By Niluksi Koswanage
KUALA LUMPUR Feb 28 (Reuters) - Malaysia's central bank tightened rules on the fixing of onshore rates for the ringgit currency on Thursday in a move aimed at improving the integrity of the rate-setting process that other regulators in Southeast Asia are expected to follow soon.
Bank Negara's new rules are part of wider efforts to overhaul the process of setting key currency rates after the scandal over the London interbank offered rate (Libor), and as evidence emerges that traders at Singapore banks were colluding to manipulate the foreign exchange market.
The move marks a shift away from a set of rates overseen by a banking association in Singapore that was found to have been subject to attempts at manipulation. The set includes spot currency and interest rates for the Singapore dollar, Thai baht and Indonesian rupiah, ringgit, and Vietnamese dong.
Bank Negara said from March 1, the calculation to fix the ringgit rate against the U.S dollar will have to be based on quotes with a bid and ask spread of not more than 10 pips. A pip is the smallest unit of a currency in dollar terms, equivalent to one-hundredth of a cent.
"The revised methodology for the fixing will ensure that the rates used in the fixing calculation are tradable rates and the derived fixing rate appropriately reflects the market rates,' the central bank said in a statement.
Two sources with direct knowledge of the plan earlier told Reuters that Bank Negara asked the association to increase the number of banks contributing to the ringgit reference rates to 15 from 11.
Underlying this is a move to promote Southeast Asian countries' own onshore currency reference rates. Central banks in both Malaysia and Indonesia have already directed local banks under their jurisdiction to use domestic reference rates instead of the Singapore benchmarks.
They would like banks to price derivative contracts such as foreign exchange forwards against those reference rates, rather than using ones set in Singapore.
Bank Negara's plans are unlikely to have an impact on currency market flows, traders said. The Malaysian currency rose nearly 0.4 percent on the day to 3.0895 per dollar, breaching a 200-day moving average at 3.0940.
The ringgit appreciated 3.5 percent against the U.S. dollar last year as foreign investors flocked to Southeast Asian markets, but it has slipped more than 1 percent so far in 2013 on growing political uncertainty ahead of general elections.
The Malaysian currency was the second most traded in Southeast Asia after the Singapore dollar in 2010 although it accounted for just 0.3 percent of total global foreign exchange market turnover daily, according to the Bank for International Settlements (BIS).
"Malaysia and also Indonesia markets need to be deep enough to generate high quality rates," said Professor Jin-Chuan Duan, director of the Risk Management Institute at the National University of Singapore. "Or else, it becomes difficult to achieve."
TAKING AIM AT SINGAPORE'S FX MARKETS
Central banks in Southeast Asia had discussions in February to look at ways to overhaul the reference rates. They were mainly targeting Singapore's foreign exchange market, the second biggest in Asia after Japan, that has frustrated their efforts to control their domestic currencies.
At the centre of these regulators' concerns are non-deliverable currency forwards (NDFs), which allow hedging or speculation on emerging market currencies that cannot be directly or freely traded due to exchange controls.
The contracts are settled in U.S. dollars, so there is no exchange of the underlying currency, although they reflect investor expectations on a currency's direction and can affect spot exchange rates.
The biggest banks in Asian NDF markets include UBS AG , JP Morgan Chase & Co and HSBC Holdings Plc .
"Whether it's Libor or the Singapore case or anywhere else in the world, central banks need to test the prices, test traders from these banks," said National University of Singapore's Duan. "They need to see if these traders would stand by their bids and offers."
The Monetary Authority of Singapore said last year it was working with the Association of Banks in Singapore and the Singapore Foreign Exchange Market Committee to review the way the NDF rates are set.
This came hot on the heels of U.S. and British regulators cracking down on manipulation of Libor, which is used to set interest rates for around $600 trillion worth of securities.
Malaysia has a reputation of moving quickly to defend the ringgit. The country slapped on capital controls and pegged the ringgit to 3.80 per dollar during the Asian financial crisis in 1997 and 1998, blaming speculators including George Soros for a 34 percent plunge in the currency then.
While Bank Negara removed the dollar peg in 2005, a ban on offshore trading of the ringgit has remained in force ever since the crisis.
Analysts said any possible steps towards internationalising ringgit trade was out of the question with the Libor scandals and the news of forex rate-rigging in Singapore. Strong inflows into Southeast Asia has also kept the Malaysian central bank cautious.
"The Malaysian central bank wants stability and is taking a pre-emptive move," said Irvin Seah, an economist with DBS Bank in Singapore. "I don't think you will see negative reaction in the financial markets as Bank Negara is trying to smooth out the financial imbalances."