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FX swap debt a $80T 'blind spot', global regulator says

94 points1 yearreuters.com
danielmarkbruce1 year ago

They should mention that each "debt" has a counter party that has an "asset". Ie, net zero. Which doesn't resolve the liquidity issue, but it's not a black hole like they make out. In addition, it's not clear they are netting across all transactions. Many of the players in this market have offsetting positions.

It's derivatives. It is what it is. Marking everything to market all the time isn't a great answer either.

naveen991 year ago

If some of those counter parties go chapter 11, the resulting black hole will cause some tidal waves as it pulls the dominoes.

danielmarkbruce1 year ago

Yep, that's the derivatives market. And the insurance market. And many other markets where transactions are set up and then play out over time. It is what it is.

travisluis1 year ago

> And the insurance market.

No. Insurance is subject to the "insurable interest" doctrine, which generally prohibits using insurance as naked speculation. There are also far more backstops, reserve requirements, government guarantees, etc., designed to prevent this kind of implosion. Not saying it doesn't happen, but we've had since the South Sea Bubble to learn how to regulate insurance to prevent this kind of thing.

The key difference is that insurance is generally regulated from a consumer protection perspective, since many insurance lines are sold directly to unsophisticated consumers. CDSs are, by contrast, sold primarily these days to sophisticated financial speculators, who are presumably fully aware of the kinds of risk involved.

+1
dh20221 year ago
danielmarkbruce1 year ago

And yet insurance companies go belly up. Google "failed insurance companies". Remember just 15 years ago? MBIA, Ambac, AIG?

Regulation doesn't get rid of the risk. And it's got zero to do with naked speculation. We simply cannot make risk disappear. Contracting with someone else to eat the risk creates a new risk. Counter party risk just doesn't go away, despite our hopes and dreams.

bombcar1 year ago

Even with insurable interest you can have an insurance company wiped out by fraud, mistakes, or (most likely perhaps) a mass event that causes claims at the same time.

This is why flood and earthquake insurance often end up being (underfunded) and run by the state.

thfuran1 year ago

But is it what it should be?

+1
vkou1 year ago
danielmarkbruce1 year ago

It's all that it can be.

JumpCrisscross1 year ago

> that's the derivatives market

These are run through clearinghouses in most money centre jurisdictions.

totalZero1 year ago

Sometimes. Yet you can find a substantial over-the-counter segment of the derivatives business in most major financial markets.

temp_account_321 year ago

They don't think it be like it is, but it do

CurrentBias1 year ago

Lol. Lmao

naveen991 year ago

Which book are the transactions recorded in, and how many books are there ? Maybe some Enron accountants can come out of retirement or get early parole to help ?

It’s the pension fund take on overpromise and adultery.

+1
danielmarkbruce1 year ago
fnordpiglet1 year ago

Counter parties go bankrupt all the time. Usually you’re faced with not receiving floating or not paying floating, and loss of your upfront fees for the contract. This isn’t a huge blow usually. Sometimes swaps blow up a counter party and you can’t get a windfall because they can’t pay it, but this isn’t a material loss but an opportunity loss.

xwolfi1 year ago

The problem is the amount and the lack of supervision. Granted, supervision alone isnt enough if the superviser let it happen anyway, but they're "ohla, it's getting a little bit worrying, can you unswap all this or at least show us all your card so we can force you to be capitalized like banks".

danielmarkbruce1 year ago

Exactly. This is what BIS is highlighting. It's big and it's hard to watch from a system perspective.

yourapostasy1 year ago

Lest we throw rocks while we live in glass houses, counterparty risk is rampant in software ecosystems as well, especially distributed and cloud environments. This is an old, old problem in complex environments.

I've yet to find a solution that tracks down every dependency from a call made inside an application that crosses many platform boundaries. There are dependency mapping "solutions" but they all are incomplete inventories at best, and I've yet to find one that acts as a metadata repository for distributed tracing solutions.

I would really like an AOP-style way of attaching code, turtles all the way down as much as possible, that shows me all dependencies and each of their various affiliated sensors and probes that get automatically called for known failure modes whenever there is an unexpected value, and when an unknown failure mode happens dumps all the sensors and probes instead of just a stack trace. I want to be able to attach such tracing code to third party code without causing their support teams to suck in their breath through their teeth and with a grimace tell me they can't support that "modification". These days, I not only need a call graph, I need the exact state of everything when something broke because I increasingly see Heisenbugs in environments due to various pressures in software development, and most vendor support teams' way of collecting data is woefully inadequate in cloud/distributed ecosystems.

time_to_smile1 year ago

Ah, the classic "this is fine" comment on any HN article suggesting that we may have been underestimating the scale of systemic risk.

The issue that BIS is raising isn't the mere existence of derivatives. It's both the scale of debt and the lack of public visibility into it.

The concern BIS has is basically that policy makers are making decisions that can have major impacts on price of the dollar and global interest rates. Given both the scale of this debt and it's lack of visibility, BIS is pointing out that policy makers might not have all the information they need to make safe decisions.

It's neither a case of "the sky is falling" or "it is what it is". This is absolutely something that should not be shrugged off with a "meh" which is why BIS wrote the report in the first place.

danielmarkbruce1 year ago

Look at the footnotes on page 71 of the BIS report. They know they are significantly overstating it and yet can't be bothered figuring it out, or making the best estimate they can.

And then the reuters report lede makes it sound like pension funds are short $80 trill. People on this thread think it's what is being reported.

