“In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Warren Buffett

One still remembers the disastrous Global Financial Crisis (GFC) that happened over a decade ago and its ramifications that spurs reminiscence about undermined and proliferation of unregulated financial derivatives during that time. The excessive risk and over-extended leverage taken by speculators in derivatives trading have the capacity to expose the economy to systemic risks, as derivatives markets are free from the constraints of the real economy because their value is derived from financial assets and indices (Amadeo, 2021; Bajracharya, 2009). Greater regulation was followed by the third Basel Accord, a framework that sets international standards for banks. However, no matter what regulations are put in place, there are always channels to go around them (Bajracharya, 2009).

Bank for International Settlements (BIS), the bank for central banks, recently reported concerns surrounding the issues of US dollar-denominated debt in currency derivatives such as swaps and forwards that are off-balance sheets (Borio, McCauley and McGuire, 2022, p. 67). In other words, they are hidden under the current accounting reporting framework and standard debt statistics. The majority of this hidden debt is due to the ever-expanding and intertwined links between the conventional financial system and the shadow banking sector (bank-like activities outside the traditional banking sector, such as funds) (Davies, 2022). 

Therefore, it poses challenges to policymakers in scrutinising the situation as there are only shreds of information about the geographic distribution of the missing debt (Borio, McCauley and McGuire, 2022, p. 67-8). According to the BIS, this is an issue as swaps were a flashpoint during both the GFC and the early days of the Covid-19 pandemic when the US dollar funding prompted central banks to intervene to assist struggling borrowers (Ritchie, 2022). The explosion of the hidden debt is anticipated as the black swan event to look out for in 2023.

The types of Derivatives; Foreign Exchange Swaps/Forwards and Cross Currency Swaps

A foreign exchange swap or forward begins as an agreement between two parties with both wanting to borrow one currency and lend another simultaneously at an initial date (CFI Team, 2022b). The parties exchange quantities of equal value at the spot rate (current exchange rate), and then exchange amounts are determined by the forward rate when the contract matures. This arrangement allows each party to receive the currency lent and return the currency borrowed (CFI Team, 2022b). Note that the forward rate is simply the exchange rate on a future transaction, determined between the parties based on expectations.

Illustrative example (assuming numerical values)

Suppose Party A is from Malaysia and needs USD, whilst Party B is from the United States and needs MYR. Suppose both parties entered into a swap for six months. They agreed on the initial amount of RM100,000 or $25,000, based on an abstract spot rate of 4 USD/MYR. Both agreed on a forward rate of 4.5 USD/MYR as they deem that MYR will depreciate relatively to USD. After six months, Party A will then return $25,000 to Party B and receive RM112,500 from Party B, ending the swap. It allows both parties to hedge against forex risks and predict cash flows in the future. It is also evident for large entities such as central banks to engage in swaps/forwards without impacting the exchange rate.

The difference between foreign exchange swaps and cross-currency swaps is the interest payment (CFI Team, 2022a). Suppose a European firm needs US dollars to invest in the United States, and the firm may find it expensive to borrow, which is evident as the dollar index has risen sharply in response to the aggressive rate hike by the Federal Reserve this year. Through a swap bank (acting as a middleman), the European firm may find a US firm with the opposite demand, as the US firm will find it relatively expensive to borrow euros since it is not a domicile firm (not based in Europe). Hence, cross-currency swaps function by finding a counterparty from a foreign country that can borrow at a lower local rate (CFI Team, 2022a). At the same time, the party borrows at their domestic rate, and the two parties promptly swap debt obligations. From our example, the European firm is responsible for repaying the dollar-denominated debt based on the lower local rate that the US firm borrowed. By using cross-currency swaps, entities could benefit from a lower borrowing cost and eliminate fluctuations in foreign exchange prices as the rate has been determined initially (CFI Team, 2022a). However, the risk is obvious as counterparties may fail to meet their obligations in repaying their loan (CFI Team, 2022a).

Why is it troublesome now?

Simple – Payment obligations arising from foreign exchange swaps/forwards and currency swaps are currently at staggering levels. The outstanding amount considering all currencies stood at $97 trillion as of end-June 2022, equivalent to the global GDP in 2021 and three times the global trade (Borio, McCauley and McGuire, 2022, p. 69). Dollar-denominated debts alone accounted for $80 trillion, exceeding the combined value of dollar Treasury bills, repurchase agreements, and commercial paper (Ritchie, 2022). Furthermore, the average swaps and forwards’ short maturity present the possibility of liquidity squeezes, with 80% of outstanding amounts maturing in less than a year as of end-June 2022 (Borio, McCauley and McGuire, 2022, p. 69). The problem arises when dollars become scarce, especially when borrowers frequently employ short-term swaps to purchase long-term assets (Davies, 2022). To see the sheer volume of settlement risk, Glowka and Nilsson (2022, p. 76) reported that in April 2022, $2.2 trillion of daily forex turnover was subject to settlement risk. The absolute on-balance sheet debt obligation and settlement risk is enormous, let alone those debts that are been hidden from the books.

