Forex derivatives losses in other emerging economies

This issue was a rage last year in business media but has been forgotten as of now- the losses from forex derivatives. The latest F&D Magazine has an article  saying similar losses were made in Latin American economies. The losses in these economies were quite large.

In another articleon the same issue, Randall Dodd asks:

If the KIKOs and TARNs were not suitable for hedging and not the best alternative for speculating, why were they traded in such large quantities? One hypothesis is that the investors were either unsophisticated or that they were not informed or knowledgeable of the risks. Indeed, the international financial markets had been benign for so long that investors in many markets began to underestimate certain risks. And the nonfinancial firms were presumably less sophisticated than the major banks offering these trades.

Another hypothesis is that investors were sometimes pressured into the contracts by banks as a condition for rolling over their loans. Some emerging market financial authorities, in interviews with the author, said that investors complained to them of bank pressure when the investors were refinancing loans. Yet one other explanation for the popularity of the derivatives is that the KIKOs and TARNs were priced in a way that attracted investors to the higher risks because the exotic derivatives offered exchange rates that were better than those prevailing in the market for standard forwards and options. This last point implies that investors were somewhat aware of the products and their risks. However, it does not follow that such exotic investments were their best choice. If investors knowingly accepted that risk-return trade-off, it would amount to a dangerously inefficient trade in which nonfinancial firms were selling insurance against large amounts of extreme risks to more sophisticated financial firms.

He suggests few points for regulators:

 At a national level, investor protection laws and antifraud provisions should be clarified and strengthened to discourage the use of inappropriate derivative transactions.

• Reporting requirements for derivative transactions should be established. Reporting price and other transaction data for derivatives would make the market more transparent and would endow national and multinational surveillance authorities with greater capability to detect potential problems before they escalate.

• The introduction of new and complex derivatives, or at least their use by firms other than qualified speculators, should be regulated through the use of either “positive” lists of acceptable financial instruments or “negative” lists of prohibited ones.

• Multilateral surveillance is needed to monitor markets globally and, among other functions, identify patterns of market misconduct and trading abuses such as occurred with KIKOs and TARNs. The authority, through its established relationships with national supervisory authorities, should be capable of promptly notifying them of alarming or suspicious developments. As a multinational body, the IMF could perform this task and already possesses some of the necessary resources and formal channels of cooperation among member countries

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15 Responses to “Forex derivatives losses in other emerging economies”

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