It's awful.

lazide1 year ago

The reality is, there is no apparent limit to the side effects of monetary policy. If they attempted to quantify all of them, they’d never be able to do anything, good or bad.

So, they look at the ones that have historically caused the biggest issues and are causing the most obvious pain right now, make changes that hopefully give others time to adapt to without catastrophic issues, and cross their fingers.

If the things that explode are within the scope and scale expected? Then success.

If not? Try to figure out what happened, and try to do better next time.

There is no ‘good’ decisions in these situations, even doing nothing has major costs. It’s about the least bad decision, and trying to avoid taking on unnecessary risk and hence unnecessary pain.

so far CDS’s are a potential problem, but not as big of a known historic problem as economy wide out of control inflation.

So, off we go.

brookst1 year ago

Ah, the classic "anyone who adds context to a hyperventilating article must be 100% embracing any real issue that the article misrepresented" comment ;)

halpmeh1 year ago

These are FX swaps, so you can't really say that "it is what it is." Currency and interest rate fluctuations can cause massive changes to the market. The pound literally almost collapsed just a few weeks ago due to interest rate swaps forcing a fire sale on gilts.

danielmarkbruce1 year ago

They can. It did. It is what it is.

halpmeh1 year ago

And then the Bank of England intervened because they saw trouble in the market. That's not "it is what it is." That's "with proper insight into important market positions, economic catastrophe can be avoided."

danielmarkbruce1 year ago

Central banks have monitored derivatives markets for decades, will continue to do so and will step into the markets as a backstop from time to time. It's not going anywhere. FX swaps are critical for global trade and investment.

solumunus1 year ago

> They should mention that each "debt" has a counter party that has an "asset". Ie, net zero.

In an ideal world sure, yet naked shorting and similar practices are rife. There are ways around these things.

LudwigNagasena1 year ago

It’s not really net zero. The problem is that the value of that “asset” may get to zero because the debt is not going to get repaid.

danielmarkbruce1 year ago

As the fx swaps roll off, payments will be made and the "debt" will in fact go to zero.

kasey_junk1 year ago

This feels pretty sensationalist to me. The report is irritating because it lumps 80% of the fx ‘debt’ into 1 big bucket of “less than 1 year”. But a huge swath of those transactions are cleared in days.

One of the main reasons to do a currency swap is to handle liquidity mismatched more efficiently than going to the currency markets. Firm a has x dollars now but needs to pay out a fixed y currency 2 days from now. Another firm (or set of firms) has the opposite problem.

A currency swap is agreed to with a fixed exchange rate/ fees which can be much much lower than the market rate as there is no fx rate exposure to hedge. That’s why it’s off balance sheet. It’s perfectly 1:1. There is counterparty risk but it’s much much cheaper and less risky to deal with that than the corresponding credit line plus fx exchange that the swap is replacing.

I can see how it makes central bankers nervous because they don’t have insight into it, but it’s strictly less risky than the alternative.

spiantino1 year ago

Calling the total notional value of a pile of swaps "debt" is really misleading. If you and I do $1m in fx swaps, in no sense do either of us owe each other $1m. Currency swaps settle daily I think, so if one of us goes bust all that happens is that I don't get your payments and my currency risk goes back to what it was.

Anyway, headline is sensational enough that I'm not willing to read the article

spiantino1 year ago

OK I lied and opened the article:

"FX swap markets, where for example a Dutch pension fund or Japanese insurer borrows dollars and lends euro or yen before later repaying them, have a history of problems."

Isn't this false? If we do a swap nobody borrows anything, we just agree to track the returns and pay the difference in one direction or another. An FX forward does the same thing, but actually involves borrowing from a bank, which is why the swap is easier.

Anyway that's my understanding

kasey_junk1 year ago

Most fx swaps have a future component, but either the rate will net out or the difference will be paid back.

This minimizes credit costs and fx exposure by trading it for counterparty risk.

The report is suggesting that a liquidity crunch specifically on dollars that need to be delivered in the future may create systematic counterparty risk that central banks will need to solve.

WastingMyTime891 year ago

Yes, it’s a completely sensational headline.

Anyone with a modicum of knowledge about international finance knows that FX swaps are used to hedge currency risk.

As far as I know (not much to be fair - my business school education is far away and I don’t work in the field), they are not a very popular speculative investment.

CyanBird1 year ago

> they are not a very popular speculative investment.

That's the thing that's being argued from bis. That they have become popular speculative investments in wallst

kasey_junk1 year ago

It’s very much not being argued that the increase is due up speculative wall st bets.

The bis report quite clearly points out that the vast majority of the swaps market dollar obligations are outside of the us and nothing about the report suggests it’s due to speculation.

Rather it’s about the central bank policy issues with the way the swaps are accounted for and their short term nature.

blitzar1 year ago

CLS is very well collateralised and covers effectively all of the short dated FX. If central bankers want an insight it is a phone call away and there is nothing to see there.

pedro_hab1 year ago

I agree with your point here, but I am curious if there isn't space for people to gamble and not be hedged? Speculating naked with the contracts.

kasey_junk1 year ago

Sure, anything derivative can be misused but the regular currency markets and currency futures are much simpler and higher leverage.

naveen991 year ago

Global gdp is around $100 trillion. I would think you need about a year to roll over $80 trillion. Don’t think you can do a lot more than 2-4% / week.

whatshisface1 year ago

GDP calculations don't include this kind of stuff.

treebeard9011 year ago

There are many liquidity problems brewing that when combined create a dangerous and uncommon financial environment.

