The Bangko Sentral ng Pilipinas (BSP), through Circular No. 1194 Series of 2024, issued significant amendments to the regulations governing the derivatives activities of banks, quasi-banks, and trust corporations.
The amendments clarify and expand the definitions of several key derivatives instruments.
A credit derivative is defined as a contract where the credit risk of a reference asset or assets is transferred from one party (protection buyer or credit risk seller) to another party (protection seller or credit risk buyer) in return for a premium or interest-related payments reflecting the underlying credit risk.
Under these regulations, credit default swaps (CDS) and total return swaps (TRS) are explicitly considered credit derivatives. A Total return swap (TRS) itself refers to a credit derivative where parties agree to exchange cash flows on interest payments and capital gains/losses at certain times in the future according to an agreed-upon formula.
The Circular also defines a Non-deliverable swap as a variation of an FX swap agreement where no exchange of the two currency cash flows occurs; instead, the net difference between the contracted swap rate and the spot rate is paid by one party to the other.
An FX option is defined as a contract giving one party the right, but not the obligation, to buy or sell one currency against another by a certain time for a certain price.
Another defined instrument is the ROP’s Paired Warrants Program, which refers to instruments granting holders the right to convert or exchange their Republic of the Philippines (ROP) Global Bond holdings into Peso Government Securities (GS) at pre-determined tenors, exchange prices (par for par), and pre-agreed coupons; this right is only exercisable upon an ROP Event of Default on its foreign currency debt.
The Circular revises and details the list of Generally Authorized Derivatives Activities (GADA) that Universal Banks (UBs) and Commercial Banks (KBs) may transact as a dealer without needing prior BSP approval. These GADA include Deliverable FX forwards and FX swaps, Non-deliverable FX forwards and FX swaps, Currency swaps, Interest rate swaps and forward rate agreements, Interest rate and currency futures, and any financial derivative traded in an organized market where the UB or KB is recognized as a dealing participant or member. An organized market for this purpose is defined as an exchange or a BSP-recognized over-the-counter market governed by transparent and binding market conventions on price transparency, trade reporting, market surveillance, and orderly conduct/operations.
A crucial element of the Circular focuses on activities requiring notification to the Bangko Sentral before engaging in them. Notification is required for any variant of a stand-alone derivative that a UB/KB or its trust department is allowed to transact under GADA, or for which the bank or trust department has an existing Type 2 or Type 3 additional derivatives authority. A “variant” is specifically defined as an instrument where the features of the authorized product are altered, changing the timing and amount of cash flows, the commencement of the contract, or the basis of payments (e.g., amortizing or accreting notional amount). Additionally, adopting a different underlying for a previously authorized product (such as a different reference entity for a credit default swap if the latter was approved under a Type 2 or Type 3 authority) also constitutes the creation of a variant requiring notification.
Notification is also required for a structure or combination involving two or more separate stand-alone derivatives contracts, or stand-alone derivative contract(s) combined with a plain vanilla cash instrument, provided the instruments are offered or distributed together. This applies when all the derivatives involved are part of a UB/KB’s GADA, or a bank’s or trust department’s existing Type 2 or Type 3 additional derivatives authority. Furthermore, notification is necessary for a structured product (SP) where the embedded derivative(s) differs from the product approved under a bank’s existing Type 2, Type 3, or Type 4 additional derivatives authority, or a trust department’s existing Type 3 additional derivatives authority. It is important to note that the notification requirement does not apply to banks that have been granted a Type 1 expanded dealer authority.
For trust departments of UBs or KBs, they may transact in financial derivatives as an institutional counterparty on behalf of their trustor/principal/s, provided the transaction is authorized by the trustor/principal/s.
Trust departments are also subject to specific investment limitations, including that the total carrying value of investment in Structured Products (SPs) and Credit-linked notes (CLNs), including those held under the trust department’s Type 3 authority, shall not exceed twenty percent (20%) of the assets being managed by the trust department. Authorized SPs include Principal-protected foreign-currency denominated SPs whose revenue streams are linked to interest rate indices, interest rate instruments, listed equity shares or indices, FX rates, credit rating or index, or gold, with a maximum contractual maturity of five (5) years. They may also transact in Plain vanilla single-name CLNs where the reference asset is an obligation issued or guaranteed by the Republic of the Philippines. Quasi-banks (QBs) and their trust departments that notify the BSP about engaging in these instruments shall only transact in the notified instruments in the capacity allowed for the previously authorized product.
