By Daniel Leussink

TOKYO (Reuters), Asia’s emerging countries should have better oversight over foreign currency liquidity risk and currency hedging flexibility, as increasing dollar investments can make the region more susceptible to currency swings. This is according to the Bank for International Settlements.

The BIS released a quarterly report Monday that stated the increasing wealth and ageing population has led to a growing number of dollars-denominated assets of institutional investors in Asia’s emerging countries.

In March 2020, Asia’s vulnerabilities were evident when the pandemic erupted. This led to an increase in dollars hedging demand. Financial markets are now under increased stress, according to the BIS. It holds regular meetings with the central banks of the world.

Hyun Song Shin (economic adviser, head of research, BIS) said, “You have the juxtaposition that demand is long-term but supply is short-term.”

“Unless you can secure long-term hedging… there is always this maturity mismatch between this supply of hedging services and the demand for hedging services.”

This issue presents new problems for Asia’s developing economies. In the Asian financial crisis of the 1990s, the problems faced by emerging nations were caused by large debt loads. These burdens were made more difficult due to capital outflows and sharply declining currencies.

The report stated that derivative trading in the currency of any of the six emerging Asian economies, including South Korea and Malaysia, has increased to almost $9.4Billion in 2019, nearly twice the 2013 level.

This has led to increased demand for hedging services, which may create new risk in financial distress, when the demand for short-term dollars funding rises.

The report stated that financial authorities need to be more vigilant about the foreign currency funding liquidity risks created non-bank investors like pension funds and insurers.

BIS urged Asian emerging economies that they modify their foreign exchange hedge rules in order to counter short-term dollar demand, as was the case during last year’s COVID-19 pandemic.

According to the report, economies can do this by making it easier for currency risk hedges to be flexible and encouraging long-term foreign currency hedging among institutions such as insurers.