Other than the changes happening with the U.S Dollar as global reserve currency, some of this manifests itself in the Reverse Repo Market. You can see over the last several years and since the 2008 crisis that it has grown exponentially. This typically can be used as an indirect measure of Treasury Liquidity as a whole, which Yellen at the Treasury has been warning about.

With this comes an unwinding of quanatitiavive easing, also in place for over a decade and will continue to have unknown effects. It's safe to assume that much of the economy and zombie companies were able to exist on basically free money.

As all of this comes together, and if the robbing peter to pay Paul economy continues where trillions can be created just by modifying a balance sheet, then things could end very poorly.

Pension funds, real estate both commercial and residential, and many other factors could lead to a bond market crash and a debt crisis that would have no way out since everything is so over leveraged on easy money already.

While the future of inflation is up in the air, it remains to be seen if the Fed can manage all of these actions without causing a severe recession.

We might find that a bandaid was put on the global economy after 2008 and much of the structural problems remain.

Government spending on all kinds of things will have to be reduced along with the Feds balance sheet and where this leads is unknown.

pphysch1 year ago

2008 was maybe the last moment when Washington could've credibly pivoted and attempted to tackle the debt problem with massive, uncomfortable structural changes.

Instead, they chose to kick the can down the road, the use every conceivable tool to "cheat" the global financial system and preserve Washington's hegemony over it.

Since 2008, the national debt has gone from $10T to $30T.

The only way out at this point is a total collapse of the foreign US debt markets and a hard pivot away from USD as global reserve currency. The rest of the planet is not going to keep getting ripped off like this. Even if Washington tries to start paying down its debt, it's gonna take way too long at this point. The jig is up.

wins327671 year ago

There is nothing to replace it. The reason the US dollar is the global reserve currency now is that the US is the only nation who is exporting enough currency to allow any two arbitrary counterparties anywhere in the world to get their hands on a common currency. And the only way the US can export that much currency is to run a persistent and structural trade deficit financed by debt. No one else has a big enough economy to throw off that much currency other than maybe China and the EU and neither of those want to dislocate their main economic engines by becoming huge net importers.

gameshot9111 year ago

Like democracy is for governments, the USD is the worst currency, except for all the others.

There's a reason the world always floods to USD in times of crisis.

onlyrealcuzzo1 year ago

> Pension funds, real estate both commercial and residential, and many other factors could lead to a bond market crash and a debt crisis that would have no way out since everything is so over leveraged on easy money already.

Why is the easy way out not 50% or 100% or 200% inflation?

It's massively unfair. But it's a lot easier than a decades long depression.

One could argue that the renter class of the world has gone through a decade long depression already from 2008.

Not sure why they wouldn't just keep that going indefinitely...

echelon1 year ago

> changes happening with the U.S Dollar as global reserve currency

Could you expand on this? Where, how, and to what level is this occuring? Is it due to the geopolitical tensions with Russia and Saudi Arabia with respect to oil? Is China making a big move with RMB?

treebeard9011 year ago

I am not aware of any real long term metrics to track reserve currency usage worldwide. One of the many ways the dollar system is reinforced is by the old idea of the petrodollar. Some would say this has been in place since the 1970s. It's not the entire picture of what makes the dollar the reserve currency, maybe the U.S. Navy can ultimately take credit for it along with the historically liquid financial system behind it.

With that being said, much of this system relies on the Treasury market. Saudi investment seems to move based on which political party is in power. Russia has a complicated relationship to the petrodollar as well and has grown more complicated since Crimea in 2014...

Part of the staying power of this system is arguably technical because of SWIFT. The double edged sword of using sanctions for geopolitical goals has driven other means of settling international payments even for things like oil. It's less ideal than the system used to be but in the oil producing countries, it's better than being at the mercy of the U.S.

Even Japan, which acts as a sort of off shored Federal Reserve given their historical bond holdings has recently cut back and said they plan to cut back more.

China also has complicated the picture. The trade war changed many fundamental inflows and outflows and as time goes on more countries will find ways to trade without relying on the dollar.

This can be patched over by something like quantitative easing where the Fed steps in to provide liquidity that global trade used to provide, but there is a cost to that as well since they are kind of stuck in a trap of inflation vs job loss and recession. Assuming inflation continues.

Don't get me wrong though, the US dollar is still the reserve currency and will be for some time. It's just that the mechanics behind it can and do change and is something that I feel is not widely understood.

How about that Bancor though?

Workaccount21 year ago

Watching congress grill Powell, it doesn't look like the government is keen on doing anything except blame the fed.

Early on I was hoping that Biden, seeing the writing on the wall that he can't do a second term, would step up and be the fall guy for the "terrible policy" of cutting spending and raising taxes. Looks like that isn't going to happen though.

mistrial91 year ago

Joe Biden and his people have historical roots with the same groups that participate in the economy of Argentina, modern Spain and a host of small other countries. The M.O. is to be the great protector, incapable of error.. meanwhile slick PR to gloss over, dismiss or ignore any and all problems, as long as the leadership remains intact.

I believe the original authors of the Constitution of the USA would be familiar with much of this, from a command and control perspective. Elaborate insurance and futures markets were already several hundred years old at that time, right?

amar-laksh1 year ago

Here's the original BIS report, I don't understand anything, hopefully someone will: https://www.bis.org/publ/qtrpdf/r_qt2212.pdf

googlryas1 year ago

The fact that Wallstreetbets and superstonk have picked up on this is a sure indication to me that this means absolutely nothing at all. Their track record approaches 0%

tyleo1 year ago

What? Sure there is a lot of chaos in WSB but they really were onto something with GME and literally squeezed some institutional investors into bankruptcy.

