FX swap debt $80 trillion ‘blind spot’ global regulator says

LONDON, Dec 5 (Reuters) – Pension funds and other ‘non-bank’ financial institutions have more than $80 trillion of hidden, off-balance sheet dollar debt in FX swaps, the Bank for International Settlements (BIS) said.

The BIS, known as the central banks of the world, also said in its latest quarterly report that the market upturn in 2022 is headed without major problems.

Having repeatedly urged central banks to act forcefully to reduce inflation, it struck a more measured tone and singled out crypto market issues and September’s UK bond market turmoil.

Its main warning described FX swaps as a debt “blind spot” that risks leaving policymakers “in a fog”.

FX swap markets, such as a Dutch pension fund or Japanese insurer borrowing dollars before repaying a euro or yen loan, have had a history of problems.

When the global financial crisis and the Covid-19 pandemic wreaked havoc in March 2020, they saw the need for central banks like the US Federal Reserve to intervene in dollar exchange lines.

More than $80 trillion of “hidden” debt is estimated to exceed stocks of dollar Treasury bills, repos and commercial paper, the BIS said. That’s grown from more than $55 trillion a decade ago, while FX swap contracts totaled nearly $5 trillion a day in April, about two-thirds of daily global FX turnover.

For both non-US banks and non-US ‘banks’ such as pension funds, dollar liabilities from FX transfers are now estimated to double their balance sheet dollar liabilities.

“The missing dollar debt from FX swaps/forwards and currency swaps is huge,” the Switzerland-based firm said, citing lack of direct information on the scale and location of the problems.

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Off and on-balance sheet dollar debt

Closer

The report also assesses the broad recent market developments.

As inflation has taken hold, BIS officials have been vocal in their calls for more forceful interest rate hikes from central banks, but this time it struck a more measured tone.

Asked if the end of the tightening cycle could come next year, Claudio Borrio, head of the BIS’s monetary and economic department, said it would depend on how conditions develop, noting the problems of high credit levels and uncertainty about how sensitive borrowers are now. There are rising rates.

The crisis that erupted in UK gilt markets in September underlined that central banks can be forced to step in and intervene – in the UK’s case by buying bonds even as they raise interest rates to control inflation.

“The simple answer is it’s closer than it was initially, but we don’t know how far central banks have to go,” Borrio said of interest rates.

“The enemy is an old enemy and a known one,” he says, referring to inflation. “But it’s been a long time since we’ve fought this battle.”

Market volatility

Dino-Mite

The report also focuses on the findings of the latest BIS Global FX Market Survey, which estimates that $2.2 trillion worth of currency trading is at risk of being compromised on any given day.

The amount at risk represents a third of total deliverable FX revenue and is $1.9 trillion more than three years ago when the last FX survey was conducted.

FX trading is moving away from multilateral trading platforms and into “less visible” venues, preventing policymakers from “appropriately monitoring FX markets”.

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The bank’s head of research and economic adviser Hyun Chang Shin, meanwhile, described recent crypto market problems such as the collapse of the FTX exchange and stablecoins TerraUSD and Luna as having similar characteristics to bank failures.

He described that many crypto-currencies are sold as “DINO – Decentralized in Name Only” and that most of the activities associated with them take place through traditional intermediaries.

“It’s essentially taking people’s deposits out of unregulated banks,” Shin said, adding that it’s about unwinding large leverage and maturity mismatches, just as it was during the financial meltdown more than a decade ago.

Mark Jones reports; Editing by Toby Chopra and Alexander Smith

Our Standards: Thomson Reuters Trust Principles.

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