The Huge Market for Foreign Exchange Derivatives
The Bank for International Settlements (BIS) has warned of significant risks in the global foreign exchange derivatives market in a recently published report. This market, mainly dominated by currency swaps, has reached a volume of around 111 trillion US dollars (as of the end of 2024). Major investors such as insurance companies and pension funds utilize this market to hedge their global portfolios against currency risks.
Possible Risks to Global Financial Stability
According to the BIS, the sheer size of the market itself poses a risk factor for global financial stability. The interlinking of financial markets, particularly bond markets, through these derivatives could lead to potential contagion effects throughout the financial system. Sudden withdrawals by investors from risky asset classes in one region could quickly spill over to other markets and countries.
Example of Carry Trades with the Japanese Yen
A concrete risk emerged in August 2024 with the so-called carry trades involving the Japanese yen. When investors unwound these positions on a large scale, the resulting market turbulence caused concern. Although these were short-lived, they highlighted the need for increased vigilance in light of growing carry trade volumes.
Global Crisis Spread as a Threat
Hyun Song Shin, economic advisor to the BIS, emphasizes the increased transmission of financial conditions across borders, which raises the risk of a global crisis spread.
In summary, the BIS warns that the vast market for currency swaps not only serves as a hedging instrument but also poses a source of systemic risks. A destabilization of the market could have far-reaching consequences for investors worldwide.