Emerging Asia needs dollar hedging reforms to reduce market risks, BIS says

By Daniel Leussink TOKYO (Reuters) - Asia's emerging economies should improve oversight of foreign exchange liquidity risks and make currency hedging more flexible as growing dollar investments make

December 6, 2021

By Daniel Leussink

TOKYO (Reuters) – Asia’s emerging economies should improve oversight of foreign exchange liquidity risks and make currency hedging more flexible as growing dollar investments make the region more vulnerable to currency swings, the Bank for International Settlements said.

Increasing wealth and ageing populations have led to growing holdings of dollar-denominated portfolios of institutional investors and asset managers in Asia’s emerging economies, the BIS said in a quarterly report released Monday.

Vulnerabilities in Asia were seen in March 2020 when the onset of the pandemic led to a surge in dollar hedging demand, creating new stresses for financial markets, the BIS, which holds regular meetings for the world’s central banks, said.

“You have this juxtaposition that demand for hedging is long-term, but the supply of hedging services is short-term,” said Hyun Song Shin, economic adviser and head of research at BIS.

“Unless you can secure long-term hedging… there is always this maturity mismatch between this supply of hedging services and the demand for hedging services.”

The issue has raised new challenges for Asia’s emerging economies. During the Asian financial crisis in the late 1990s, emerging nations’ problems centred around massive debt burdens made worse by a capital outflows and sharply falling currencies.

Trading in derivative contracts referencing the currencies of one of six Asian emerging economies – including South Korea, Malaysia and Thailand – against the U.S. dollar has risen to nearly $9.4 billion in 2019, more than double 2013 levels, the report said.

That has brought greater demand for hedging services with it, which can create new risks in times of financial stress, when demand for short-term dollar funding increases, it said.

Financial authorities should aim to increase oversight of foreign exchange funding liquidity risks created by non-bank investors, such as pension funds, insurers and asset managers, the report said.

The BIS called on Asian emerging economies to tweak foreign exchange hedging rules to offset demand for short-term dollars, such as during the start of the COVID-19 pandemic last year.

Economies could do so by allowing flexible hedging of currency risk and encourage longer-term foreign exchange hedging to address such needs among insurers and other institutions, the report said.

(Reporting by Daniel Leussink; Editing by Sam Holmes)