More than US$10.7tn of debt globally is not being recorded on any balance sheet anywhere, according to a just-published paper from the Bank for International Settlements (FX swaps and forwards: missing global debt?).
A key finding of the paper is that non-banks outside the United States of America owe large dollar sums off-balance-sheet through foreign exchange swaps and forward contracts. “The total is of a size similar to, and probably exceeding, the $10.7 trillion of on-balance sheet dollar debt,” say the authors.
Even when this debt is used to hedge FX risk, it can still involve significant maturity mismatches, something which was once anathema to practising bankers. While the volume of missing debt could have issues for financial stability, say the authors, these are hard to assess.
Further study required
Compiling a credible answer would require further study and detailed analysis than the data that are currently available to the BIS permit. They concede, however, that much of the missing could well be hedging FX positions. This, they say, works for financial stability rather than against it. In theory.
The authors, Claudio Borio, Robert Neil McCauley and Patrick McGuire, say the paper frames the relevant issues and puts forward some answers. To do this it combines data on the total value of derivatives contracts from the Bank's own statistics with data from a range of external sources.
The result is a broader picture of how much debt might be missing, where in the world it might be and the uses to which it is being put. On the basis that some currencies are more equal than others, the authors focus mostly on the US dollar.
Claudio Borio, head of monetary and economic department, BIS
“We estimate that non-bank borrowers outside the United States have very large off-balance sheet dollar obligations in FX forwards and currency swaps,” they write. “They are of a size similar to, and probably exceeding, the $10.7 trillion of on-balance sheet debt.”
On the other side of the ledger, they add, as much as two-thirds of dollar-denominated bonds issued by non-US residents could be hedged through similar off-balance sheet instruments. They say that that fraction seems to have fallen as emerging market borrowers have gained prominence since the GFC (global financial crisis).
The total outstanding of FX swaps/forwards and currency swaps was $58trn at the end of 2016, the authors calculate. This compares with global gross domestic product of $75trn, the value of global portfolio stocks ($44trn), international bank claims ($32trn) and global trade (£21trn).
The figure has risen by more than four times since the early 2000s, though on a rollercoaster trajectory. It tripled in the five years to 2007 before falling significantly during the GFC. The authors identify a reduction in hedging needs following the rout in trade and asset prices as the most likely reason for this fall.
The majority of the contracts involved are short-term agreements. Around 75% of positions taken had a maturity of less than a year at the end of 2016. Only a few percentage points went beyond five years. The dollar's share is 90%, rising to 96% in trades between dealers. The instrument of choice is the FX swap.
The conclusion to the paper states that obligations to pay dollars incurred through FX swaps/forwards and currency swaps are functionally equivalent to secured debt. In contrast to other derivatives, agents must repay the principal at maturity, not just the replacement value of the position.
The paper comprises something of a call to arms for an improvement in data collection and analysis. The authors say a fuller assessment would require better data to help evaluate the size and distribution of both currency and maturity mismatches.
They say the analysis also points to deeper and more complex questions about the accounting conventions themselves. At issue is the definition of derivatives and control, which gives rise to the asymmetric treatment of cash and other claims in repo-like transactions.
These questions, together with their regulatory implications, would merit further consideration, the authors conclude.