HEDGING THE PRICE RISK OF COMMODITIES. REF: FE CIRCULAR NO. 04 DATED 25.05.2008.

It has now been decided that authorized dealers can hedge the price risk of commodities (that are traded on exchanges or over-the-counter) of their customers through standard exchanged traded futures/options and OTC derivatives on commodities subject to prior approval of Bangladesh Bank.

The use of commodity derivatives will only be permitted when customers have genuine underlying commodity price risk exposure(s). This can be monitored by the Authorized Dealers (AD) through checking of the underlying risk exposure documents. Any kind of speculation through the use of commodity derivative instruments will not be permissible.

ADs must completely hedge the commodity price risk arising from the commodity hedge transactions by booking back to back transactions with banks having international standing or their branches operating in Bangladesh.

While applying to Bangladesh Bank for commodity hedge transactions the suitability and appropriateness form (Annex-2) must be submitted. To become eligible for offering commodity derivative products, ADs must have the ability to monitor the credit and market risk arising from such products. They should also forward relevant commodity price forecasts (page-3 of Annex-1 can be used as reference in this regard) to customers before the product is offered to them. The forecast(s), Annex-2 and Annex-3 should also be forwarded to Bangladesh Bank along with the application.

ADs should follow IAS 39 (Financial Instruments: Recognition and Measurement) for accounting of gain or loss on the commodity hedging instrument and the hedged item.

The following reporting requirements must be followed by the ADs:

– All the details of commodity hedge transactions that have been approved and booked with the clients should be reported to Bangladesh Bank on a monthly basis.

– At maturity of each transaction, ADs must send a detailed report to Bangladesh Bank.

– Audited financial Statements must have adequate disclosures of commodity hedge transactions.

BRPD Circular No. 06, dated May 21, 2008 should be referred to for assigning risk weightage for all the commodity transactions for capital adequacy.

Prior to engaging in a transaction, ADs must advise client of all costs, charges and commissions related to the commodity hedge. ADs must explicitly mention all the downside risks and worst-case-scenarios of a commodity derivative hedge to the client prior to entering into a transaction.

A detailed annexure (Annex-1) has been attached with this circular as a reference for explaining basics of commodity derivatives, counterparties who are eligible to hedge through commodities.

Please bring the contents of this circular to the notice of all concerned.

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