Sure, they are mostly smoke but their mere interest in something doesn’t disqualify it.

googlryas1 year ago

WSB ignored or laughed at roaring kitty until he showed actual large gains, and then they jumped on. They never proactively got anything right as far as I know.

Firmwarrior1 year ago

Man, you just dredged up a painful memory

I was there watching him get shat upon, and thought "Man, maybe this guy's on to something.. ah, screw it, it's not worth the risk"

He was consistently posting about GME for a long time, slowly losing his life's savings to its mediocre performance in the process and getting laughed at by everyone. Before GME took off, he'd actually stopped posting to WSB for the most part since he'd get jeered about it so much, haha.

wavesounds1 year ago

"their mere interest in something doesn’t disqualify it" - It certainly raises suspicions though. It really feels like certain groups have gotten good at turning particular news events or ideas into memes and sharing them as widely as possible in order to push a narrative that manipulates the markets. Which is probably why this story is now on the front page of HN. We certainly saw this with crypto and now it feels to me at least like those same tactics are being applied more and more to the larger stock market.

tyleo1 year ago

I agree with this point. It isn’t the case that WSB interest disqualifies the viability of financial information… but it also doesn’t make it more credible.

The point I disagree with (and I think the original post is making) is just because an unpopular group (WSB) is interested in something, doesn’t discredit it.

+2
this_user1 year ago
mox11 year ago

So 'superstonk' was created after all that. It was basically the crazies from WSB after the WSB mods wanted to tone down the conspiracy theories.

Prior to the GME squeeze, the talk on WallStreeBets was basically "GME is sound fundamentally, its got +revenue AND its shorted to hell, conditions are right for upward movement".

It wasn't about sticking it to anyone, screwing hedge funds, etc, it was like "we think short sellers are perhaps screwing up here, we suggest you buy some GME".

ixnay1 year ago

They weren't on to something with GME, their enthusiasm was its cause.

tyleo1 year ago

This is plainly wrong. Their enthusiasm did not create short interest in GameStop, they simply took advantage of it.

brookst1 year ago

Sure, but it was self-fulfilling. It wasn't a brilliant analysis, it was a demonstration that a large group of loosely coordinated individual investors can move markets by collective action.

pgwhalen1 year ago

What exactly were they “onto” with GME? It isn’t exactly news that an investor with a short position will blow out if the stock increases in value by 10x or 100x.

Invictus01 year ago

Something like 140% of outstanding GME shares were shorted. They figured that out and then exploited it.

+1
david9271 year ago
tyleo1 year ago

“It isn’t exactly news that…” interesting that you say this considering it literally was news for weeks. Short squeezes are rare events.

Fact of the matter is WSB was right about GameStop when other investors were not. It may seem obvious now but was certainly not at the time.

pgwhalen1 year ago

You've misread my comment. Of course it was news, but it didn't reveal anything spectacular about the structure of the financial markets, at least certainly not something WSB predicted ahead of time (as other commenters note, Superstonk only arose after the GameStop situation to concentrate financial conspiracy theories to that sub alone).

david9271 year ago

That's bizarre logic. I'm a fan of Superstonk (WSB is long over). There's another couple years to go to see the track record. We'll see.

paywallasinbeer1 year ago

>I'm a fan of Superstonk

Out of curiosity, why is that? Would you care to prove the profits you've made from following GME?

rcarr1 year ago

Not a finance expert so apologies if any of this is wrong but from my understanding there’s a new strategy now. The theory, is that stock brokers are taking advantage of a mechanism which allows them to create and trade hundreds of thousands of ghost shares in GME that don’t really exist which, if true, means they can never lose and the casino is rigged. Superstonkers are direct registering their shares which means stock brokers don’t have any ability to trade them. The theory, is that once they direct register all the available shares it will expose the number of fake shares the brokers have created causing the mother of all short squeezes as people start calling in their positions but there are no real shares available for the brokers to purchase and fulfil their positions. The superstonkers think this will be enough to crash the entire market and expose the traders to fraud as there will be no legitimate reason that will hold up in court for the vast quantity of these imaginary shares - they believe the quantity will vastly outweigh the acceptable number that could be created for the purposes of the mechanism. The percentage of the shares that have been registered so far is around 60% and growing. Whether the Superstonkers are right or wrong about the outcome won’t be able to be determined until they reach 100% or maybe close to it if the brokers start panicking beforehand and a short starts.

I don’t have any shares but it is really fun to watch as an outsider.

+1
jcranmer1 year ago
+1
yucky1 year ago
david9271 year ago

Why do I need to show profits after six months? Would you say that of AAPL? I'm convinced that the hedge funds didn't close their shorts. Like legions of others, I've directly registered my shares and am willing to wait.

fnordpiglet1 year ago

Notionals on a swap have nothing to do with their risk exposure, but they have everything to do with clickbaiting the public and getting politicians elected.

dang1 year ago

Can you explain more? When a story is clickbait, it's helpful if knowledgeable people help the rest of us understand.

fnordpiglet1 year ago

Yes sorry I was going to do that as an edit after I had a chance to read other comments.

First, the article meanders through a lot of unrelated stuff like crypto markets and interest rates and inflation. These add nothing to the subject, please do not be confused by it.

Second, what’s being quoted is a notional on a swap, which is the reference amount being indexed on in the contract.

