing system currently available are blocked for our banks. The new package of US sanctions, introduced on February 24, 2023, which included several Russian banks actively involved in foreign exchange settlements, demonstrated that as long as the war in Ukraine continues, sanctions pressure on the Russian financial system will not cease. Kyrgyzstan, traditionally a hub for regional trade settlements due to its open economy and the absence of foreign exchange restrictions, should be fully prepared to operate independently in the regional financial market. This is not only a matter of providing quality service to our banking clients but also ensuring the stability of the entire financial system of the country.
Artur Muradov
