## tarea2025014-print-pdf — Extracts from Preface, Chapter 5, Annexes III, IV, V, VI

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### Mission, purpose, and high-level findings (Preface)
- Mission: A Monetary and Capital Markets (MCM) Department mission visited Bogota from April 22 to May 3, 2024, at the request of Banco de la República (BR) and Superintendencia Financiera de Colombia (SFC).
- Objective: assist authorities in regulatory framework and development strategies for the foreign exchange (FX) market; identify regulatory and other hurdles to market development and propose measures to overcome them without increasing financial stability risks.
- Key counterparts: Leonardo Villar (Governor, BR), Hernando Vargas (Deputy Technical Governor, BR), Cesar Ferrari (Superintendent, SFC).
- Major findings:
  - Colombian FX market developed notably; exchange rate responds flexibly to shocks, but components can be deeper and more internationally integrated.
  - Convertibility/internationalization: convertibility of the COP is incomplete; level of internationalization is moderate and comparable to other EMEs in measured integration.
  - FX trading: slowly increasing relative to foreign trade; offshore trading comparatively low in proportion but growing rapidly (driven largely by NDFs).
  - Spot FX market: liquid, competitive, and efficient by international standards.
  - Hedging market: dominated by NDFs; limited activity in FX swaps, cross-currency swaps, deliverable forwards, and options.
  - Market segmentation: onshore and offshore NDF markets are segregated in settlement currencies and risk mitigation mechanisms, undermining effectiveness and fairness.
  - Economic vulnerabilities: commodity exports ~ half of total exports; persistent current account deficit and external financing needs; FX-denominated debt ~ 35 percent of private sector corporate debt.
  - Regulatory and administrative requirements increase burden on participants and limit market efficiency and COP internationalization.

### Benefits of currency internationalization; risks; convertibility concepts (Chapter 5)
- Benefits:
  - Prevents excessive exchange rate volatility, enhances monetary policy flexibility, boosts economic resilience, facilitates smoother adjustments.
  - Settling payments in domestic currency reduces transaction costs and mitigate exchange rate risk.
  - Allows domestic firms to invoice exports in their own currency, passing exchange rate risk to foreign customers.
  - Seigniorage gains can finance government expenditures, support debt reduction, lower borrowing costs, strengthen fiscal sustainability, and support investments.
  - Attracts foreign investors and enhances international finance position.
- Risks and vulnerabilities:
  - Can amplify exchange rate volatility via speculative trading and sudden sentiment shifts.
  - May limit central bank effectiveness as foreign investors access local currency instruments.
  - Increased capital inflows can contribute to financial fragility (risk-taking, asset price bubbles, currency mismatches).
  - Requires robust risk management frameworks and monitoring of capital flows.
- Convertibility definitions:
  - Current account convertibility; capital account convertibility; external convertibility; internal convertibility (Guitián 1996).
  - Full convertibility when three criteria met: unrestricted usability for all financial purposes; freedom to be exchanged without financial constraints; tradability at an established exchange rate.

### Assessing the Colombian Peso’s internationalization and FX turnover
- Metrics and observations:
  - Colombia FX turnover rose from 0.05 percent of the total FX turnover in 2007 to 0.18 percent in 2022.
  - Average FX turnover among EMEs was 6.26 percent in 2022.
  - Offshore trading averaged around USD 7 billion between 2016 and 2022, surpassing the combined onshore and cross-border trading (~ USD 4 billion).
  - FX trading volumes relative to GDP and international trade remain low compared with peers (e.g., South Africa).
  - Instrument adoption: Colombia, Brazil, Chile, and Peru primarily use NDFs; Mexico, South Korea, Poland, and South Africa use FX swaps and deliverable forwards.
- Economic drivers:
  - Negative current account and a negative net IIP over 2000-2023 (foreign liabilities exceed foreign assets).
  - Businesses rely on forward contracts and natural hedging; inability for many businesses to open foreign currency accounts with domestic banks increases offshore reliance.