Some background: There are different types of swaps, some of which have been standardized via ISDA agreements, or are being cleared on an exchange or other multiparty platform that provides some standardization and doesn’t require a “bilateral” contract that’s between two counter parties, often paired by a securities market maker - but historically they’re “over the counter” and bilateral in that there’s no market or exchange, it’s just an agreement.

I’m that agreement or contract there’s a reference currency pair in the case of fx swaps. Say it’s USD/EUR - I.e., the exchange rate between USD and Euros.

The notional is the amount of that indexed pair. They’re are often enormous amounts. Much more money than either actually have on hand. But, they’re often used against things like non repatriated earnings - which can be enormous. Those earnings are never involved in the contract mind you, but are instead referenced as the notional.

The two counter parties in the contract agree to swap a risk in a swap. Typically they can be conceived of the seller gives the buyer currency at the current exchange rate. The buyer simultaneously issues forward contracts to the seller. The difference between the two is the swap point. This swap point is where profit and losses lie, and it’s a very small percentage of the notional. I’m not as familiar with OTC swaps in FX, but typically there’s no need to actually swap assets but rather agree to pay the PNL without owning the underlying assets.

What’s at risk is the payouts, which are no where near the notional value of the swap.

The article however implies notional values are somehow debt owed. They further imply that they’re “hidden,” but generally bilateral contracts aren’t disclosed securities by many participants in the market. The real ask is embedded deep in the article which is BIS wants to see more of these transactions settled via a standardized clearing house or exchange that usually have reporting requirements. The BIS is worried this returns us to some of the opacity before the financial crisis.

As someone who worked many years as a quant in the space of credit default swaps, which has largely standardized to my understanding, I do not agree. OTC has its place and cleared has its place. Some markets don’t have a successful place to clear in the open. But it’s not hiding anything, and it’s absolutely not hiding debt, nor are these instruments dangerous.

kasey_junk1 year ago

Currency swaps range the gamut from _extremely_ short period swaps (read hours to days) to very long period swaps (I've never heard of one bigger than 5 years but they may exist).

The short period swaps are almost pure liquidity imbalance mitigation techniques. It's cheaper and less risky to do than the equivalent bridge loan plus fx transaction. In these cases the notional really is fully owed on a future leg, but a) its a really small number and b) the counterparty risk is miniscule. These happen a lot. Large treasury groups may be making hundreds of swaps a day if they have lots of multi-currency cash flows, so the notionals can add up even though the actual dollar amounts per swap are small.

The longer period swaps I have a lot less expertise in, but in my experience they are modeled like CDS' and your premise is right. The notional largely doesn't matter as its the cash flow that is at risk.

As far as I know, in _neither_ case do people write the legs as 'debt'.

+1
fnordpiglet1 year ago
kasey_junk1 year ago

80T in 'debt' is not 'debt' in the way most lay people would call debt (in fact most industry people would not consider this debt at all). Further, the lead about 'pension funds' is just a straight up bad pull quote. The BIS report uses a pension fund as one type of financial institution that uses swaps, without singling them out specifically.

A better headline would be "Central Banks should spend more time researching US Dollar domination of FX/Currency Swap market)".

fnordpiglet1 year ago

From the summary of the section of the report I think this is the extent of the BIS concern - a move away from cleared to otc bilateral agreements dilutes the utility of post financial crisis asset reporting. This is not an exciting topic, and can’t sell advertisements.

“”” In the FX space, an accelerating shift towards less “visible” trading venues and bilateral trading may reduce the information content of prices and the network benefits of integrated markets. “””

They are spot on here. But there’s no doomsday coming from having prices off market or integrated markets. These issues are issues of efficiency rather than doom and gloom.

My revised headline would be:

“Reporting quality in FX Swaps is reduced by use of Over The Counter bilateral agreements instead of clearinghouse.”

But no one will buy Herbalife with that headline.

LatteLazy1 year ago

I think this is Exposure, not Debt right? If you borrow in USD and lend in non-USD, then the asset and the debt balance (roughly) and you are Exposed by $X to fluctuations in the value of USD. But you only actually lose $X if the other currency (Euro, Yen etc) becomes worthless.

Also, how reliable are these numbers? If I borrow 1tn USD and turn it into 1.1tn EUR, then borrow 1.1tn EUR and turn it into 1tn USD then my actual exposure net is zero in either currency. But journalists and sensationalists like to pretend that is 2tn USD and 2.2tn EUR...

Finally, and this is just my ignorance: why are swaps not on balance sheets? It's pretty simple with an FX swap like these to just list the (USD) liability and (non USD) asset and convert using today's rate to whatever actual currency you report in. I understand that swaps are a dumb way for pension funds to ratchet up their risk while pretending they are investing in low risk securities but that should not change how they are reported...

mikeyouse1 year ago

It's been too long since I've studied the details, but it's my recollection that the value at risk is on the balance sheet, it's just the notional amounts that aren't. The BIS hypothetical is that if markets freeze up and you can't buy one leg to cover your swap, you could be left with a huge liability.

Edit -- actually BIS has a little accounting example with two options noting that most people use the net basis as I remembered but they would prefer the gross basis: https://www.bis.org/publ/qtrpdf/r_qt1709x.htm

naveen991 year ago

Maybe the balance excel sheet needs a column for notional value / leverage also.

tomojola1 year ago

I agree that hte headline is deceiving, $80TN is not the right number

The correct number is closer to $26 tn , based on the BIS report and the REAL risk is the market risk exposure to equity from the assets that these loans fund.