Figure 1 Forex swaps, Forex forwards and currency swaps outstanding, by currency (left) and maturity date (right) (Borio, McCauley and McGuire, 2022, p. 69)

Conventional accounting standards let banks, pension funds, insurers, and others to only record their net derivatives exposure (Davies, 2022). The initial net exposure with a forex swap is zero and will only increase or decrease if exchange rates fluctuate (Davies, 2022). Although one may hide their debt obligations, the swaps and forwards need to be repaid eventually to the counterparty to complete the deal on the maturity date (Fox, 2022). As long as the foreign entity hangs onto the US-based asset, it has a currency obligation until the trade is completed (Fox, 2022). The concealed dollar debt unrecorded on the balance sheets of non-US banks and shadow banks as of June 2022 was $65 trillion, which was 2.5 times the size of the entire US Treasury market and accounted for 14% of global financial assets (Borio, McCauley and McGuire, 2022, p. 69-70; Davies, 2022; Ritchie, 2022). The figures have nearly doubled since 2008 (Davies, 2022). The missing dollar debt is mostly held outside the United States, with banks and non-banks holding approximately $39 trillion and $26 trillion, respectively (Borio, McCauley and McGuire, 2022, p. 69-70).

Figure 2 US dollar-denominated debt held by non-banks outside the United States (left) and non-US banks (right) (Borio, McCauley and McGuire, 2022, p. 70)

The Policy challenges, what the outlook is, and conclusion

The foreign exchange and currency swap markets are prone to financing squeezes. This is significant during times of economic and financial turbulence, such as the GFC and in March 2020, when the COVID-19 epidemic wreaked havoc (Fox, 2022). Swap markets emerged as a flash point in both periods, with dollar borrowers compelled to pay exorbitant rates if they could borrow at all (Fox, 2022). Disruptions in dollar funding will pose systemic risks in the financial markets, and we may expect a financial meltdown whose scale is larger than the 2008/9 GFC. Exceptional policy in the form of central bank swap lines, whereby the Federal Reserve will transmit US dollars to major central banks, will be hard to implement and target due to asymmetric information  (Borio, McCauley and McGuire, 2022, p. 71). 

However, the event this time is extraordinary. Off-balance sheet debts may be out of sight and out of mind for the time being. The concealed leverage and maturity mismatch in the portfolios of pension funds, insurance firms, and other entities, will only be revealed when the next dollar squeeze unfolds (Borio, McCauley and McGuire, 2022, p. 71). The situation will be accelerated by the possible continuous appreciation of the dollar, predicted by Alan Greenspan, former governor of the Federal Reserve Board (Sor, 2022). He said that the dollar would stay strong even if the Fed eventually eases up on rate hikes and pivots (Sor, 2022). Policy responses set to replenish the flow of funds would remain hazy and uncertain. The brink of collapse of the pension funds in the United Kingdom and Credit Suisse are not independent events and won’t be the last shocking event that we will navigate in the near future.

Researcher(s): Yeoh Jia Xin

Reviewer(s): Sherilynn Ngerng Siew Fong, Muhammad Bahari, Elina Yong

Editor(s): Marcus


Amadeo, K. (2021) Role of derivatives in creating mortgage crisis, The Balance. Available at: (Accessed: December 12, 2022).

Bajracharya, S. (2009) Are derivatives the cause of a financial crisis?, Research Gate. Available at: (Accessed: December 12, 2022).

Borio, C., McCauley, R. N. and McGuire, P. (2022) “Dollar debt in FX swaps and forwards: huge, missing and growing,” in Borio, C. et al. (eds.) BIS Quarterly Review. Bank for International Settlements, pp. 67–73. Available at:

CFI Team (2022a) Cross currency swap, Corporate Finance Institute. Available at: (Accessed: December 12, 2022).

CFI Team (2022b) Foreign exchange swap, Corporate Finance Institute. Available at: (Accessed: December 12, 2022).

Davies, P. J. (2022) It’s the $65 Trillion in Debt You Can’t Find That’ll Get You, Washington Post. Available at: (Accessed: December 12, 2022).

Fox, M. (2022) “There’s an $80 trillion ‘blind spot’ in the financial system that could spell trouble for markets as debts held off-balance sheet grow at a rapid pace,” Business Insider, 7 December. Available at: (Accessed: December 12, 2022).

Glowka, M. and Nilsson, T. (2022) “FX settlement risk: an unsettled issue,” in Borio, C. et al. (eds.) BIS Quarterly Review. Bank for International Settlements, pp. 75–81. Available at:

Ritchie, G. (2022) ‘Huge, missing and growing’: US$65 tril in dollar debt sparks concern, The Edge Markets. Available at: (Accessed: December 12, 2022).

Sor, J. (2022) “The US dollar will stay strong even once the Fed eases rate hikes, and the central bank’s balance sheet reduction is the ‘elephant in the room,’ former Fed chief Alan Greenspan says,” Business Insider, 2 November. Available at: (Accessed: December 18, 2022).

Researcher(s): Yeoh Jia Xin

Reviewer(s): Sherilynn Ngerng Siew Fong, Muhammad Bahari, Elina Yong

Editor(s): Marcus

Designer(s): Qurratul Ainin

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