Legal framework for commodity options contracts in Vietnam: remaining challenges

On June 26^th 2023, the Mercantile Exchange of Vietnam (MXV) officially launched nationwide trading of commodity options contracts, marking a significant milestone in the development of Vietnam's financial and commodity markets. This is a commendable effort to integrate with international standards and promote the widespread use of options contracts on other underlying assets. However, this nascent market faces numerous regulatory challenges that pose risks to investors and hinder sustainable development.

Pursuant to Clause 3, Article 64 of the Commercial Law 2005, a contract for the purchase or sale of an option is an agreement under which the buyer of the option has the right to buy or sell a specified commodity at a predetermined price (known as the strike price) upon payment of a certain amount (known as the option premium). The option buyer has the right to exercise or not exercise the right to buy or sell such commodity.

Pursuant to Decision No. 556/QD/TGD-MXV of the Mercantile Exchange of Vietnam, which specifies the Commodity Options Contract traded on the Mercantile Exchange of Vietnam, eight option products will be available for trading starting from June 26^th 2023, including: Corn (CBOT), Soybean (CBOT), Wheat (CBOT), Arabica Coffee (ICE US), Sugar 11 (ICE US), WTI Crude Oil (NYMEX), Brent Crude Oil (ICE EU), and Natural Gas (NYMEX).

Risk management and investors protection mechanisms

The commodity options market is a high-risk derivative financial instrument. While financial products such as stocks and bonds are clearly regulated by investor protection laws such as the Law on Securities 2019, derivative securities such as commodity options still lack a detailed legal framework. Specifically, the Securities Law requires securities participants to provide investors with full information about financial products, services and potential risks. However, for commodity options trading, there is no legal system that provides detailed guidelines on how to disclose this information transparently and on measures to protect investors' rights, which increases the risk of market abuse or price manipulation. This also leads to other negative consequences, such as retail investors suffering losses due to the lack of transparency in pricing information and market conditions. In some cases, investors may not receive timely warnings when the market is experiencing sharp fluctuations, leading to poor decision making and financial losses. The lack of support tools, such as early warning systems or automated risk management, is a significant barrier for market participants.

In the United States, the Commodity Futures Trading Commission (CFTC) requires exchanges to publish data on prices and trading volumes, enabling investors to assess and manage risk[1]. Implementing similar regulations and institutions in Vietnam would allow investors to anticipate market fluctuations and protect them from unnecessary losses.

In addition, Vietnamese investors also face counterparty risk (where one party fails to meet its obligations) and liquidity risk (where investors are unable to buy or sell an asset in the time required to realise its fair value). In contrast, exchanges in countries such as Japan and Korea have implemented risk management mechanisms such as reverse options (which give the holder additional conditions or flexibility in exercising the option) and insurance contracts to mitigate losses during periods of market volatility[2].

Tax harmonization for different financial transactions

In Vietnam, tax regulations for financial transactions, particularly commodity options contracts, remain vague and inconsistent. This creates difficulties for both investors and companies in fulfilling their tax obligations.

According to the Law on Tax Administration 2019, all income from financial transactions must be declared and taxed. However, for commodity options, there is no specific guidance on how to calculate tax on gains from these contracts, which makes tax reporting complex and inconsistent for investors. If an investor exercises a put option and gains from the transaction, it remains unclear whether corporate or personal income tax should be applied to such gains. This creates difficulties for investors and companies in preparing financial statements and complying with tax rules. In addition, the lack of coordinated rules between tax authorities and commodity trading regulators hampers the monitoring and collection of taxes from commodity options transactions.

To address this issue, the author suggests that Vietnam could adopt an approach similar to major financial markets such as Singapore and the United States, where specific tax rates are prescribed for each derivatives transaction. This would increase tax transparency and efficiency. In the United States, gains from options contracts are clearly classified as taxable income, and investors are required to accurately report this income to the Internal Revenue Service (IRS)[3]. In contrast, the ambiguity in Vietnam's tax regulations can expose investors to legal risks, particularly in the event of audits or investigations.

In this era of globalization, tax structures need to be more flexible to not only to ensure tax compliance but also to encourage market development. A flexible tax policy based on the type of product traded, risk level and holding period is the way forward. This would not only create a fairer tax system but also encourage long-term investment, leading to sustainable market growth. In addition, transparent and simplified tax declaration and payment procedures for commodity options would facilitate both domestic and foreign investors. Detailed guidelines on how to report income from these transactions, along with tax breaks or incentives for long-term investors, would be an important step in attracting investment and promoting the international integration of Vietnam's financial market.

A rigorous oversight mechanism to prevent market manipulation and fraudulent activity

Commodity options are complex financial instruments that give the holder the right to buy or sell an underlying commodity in the future at a specified price. Their complexity makes them susceptible to market manipulation and fraud. To ensure market integrity and fairness, regulators need to establish a comprehensive and effective oversight framework.

Firstly, there is a need for cooperation between government regulators and self-regulatory organisations in the financial sector to enhance the effectiveness of supervision and create a stable legal environment. The State Securities Commission of Vietnam should cooperate with the Mercantile Exchange of Vietnam to monitor and assess commodity options transactions. By sharing data and information, these agencies can promptly detect anomalies and prevent market manipulation. This cooperation should also include consultation and cooperation with international organisations to ensure the application of international standards in supervision, thereby contributing to standardisation and integration.

Secondly, advanced technology should be implemented in the surveillance system. The US Securities and Exchange Commission's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system is a prime example of a powerful tool for detecting and preventing market manipulation and fraud.  By collecting vast amounts of trading data, including price, volume and time information, and using advanced machine learning algorithms to analyse patterns, EDGAR can identify suspicious trading activity, such as high-frequency trading or transactions between related accounts. When anomalies are detected, the system automatically generates alerts for SEC analysts, who can then conduct further investigation and take appropriate enforcement action.

In particular, this automated trading surveillance system is continuously enhanced to counter increasingly sophisticated fraud techniques. The system not only uses data from past fraudulent activity to improve its detection capabilities, but also regularly updates its algorithms and models. This allows the system to adapt to changes in trading behaviour and emerging market trends, thereby enhancing the effectiveness of surveillance. Implementing a similar surveillance model for Vietnam's commodity options market could therefore provide similar benefits, and should be considered by regulators in the near future.

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