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Brokerages, insurers face stricter monitoring over foreign exchange exposure
Kim Seong-wook, left, director general for international finance bureau at the Ministry of Economy and Finance, speaks during a press briefing at Sejong Government Complex, Tuesday, Courtesy of Ministry of Economy and Finance
By Lee Kyung-min
Monitoring of dollar demand, short-term borrowing in swap market, overseas asset operation maturity are top priorities
By Lee Kyung-min
Korea plans to beef up the monitoring of foreign exchange liquidity conditions at non-banking financial firms, including brokerages and insurers, to prevent potential market turmoil caused by a dollar shortage, the Ministry of Finance and Economy said Wednesday.
Under the plan, non-banking financial firms will be required to submit a monthly plan on borrowing U.S. dollars, including ways to counter a sudden spike in demand for the key reserve currency brought on by unforeseen risks.
Their foreign currency exposure will be calculated by net overseas assets divided by total overseas assets using a method the finance ministry created to measure the financial health of non-banking financial firms.
“The extreme volatility seen in the forex market last March was the highest seen since the global financial crisis of 2008. We sought to enhance regulatory measures in a broader, preemptive move to maintain financial health, a key factor in determining Korea's credit rating,” said Kim Seong-wook, director general for the ministry's international finance bureau.
Non-banking financial companies will also be required to submit a monthly report on the maturity dates of their dollar-denominated debt and assets, with both clearly specified by the amount of cash at hand and forward contracts.
The measures seek to identify the amount of dollars borrowed over the short term in the swap market, a figure that is not stated on balance sheets and is therefore considered as a major risk in the event of a liquidity shock.
They are among key measures announced by the Ministry of Economy and Finance, Financial Services Commission (FSC), Bank of Korea (BOK) and Financial Supervisory Service (FSS) to strengthen the financial soundness of non-banking financial institutions.
The firms will no longer be able to claim their assets as being liquid if dollar-denominated assets cannot be converted into cash immediately or in a short amount of time.
Brokerages will be required to hold at least 20 percent of hedged sales of derivative-linked securities as liquid overseas assets, while insurers will be required to opt for long-term swap transactions over short-term ones.
The slew of measures to reduce liquidity risks in the foreign exchange (FX) market ― especially involving non-banking firms ― followed extreme market volatility about a year ago, defined by a massive outflow of U.S. dollars that caused the Korean won to plummet in value to 1,280 won against the American currency in March 19.
The sharp devaluation of the Korean currency came after many local brokerages failed to meet margin calls made by their overseas counterparts following a pandemic-triggered stock market crash around the world and the resulting nosedive in indices of exchange-linked securities (ELS) whose underlying assets included key global financial market indices.
Many local brokerages sold the ELS in question, and about six of them were asked to put up a combined 1 trillion won in a matter of days, a chief driver of the rapid mid-March weakening of the Korean won that stabilized only after a $60 billion currency swap was signed between Korea and the U.S., March 19.
Logo for IMF
Reflected in the measure is a sharp increase in foreign assets held by non-banking firms amid Korea's growing current account surplus, as illustrated by those held by securities companies doubling every year for the past three years. The figure was $81.3 billion in 2018, up from $49.8 billion in 2017, a further jump from $16 billion in 2016. It remains at $92.8 billion as of 2019.
Insurers are also increasing long-term, high-return investments, yet their markedly small overseas debt on paper calls into question where they borrowed the money from.
“Insurers' overseas assets stood at $146.3 billion in 2019, but their debt was only about $9.9 billion, meaning the difference was borrowed in the swap market. We sought to identify what remains unnoticeable in order to put them in a wider risk-management perspective,” Kim said.
Logo for BIS
The comprehensive measure is a follow-up to recommendations made by the International Monetary Fund (IMF) and Bank for International Settlements (BIS) over the past few years.
The IMF said in a 2019 October report that the vulnerability of non-banking sectors was increasing due to a rise in their high-risk and less-liquid asset investments, suggesting the need for more stringent supervision backed by information disclosure and setting up liquidity standards. It also proposed strengthening stress tests and monitoring to limit the vulnerability of non-U.S. banks in securing dollars.
More timely is a Bank for International Settlements report released last April, immediately after global financial markets experienced an extreme dollar shortage. The BIS, which provides banking services to central banks and international organizations, said the risk related to securing dollars for the banking sector decreased significantly compared to the past, highlighted by an elevated risk in the non-banking sector.
“Financial authorities around the world have no clear set of data on non-banking firms' overseas investments to accurately measure their foreign currency exposure. I hope Korea's work can serve as an exemplary case for our global peers to follow,” Kim added.