The Use of "Asset Swaps" by Institutional Investors in South Africa
Leading financial economists have proposed the use of international asset swaps (Merton 1990, Bodie and Merton 2002) as a way of efficiently achieving international diversification without eroding the level of foreign exchange reserves and weakenin...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2003/12/2860750/use-asset-swaps-institutional-investors-south-africa http://hdl.handle.net/10986/17644 |
| Summary: | Leading financial economists have
proposed the use of international asset swaps (Merton 1990,
Bodie and Merton 2002) as a way of efficiently achieving
international diversification without eroding the level of
foreign exchange reserves and weakening local market
development. International asset swaps entail limited
foreign currency flows (only net gains or losses need to be
exchanged). They protect foreign investors from market
manipulation and expropriation risk and have much lower
transaction costs than outright investments. But asset swaps
are constrained by the attractiveness of local markets to
foreign investors, and by various regulatory issues covering
counterparty risk and collateral considerations, and
accounting, valuation, and reporting rules. Institutional
investors are well developed in South Africa. Their total
assets corresponded in 2001 to 159 percent of GDP, a level
that was surpassed by only four high-income countries. But
because of the imposition of exchange controls, they lacked
international diversification. In July 1995 South Africa was
the first developing country that explicitly allowed its
pension funds and other institutional investors to make use
of "asset swaps." But the South African
authorities did not authorize the use of properly specified
swap contracts as described by Bodie and Merton, but rather
permitted institutional investors to "obtain foreign
investments by way of swap arrangements." As the author
argues in this paper, the asset swap mechanism turned out to
be cumbersome and inefficient. However, it did allow
institutional investors to attain some level of
international diversification. Other developing countries
should consider authorizing their institutional investors to
engage in international asset swaps. But they should
authorize the use of properly designed swap contracts,
preferably based on baskets of liquid securities, permit
only global investment banks to act as counterparties,
require the use of global custodians, properly monitor
credit risk, maintain adequate collateral, and adopt
market-to-market valuation rules. Asset swaps are clearly a
second-best option compared to the lifting of exchange
controls. However, they may facilitate risk diversification
in the presence of such controls. And they may even have a
role to play in their absence. |
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