In these contracts the borrowers lose money when the value of the asset they hold deviates from FX. if you borrow $500mm to buy AAPL stock and AAPL stock is down 10% you lose $50mm dollars. You needed to post 476MM EUR at the beginning with the expectation of receiving the same amount in 7 days and on that same day you would pay the USD 500mm you borrowed back.

You expect to do this 1000's of times, or until you sell AAPL stock.

If at the same time EURUSD moves from 1.05 to 1 when it comes time to "roll" your transaction, you need to find an extra 25mm EUR. Now the $500mm of debt requires 500mm EUR of collateral. If AAPL was up, you could sell some of it to cover the roll, if its down like in my example you have a $50mm and EUR 25mm are real equity losses.

I think these swaps are not on balance sheet because of accounting history. Generally the swap is described above woudl be held as a EUR 25mm derivatives payable. so on the balance sheet it goes from 0 to $25mm liability.

The REAL balance sheet, in addition show a EUR 475mm asset, a loan receivable & a 500mm borrowing a loan payable.

Unlike single currency derivatives , you MUST pay the full notional at maturity, you do not get to just net the $25mm owed, so generally your only options are to buy USD outright, using equity or local currency borrowing, in the entire size then send it to the counterparty, or to sell the USD asset to cover.

Also you are getting margined every day so it eats into equity...

rundmc1 year ago

The OECD has just published it's updated Pensions Outlook which explains to governments how to implement Asset Backed Tontine style pensions to make the global pensions sector more financially robust and to better serve the needs of retirees.

The team here at Tontine Trust (https://tontine.com) are committed to adding a "Proof of Reserves" feature that will prevent the above quoted shenanigans by exposing the assumptions being relied upon to keep the auditors happy but that the pension funds may not want their members or the public at large to know.

https://www.oecd.org/pensions/oecd-pensions-outlook-23137649...

etothepii1 year ago

Tontine's are illegal in the UK.

Edit: since the passage of the Life Assurance Act 1774 tontines have been illegal in the UK.

rundmc1 year ago

Perhaps you should send your supporting evidence to the UK government because right now they are going all in on shifting the pensions industry to a Tontine style CDC model. The email of The Pension Regulator is report@tpr.gov.uk

Don't forget to come back here to update your comment once you get a response.

https://www.oecd-ilibrary.org/sites/20c7f443-en/1/3/5/index....

qaq1 year ago

Is this actual thing or notional value of swaps? Cause scary numbers are good for clicks but might be fairly meaningless.

lucozade1 year ago

FX swaps swap the principal amounts. So a default between the spot and forward legs can leave you with a chunky liability.

Unlike single currency interest rate swaps where the principal is notional in the sense that they aren't exchanged, they're just used to calculate the coupon exchange.

AnimalMuppet1 year ago

OK, but "chunky" is still much less than the notional value, right? (I mean, if one currency suffered runaway inflation, it could approach 100%, but that should be rare...)

lucozade1 year ago

It's not a notional principal for a fx swap, it's an actual principal that you swap. If your counterpart defaults, you're still liable for what you owe (usually multiple millions) but you won't receive the other side.

snake_doc1 year ago

But in a sense, only the cost of capital is at risk, not the capital borrowed. The 80T number is capital borrowed. It’s definitely worthy of skepticism.

It’s definitely a liquidity risk given the short term and principal swaps requirements, hence mostly a central bank issue as a backstop. But potential losses in economic terms seem smaller.

qaq1 year ago

Thank you for the explanation, I guess time to be concerned.

secondcoming1 year ago

I fully expect to never see any of my pension. I still contribute to it as it's tax efficient (UK) but the financial fiasco caused by Liz Truss already lost my pension some money.

Years ago I bought some gold for shits 'n giggles, but I may buy some more.

lotsofpulp1 year ago

You will receive a benefit, but you will not be able to purchase as much as you might have expected to with the benefit.

gitfan861 year ago

This is the right way to look at the issue. It is the same way you should look at Bitcoin. It is very possible Bitcoin will hit 100k someday. But the interesting measurements will be how many loaves of bread can you buy with that one Bitcoin at that time.

TacticalCoder1 year ago

> Pension funds and other 'non-bank' financial firms have more than $80 trillion of hidden, off-balance sheet dollar debt in FX swaps, the Bank for International Settlements (BIS) said.

Ah yup pension funds. In some countries they're mandatory: money is forcibly taken out of your salary to put into pension funds. Which may or may not give money back to you in 30 years once you retire. A few weeks ago the governor of the bank of England said pension funds were "hours away from collapsing".

Why the fuck was that? Can't pension just simply DCA reputable stocks and call it a day? No. They have to do crazy things. Like that Canadian teachers pension fund who put $95m into... FTX. Yup. FTX.

I don't know about you but I'd rather not have the state use its monopoly of violence to confiscate my money and put it in a pension fund, which I see as a complete and total ponzi.

I'd rather, instead, like to pay less taxes and be able to do what the fuck I want with that money. Like buying stocks, gold, Bitcoin or splurge at the casino.

I think about just anything I can think of, even lighting my money on fire, would be more moral than participating in the gigantic ponzi that pension funds are.

But I've got no choice as in the EU these ponzi are mandated and often run by the state and you cannot opt out.

justincormack1 year ago

The pension funds that had an issue were "defined benefit" funds, which are not usually available to people now, versus the normal "defined contribution" ones where you get to choose how you invest the money and take the risks yourself.

