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

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

The BIS, billed as the central bank of the world’s central banks, also said in its latest quarterly report that the market upheavals in 2022 had largely weathered without major problems.

After repeatedly urging central banks to act vigorously to curb inflation, she adopted a more dovish tone, addressing the crypto market troubles and the September turmoil in the UK bond market.

The main warning concerned what she described as a “blind spot” for FX swap debt that risked leaving policymakers in the “fog”.

FX swap markets, where for example a Dutch pension fund or a Japanese insurer borrows dollars and lends euros or yen before later repaying them, have had problems in the past.

They saw funding constraints both during the global financial crisis and again in March 2020 when the COVID-19 pandemic wreaked havoc, forcing central banks like the US Federal Reserve to step in with dollar swap lines.

The estimate of more than $80 trillion in “hidden” debt exceeds holdings of dollar treasury bills, repo paper and commercial paper combined, the BIS said. It has grown from just over $55 trillion a decade ago, while FX swap emigration in April was nearly $5 trillion a day, two-thirds of daily global FX turnover.

For both non-US banks and non-US “non-banks” such as pension funds, dollar liabilities from FX swaps are now twice their on-balance sheet dollar liabilities, the estimate says.

“The missing dollar debt from FX swaps/forwards and currency swaps is huge,” the Swiss-based institution said, adding that the lack of direct information on the extent and location of the problems is the main problem.

Off-balance sheet and on-balance sheet dollar debt


The report also assessed broader recent market developments.

BIS officials have been clamoring for central banks to raise rates vigorously as inflation has taken hold, but this time they have adopted a more dovish tone.

Asked whether the end of the tightening cycle could be near next year, BIS Head of Monetary and Economic Affairs Claudio Borio said it would depend on how circumstances unfolded, also noting the complexity of the high leverage and The uncertainty about how sensitive borrowers are now are to rising rates.

The crisis that erupted in UK gilt markets in September also underscored that central banks could be forced to step in and intervene – in the UK’s case by buying bonds even at a time when the country was raising interest rates, to curb inflation.

“The simple answer is you’re closer than you were at the beginning, but we don’t know how far central banks have to go,” Borio said of interest rates.

“The enemy is an old enemy and known,” he added, referring to inflation. “But it’s been a long time since we fought that fight.”

market volatility


The report also focused on the results of the latest BIS global foreign exchange market survey, which estimates that $2.2 trillion in foreign exchange trades are at risk of not being settled on any given day due to problems between counterparties, potentially causing the undermines financial stability.

The amount at risk represents about a third of the total FX turnover attainable and is up from $1.9 trillion from three years ago when the last FX survey was conducted.

FX trading also continues to shift from multilateral trading platforms to “less visible” trading venues that prevent policymakers from “properly monitoring FX markets,” it said.

Hyun Song Shin, the bank’s head of research and economic adviser, meanwhile, described recent crypto market troubles like the collapse of the FTX exchange and stablecoins TerraUSD and Luna as having similar characteristics to bank crashes.

He described many of the crypto coins sold as “DINO – decentralized in name only” and that most of their related activities took place through traditional intermediaries.

“These are people who are essentially taking deposits at unregulated banks,” Shin said, adding that it was mostly about resolving major leverage and maturity mismatches, just like during the financial crash more than a decade ago.

Reporting by Marc Jones; Arrangement by Toby Chopra and Alexander Smith

Our standards: The Thomson Reuters Trust Principles.

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