The Growing Use Of Synthetic Financial Instruments

A distinguishing feature of consolidation in emerging markets is that it has been a cross border phenomenon that has resulted in substantial foreign penetration of domestic financial systems. Indeed, colleagues in the IMF refer to a staggering increase‘ in foreign ownership and control of domestic banks in emerging markets, especially in Latin America and emerging Europe, but also to a lesser degree in Asia. Note, too, that foreign penetration can be indirect and more subtle than the ownership/control connection. The recent triennial survey of foreign exchange and derivative markets coordinated by the Bank for International Settlements (BIS), for example, revealed that growing volumes traded in the Australian foreign exchange market have a foreign-induced component, with 65 per cent of transactions now occurring between resident dealers and overseas banks, up from 50 per cent in the preceding survey (RBA 2001).  It has long been recognized that securitization has brought with it the possibility to unbundled credit risk and market risks, price them efficiently, and distribute them to institutions and investors most equipped to deal with them. Such instruments can be used also as a means for hedging the volatility risk inherent in the modern international capital market. It is therefore important that countries seek to encourage the development and appropriate use of such instruments.  The recent BIS-coordinated triennial survey of foreign exchange turnover provides evidence on the extent to which the use of such instruments is growing worldwide. In contrast to the world-wide decline in foreign exchange market turnover, there has been a 50 per cent rise in derivatives trade in the three years since the survey was last conducted, all of this due to the growth in interest-rate-related products. The trend seems to be well established in Asia. In Australia, for example, the survey pointed to a tripling in derivatives contracts since the last survey, suggesting rapid strides in the maturation of local capital markets. In summary, the growth of local debt and equity markets in Asia has been an important step that can be further developed as a defense against high volatility in international capital flows.