JakeAl1 year ago

If you're not familiar, read up on how things went down in Greece and Italy and dare I say, Argentina with their economic collapses. The concern becomes getting your money out of the bank and prices skyrocketing between the shelf and cash register. The good news is I think Greece (maybe it was Italy) got rid of their government for 18 months to cut wasteful spending. No government = no government spending which is where all the debt came from.

snake_doc1 year ago

Most of the swaps are foreign entities borrowing US dollars to hedge their own currencies’ FX volatility. This simply conveys the incredible US dollar dominance in global markets.

Also because FX swaps are collateralized with up front principal, the leverage is very low. The primary risk is short term liquidity and not default risk, which makes this a central bank issue, hence the BIS warning.

PaulHoule1 year ago

Estimates of the risk from swaps tend to miss that there are many offsetting swaps. That is, if I am a market maker in swaps my positions mostly cancel out. That $80T might really be $2T or $8T. It is still a large amount but it isn’t really $80T.

The trouble is we have no way of knowing how much the real liability is.

HelloNurse1 year ago

What serious problems (for compliant, prudent operators) can hide in this lack of visibility? Cowboys taking more risks than they should be allowed and making currency exchange more volatile and dangerous? Some form of failure chain reaction?

PaulHoule1 year ago

The blow up with credit default swaps in the 2008 crisis was one example of a failure that was large but looked even larger than it was before the facts got in.

HelloNurse1 year ago

The CDS crisis was mainly due to treating high risk assets, more or less by mistake or maliciously, as if they were less dangerous. Can something of the sort happen with foreign currencies? Who holds unbalanced, volatile portfolios of foreign exchange that could crash and bring them down, and why?

Pixie_Dust1 year ago

Was this "financial instrument" designed by the same people that designed credit default swaps. All it does is kick the risk down the road not even mitigate it, just disguises the fact that it isn't "risk-free lending".

"It is useful for risk-free lending, as the swapped amounts are used as collateral for repayment"

https://corporatefinanceinstitute.com/resources/derivatives/...

tejohnso1 year ago

> FX swap markets, where for example a Dutch pension fund or Japanese insurer borrows dollars and lends euro or yen in the “spot leg” before later repaying them, have a history of problems.

This sounds speculative / risky. Is it? If so, why would a pension fund be involved with something like that in the first place? Is it typical to have a portion of a pension fund allocated to highly speculative risk?

em5001 year ago

A Dutch pension fund will have all its liabilities (future payments to pensioners) in Euros, but they typically invest a lot of the current pension contributions in USD stocks and bonds. This exposes them to exchange rate risk (uncertainty about the USD-EUR rate in the future, when they need to pay pensioners in Euros but their investments are in US dollars), on top of the normal investment risk of USD stocks and bonds. By simultaneously entering a EUR-USD swap (where they agree now with the counterparty at what rate they'll exchange USD back to EUR in the future), they can hedge the exchange rate part of the risk.

This is at least how FX swaps are supposed to be used: to reduce exchange rate risk. It could also be used for pure speculation by entering the swap in opposite direction (so the USD profits or losses get amplified in Euro terms). We don't know which. It might be in the 90-page BIS report, but (without reading) I'm guessing that the BIS researchers didn't manage to find out either.

cperciva1 year ago

It's primarily a matter of reducing risk by hedging. Pension/insurance companies typically hold assets around the world but have liabilities concentrated where their customers are -- and thus denominated in their customers' primary currency.

Nifty39291 year ago

Not necessarily - it certainly could be very risky, but sometimes these types of things actually reduce overall risk, if you happen to have an offsetting, inversely-correlated risk elsewhere.

Like if you bet me $1M on a coin coming up heads, that could appear very risky on it's own. But if you already had a bet in place for $1M that it comes up tails, then overall the heads bet zeros out your risk.

danielmarkbruce1 year ago

A slightly better example - if the Australian Future Fund owns $50 mill of Coke bonds, they probably need an fx swap so that every time Coke sends them some USD, they can swap it into AUD and know in advance how many AUD they are going to get.

If the USD got stronger against the AUD, the swap the Future Fund are in becomes a liability for them, if viewed through a "mark to market" lens. But the USD they are receiving is worth more to them, so they could increase the value of the bond holding - this would mean everything was "on balance sheet". But there is a very good argument that this "on balance sheet" method is a bad representation of the true economics of the situation. So instead, they leave the value of the Coke bond on their balance sheet at the same level, and don't record the liability of the fx swap.

Clearly the use of the FX derivative reduces the volatility for the Future Fund.

Note this is a somewhat contrived example, but it illustrates why off balance sheet isn't a black hole per se. At the same time, if you think through a few issues that could come up in this case, it's easy to see why it can be manipulated by bad actors, and why counter party risk is a big deal.

bell-cot1 year ago

> ...then overall the heads bet zeros out your risk.

IF both bets settle successfully, then yes. (Though you've still got the administrative overhead of two $1M bets, for $0 net gain.)

OTOH, if things go horribly wrong somewhere, and you have to pay out your $1M loss, but have problems collecting your $1M win...

And "suddenly having problems settling transactions which are normally routine" is a pretty good definition of Financial Crisis.

WastingMyTime891 year ago

Yes but that’s not really how people hedge.

It’s more: through various operation you end up with a large undesired $1M bet on head as a byproduct. To counter your exposure you put another $1M bet on tail. Now whatever happens, it shouldn’t impact you. Of course managing the two bets have a cost but that’s one you are ready to pay to escape being affected by the coin flip.

