© 1993 International Monetary Fund
ISBN 1-55775-290-7
ISSN 0258-7440
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Contents
Preface
I. Introduction
II. The Foreign Exchange Market in International Investment Today: Players, Instruments, and Opportunities
III. Prologue to the ERM Crisis: “Convergence Play”
IV. Private Sector Behavior During the Crisis
Role of Institutional Investors
Global Hedge Funds
Institutional Investors and Corporations
Role of the Banking System
Liquidity Problems During the Crisis
V. Tactics for Defending ERM Parities
Official Intervention
Existing Stock of International Reserves
Borrowing from Private Markets
Borrowing from Official Sector
Defensive Increases in Interest Rates
Capital Controls
VI. Policy Options in the Aftermath of the Crisis
Characteristics of Exchange Arrangements
Putting “Adjustable” Back into “Fixed and Adjustable Peg”
Wider Margins
Move More Rapidly to EMU
Leave ERM Design as It Is but Improve Rule Implementation
Interest Rate Policy
Give Greater Independence to Central Banks
Invigorate Coordination More Widely
Intervention Policy: Re-examine “Unlimited” Obligation
Regulatory and Prudential Framework: Re-examine Position-Taking in Forex Market
VII. Conclusions
Annexes
I. Structure of the Global Foreign Exchange Market
Market Participants
Instruments Traded
Foreign Exchange Payments Systems
II. Uses of Foreign Exchange Instruments
Arbitrage Between the Foreign Exchange and Money Markets
Synthetic Money Markets
Hedging Foreign Exchange Exposure
III. Regulatory and Internal Constraints on Foreign Exchange Trading
Regulation of Financial Institutions’ Foreign Exchange Positions
Margin Requirements on Exchange-Traded Exchange Rate Contracts
Internal Risk Management Controls
IV. Mechanics of Speculative Attacks
Bank Covering Operations for Forward Contract Positions
Alternative Position-Taking Strategies and Their Costs
V. Economics of Speculative Attacks
Dynamics of Speculative Attacks
Multiple Equilibria
Lessons from the Literature
VI. The ERM Crisis of September 1992
Pre-Crisis Cross-Border Capital Flows
Speculative Attacks and Defenses
Financial Market Developments During the Crisis
VII. Glossary of Financial Terms
Statistical Appendix
References
Tables
Section
II.
1. Distribution of Assets Managed by Leading Fund Managers in Europe and the United States, December 31, 1991
2. Foreign Investments of Pension and Open-End Mutual Funds for Selected Industrial Countries, 1991
3. Regulatory Constraints on Foreign-Currency-Denominated Investments by Major Financial Institutions in Selected Industrial Countries
III.
4. External Net Capital Flows for Selected Countries in the EMS
Annex
I.
5. Net Foreign Exchange Market Turnover
6. Distribution of Turnover by Currency
7. Net Foreign Exchange Market Turnover by Counterparty
8. Institutional Investors’ Foreign Securities Investments in Selected Industrial Countries
9. Distribution of Net Turnover by Type of Transaction
VI.
10. Official Foreign Exchange Reserves of Central Banks of Selected Industrial Countries, 1992
Statistical Appendix
A1. Net Foreign Exchange Market Turnover Handled by Brokers in Selected Industrial Countries
A2. Assets of U.S. Institutional Investors by Type of Institution
A3. Investments of Japanese Life Insurers
A4. United States: Foreign Assets Held in Collective Investment Funds
A5. Outstanding Swap Transactions by Currencies
A6. Currency Futures and Options: Exchanges, Contracts, and Volume of Contracts Traded
A7. Average Daily Settlement Volume on CHIPS and Fedwire
A8. Italy: Net External Assets of Credit System
A9. Spain: Geographic Distribution of Foreign Investment Flows
A10. Germany: Geographic Distribution of Foreign Investment Flows
A11. Selected Central Bank Policies, June-December 1992
A12. Selected Sovereign Borrowing from Private Sources, June-November 1992
A13. Interest Rate Futures and Options: Exchanges, Contracts, and Volume of Contracts Traded
Charts
Section
III.
1. Interest Rate Differentials on Eurocurrency Deposits
Annex
VI.
2. Interest Rate Differentials on Eurocurrency Deposits: Deutsche Mark Minus U.S. Dollar
3. Interest Rate Spreads (Long-Term Minus Short-Term)
4. Official Overnight Interest Rates, August-November 1992
5. Domestic Short-Term Interest Rates, August-November 1992
6. Ask-Bid Spread on Interbank Rates with Various Maturities, September-October 1992
7. Ask-Bid Spread on Spot Exchange Rates Against U.S. Dollar, September-October 1992
8. One-Month Forward Exchange Rates Against Deutsche Mark, August-November 1992
9. Three-Month Forward Exchange Rates Against Deutsche Mark, August-November 1992
10. Volumes of Selected Financial Futures Contracts Traded, August-October 1992
11. Margin Requirements for Speculators and Hedgers/Members
The following symbols have been used throughout this paper:
… to indicate that data are not available;
— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;
- between years or months (e.g., 1991-92 or January-June) to indicate the years or months covered, including the beginning and ending years or months;
/ between years (e.g., 1991/92) to indicate a crop or fiscal (financial) year.
“Billion” means a thousand million.
Minor discrepancies between constituent figures and totals are due to rounding.
The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.
Preface
This report was prepared under the direction of Morris Goldstein, Deputy Director of the Research Department of the International Monetary Fund, together with David Folkerts-Landau, Chief of the Capital Markets and Financial Studies Division of the Research Department. The co-authors of the report are Peter Garber, Liliana Rojas-Suárez, and Michael Spencer.
This year’s capital markets report is divided into two parts. Part I examines the implications of the growth and integration of international capital markets for exchange rate management. Part II of the report—to be published later this year—will focus on sources of systemic risk in the international financial system. This report was prepared in connection with the annual surveillance of international capital markets conducted by the Research Department of the International Monetary Fund. It draws, in part, on a series of informal discussions with commercial and investment banks, securities houses, stock and futures exchanges, regulatory and monetary authorities, and the staffs of the Bank for International Settlements, the Commission of the European Communities, the Organization for Economic Cooperation and Development, and the Japan Center for International Finance. These discussions took place in Belgium, France, Germany, Hong Kong, Italy, Japan, the Netherlands, Singapore, Switzerland, the United Kingdom, and the United States between October and early December 1992.
In addition to the authors, other Fund staff members taking part in some of the discussions or making substantive contributions to the study at various stages included Robert Flood, Steven Fries, Zuliu Hu, and Tim Lane of the Research Department, Charles Collyns, Robert Rennhack, and Philippe Szymczak of the Policy Development and Review Department, and Steven Weisbrod, consultant. Kellett W. Hannah and Subramanian S. Sriram prepared the data presented in the report. Norma Alvarado, Maria Orihuela, and Janet Strain provided expert word processing assistance. Elin Knotter of the External Relations Department edited the manuscript and coordinated the production of the publication.
The study has benefited from comments by staff in other departments of the Fund and by members of the Executive Board. Opinions expressed, however, are those of the authors and do not necessarily represent the views of the Fund or of the Executive Directors.