After big swap losses, companies should worry about management’s lack of knowledge on how their FX swap programs work.
Supporters of Dodd-Frank’s reforms of derivative markets are indicating concern about reports that Treasury Secretary Geitner is about to rule favorably on an exemption of foreign exchange contracts from central clearing requirements. In a post Monday, Nakedcapitalism’s Yves Smith links to several commentators who see this as further watering down of the rules to the determinent of financial market safety. Ms. Smith herself however notes that many of those concerned about the FX exemption fail to appreciate that it is to be limited to FX contracts that are closer to cash than derivatives markets (e.g., spots and forwards) rather then FX options or more complex FX derivatives.
More interesting is the work of Satyajit Das, who in his upcoming book “Extreme Money” points out how exporters and multinational corporates in emerging markets ran into trouble using fairly complex FX derivative contracts to the point that they did create systemically signficant risks for dealer banks who were their counterparties.
As many as 50,000 companies in at least 12 countries including Korea, Taiwan, China, Philippines, India, Eastern Europe and Latin America suffered losses of as much as $530 billion. Mexican cement producer Cemex revealed a loss of $500 million on derivatives. Controladora Comercial Mexicana SAB, Mexico’s third-largest supermarket operator, filed for bankruptcy after losing $1.1 billion from currency derivative deals.
An IMF paper by Randall Dodd, “Exotic Derivatives Losses in Emerging Markets: Questions of Suitability, Concerns for Stability,” makes a similar argument.
The lesson from these big emerging market treasury bets on FX is probably more that their managements need to educate themselves on best practices in controlled corproate FX hedging — rather than that FX derivatives market rules are too lax.