Hedge significantly reduces the exposure of companies to events they don’t want to be exposed to. Of course it could blow but that’s still better than having companies carrying random risks they don’t want.

salawat1 year ago

So you went in with $2M (two bets on same event at $1M each) came out with $1M because only one outcome can manifest, and you call that zeroed out risk?

Or are you talking using the same million to make both bets to seperate individuals? In which case, if your tails better turns out to be full of shit and can't produce the million you were intending to pay to the guy who you owe for your bad call, you're still out your million.

I don't call that zeroed risk friend.

pessimizer1 year ago

> Is it typical to have a portion of a pension fund allocated to highly speculative risk?

It certainly was in the US during the 2006 housing bubble crash, for pensions and especially for city/state pension funds. The customers of pension funds and the taxpayers of cities have little to no access or say about what the funds are investing in, so extremely large funds can be sold bad investments by influencing a small number of people who are subjected to very little oversight, and plan to be gone (probably to work for the people they helped) before the investments blow up.

anonuser1234561 year ago

They are doing it because yields are good, and as a fund manager you are rewarded quarterly/yearly for good returns. If it blows up after a 5 year run, you’ve had 4.5 solid years of bonuses and walk away claiming ‘no one could have foreseen the <eminently foreseeable event>’

airstrike1 year ago

Pension Funds generally only have a tiny portion of their portfolios in risky assets

thehumanmeat1 year ago

Look into the eurodollar system. Most "money" today is just swaps on bank ledger entries backed by counterparty trust and can-kicking. If you thought the dollar was a scam by not being backed by anything, wait till you check this out.

tru3_power1 year ago

Are there any resources that can explain these systems clearly and with examples?

college_physics1 year ago

The BIS has been fretting about what might be lurking in shadow banking for a long time. The cynical view is that they just want to expand their regulatory surface. But the recent events in the UK pension funds universe (had to be summarily bailed-out without much ado - though interest rate, not FX derivative related) suggests they might know what they are worried about...

newsclues1 year ago

I'm not an economist, but I feel like we talk about sustainability a lot when it comes to the environment, but not about the economic aspects.

As someone born in the 80s, it seems like every financial crisis hasn't been corrected, just the can gets kicked down the road.

djyaz12001 year ago

Can someone explain to me how the debt holder would service (pay for) a debt without having it on the books?

If they don't service the debt wouldn't it just roll over indefinitely and compound, and if so why would a counter party allow that?

naveen991 year ago

So

accounting books != balance sheet

Book - balance sheet = “hidden”

“leverage ratio” as defined by pension accounting standards doesn’t include currency / counterparty risk.

reset20231 year ago

Can someone please ELI5 this article?

firstSpeaker1 year ago

Can someone with more literacy explain what is the impact of this on an average Joe?

grumple1 year ago

Has the article been removed? The link leads me to a Reuters page with no content.

ThePhysicist1 year ago

-

drexlspivey1 year ago

And this relates to the article how?

chuckSu1 year ago
ShaneMcGowan1 year ago

At what point does one give up on this whole “global economy” thing and just move to the woods?

andyjsong1 year ago

Once you have self-sustaining energy, water, and food source with the same cost parity as your current living situation. Extra points if you can convince a group of people to join you to create a community.

mikeyouse1 year ago

It would be even better if that community became skilled at producing a certain set of goods or services and traded them with the outside world to gain wealth and increase quality of life for its inhabitants. You could take payment in advance for the services, but in case of international currencies, it would probably be prudent to hedge that currency timing risk with FX swaps...

salawat1 year ago

Back to square one.

We were getting away from the drug addicted financiers with a gambling problem, and a serious misunderstanding of the concept of risk, remember?

+1
mikeyouse1 year ago
_5uxp1 year ago

[flagged]

notyourwork1 year ago

Maybe, maybe not. Without giving any substance, your post is easily disregarded. I'd suggest if you believe in crypto and want to further its position to provide factual reasons why.

UncleEntity1 year ago

Because they can start gambling pension fund money in the crypto market when this is regulated away. No problems with that as far as I can see…

_5uxp1 year ago

Tbh I'm tired, even I or someone else explain it, I don't think it will change the decade old bias here. Any bad/misinformation filled crypto article gets lots of upvotes. Then with time stripe/paypal/visa etc. starts using and offers to business to accept it. After years, nobody think why they so late, why they offer now etc. So no point to prove any information to public here. Again it's ponzi, right? Simple. Just ponzi. Yet blocks are being mined without any interruption for more than a decade.

ferminaut1 year ago

Small nit...There has been interruptions to block generation.

In 2010 for 8hours 27 min

In 2013 for 6hours 20 min

But yes, almost 9 years without issue! Pretty impressive uptime regardless.

notyourwork1 year ago

You can further your belief or not, choice is yours. Telling me you're tired doesn't help me convince myself crypto is anything but a toy for mainstream consumers. FDIC insurance, safe guards, there are lots of things crypto in fact makes worse for technically illiterate.

HhbozBlqtp1 year ago

How is it biased to ask you to explain your point?

affinepplan1 year ago

Because the second you try, about ten times as many other HN users come to tell you you're wrong and it's all just a Ponzi and anybody who is interested in crypto is just a grifter.

I absolutely understand the exhaustion.

_4481 year ago

Just yesterday I was watching this: https://www.youtube.com/watch?v=U1dpWiZoiJU

Looks like the can is being kicked down the road since 2008 by the politicians/decision/policy makers so that it becomes some one else's problem to clear the mess.