LONDON, March 9 The growing trade in currency
forwards acted as a useful "adjustment valve" for emerging
markets in the past year by allowing investors to hedge exposure
to the asset class, a BIS report said on Sunday.
Emerging markets have been buffeted repeatedly since the
U.S. Federal Reserve announced last May that it would start
cutting the monthly bond-buying that had financed an investor
spending spree on higher-yielding emerging assets.
But the turbulence may have been worse without the ability
to hedge currency exposure via forward markets, the Bank for
International Settlements said in its quarterly review.
"Surprisingly, when seemingly impending 'tapering' ... led
investors to reduce their exposures to emerging market bonds,
some markets experienced little net selling. Instead, investors
sold local currencies in well-functioning forward currency
markets, including NDFs," BIS said.
It was referring to non-deliverable forwards, derivatives
that allow investors to take positions in currencies where trade
is subject to official controls. An NDF deal is a contract for
the difference between an exchange rate agreed months before and
the actual spot rate when the trade matures.
The forwards served as "the 'main adjustment valve, allowing
investors to hedge the currency risk in their bond holdings,"
the BIS added.
Turnover in the emerging currency derivatives, including
NDFs, increased by 40 percent in the past three years until
2013, the BIS said last year, attributing this to investors
seeking to cut exchange rate risk.
NDF turnover doubled between 2008-2013 to 2.4 percent of
overall currency trade, the BIS said, and 23 percent of the
trade in forwards. It estimated that turnover in Asian NDFs was
10 times what it had been in the early 2000s.
Daily NDF turnover in London currency trade amounted to $43
billion, compared with $19 billion in October 2008, the report
said, though it contracted from April 2013 levels. BIS
attributed this partly to U.S. regulatory changes aimed at
making derivatives trading more transparent.
Indications are the selloff in emerging market currencies is
giving this market a fresh impetus.
"Since April 2013, NDF trading has been affected by
investors' and borrowers' hedging in anticipation of a reduction
in global monetary easing," BIS said, adding that hedging had
been driven by foreigners invested in emerging markets and
emerging market companies that had borrowed overseas in hard
However, growth in NDF popularity is not uniform. BIS
highlighted the Chinese yuan where Beijing has permitted a
limited offshore trade in the currency.
As a result, between April 2010-2013 offshore yuan
deliverable forwards rose from zero to $7 billion per day, while
NDFs rose by less to $17 billion per day.
Since April 2013, the offshore yuan may have closed in
further on the NDF market, BIS said, noting that the share of
yuan NDFs in the total yuan forwards market fell to 75 percent
from 85 percent between April and October 2013.