### FX market structure, liquidity, participants, and instruments
- Spot market liquidity and structure:
  - Daily average market turnover in the inter-dealer segment: USD 750 million.
  - Dealer-to-customer volume: USD 600 million.
  - More than half of dealer-to-customer volume attributable to relatively small non-financial customers.
  - The 10 most active intermediaries cover about two thirds of the spot turnover; the largest intermediary is responsible for 11 percent.
  - Average interbank bid-ask spreads close to 5 basis points.
- Hedging market:
  - Dominated by NDFs; most NDF tenors up to 6 months.
  - Swap and deliverable forward markets underdeveloped because non-residents’ COP settlement is inhibited by regulatory constraints.
  - A financial transaction tax makes deliverable derivatives more expensive relative to non-deliverable ones.
- User positions (aggregate figures):
  - Domestic pension funds: short USD (long COP) forward positions amounting to USD 19 billion.
  - Foreign investors: short COP (long USD) forwards amounting to USD 18 billion (to hedge local government bond holdings ~ 30 percent).
  - Domestic non-financial corporates: short COP (long USD) forwards amounting to USD 3 billion.
  - Domestic banks maintain close to neutral FX position.

### Market segmentation, infrastructure, and operational features
- Onshore vs offshore segmentation:
  - Onshore NDFs settled in COP; onshore clients (pension funds, domestic corporates) typically take short USD positions.
  - Offshore NDFs settled in USD; non-residents holding local government bonds typically take long USD positions offshore.
  - Counterparty risk mitigation differs: onshore clients typically do not maintain margin accounts; offshore trading uses ISDA and CSA margin arrangements.
  - Local ISDA differs from global ISDA and is used mainly by state-owned enterprises as required by the government.
- Market infrastructure and settlement:
  - Standard settlement t+0; t+1, t+2, t+3 possible.
  - Only transactions executed by 1 p.m. eligible for same-day settlement.
  - Interbank spot trading is centrally cleared.
  - Concentration of back-office activity in afternoon hours due to client documentation requirements.
- BR interventions and reserve operations:
  - BR abstains from intervening except during extreme volatility.
  - BR accumulates FX reserves via transparent auctions of USD/COP options with strike linked to a 20-day moving average; options sold when COP appreciates faster than the previous 20-days’ trend.

### Regulatory framework, FXIs, accounts, and prohibitions
- FX operations classification:
  - Regulated FX operations (mandatory channeling through FXI or clearing accounts and registered at the BR) include import/export of goods; external credit; foreign capital investments; Colombian investments abroad; financial investments abroad; collaterals/guarantees in foreign currency; derivative transactions.
  - Nonregulated FX operations (free market) include export/import of services, remittances, donations, etc., settled through ordinary FX accounts abroad or voluntarily via FXIs.
  - Export goods revenues must be channeled through FXIs or clearing accounts within six months of receipt.
- FXIs and authorized entities:
  - There are 47 entities authorized by the BR to operate as FXIs.
  - Composition: 24 banks, 2 financial corporations, 2 commercial financing companies, 1 financial cooperative; 10 stockbrokers; foreign exchange intermediation and special financial services companies; 4 companies specialized in deposits and electronic payments; 3 special official institutions.
  - Annex IV: FXI group definitions with equity requirement (PT) thresholds (e.g., FXI group 1: PT >= COP 48.5 b; group 3: PT => COP 34.4 b; group 4: PT=> COP 16 b; group 5: PT =< COP 16 b).
- Ban on domestic use of foreign exchange among residents (Article summary):
  - Ban applies to deposits, financial operations, contracts, and agreements among residents.
  - Explicit exceptions (operations allowed in foreign exchange) include: sale to other residents; purchase from free warehouses; freight and international transport tickets; international credit card personal expenses; specified insurance premiums; payment of reinsurance obligations abroad; payments related to claims covered in foreign currency; purchases/sales of crude oil and natural gas by Ecopetrol or other refiners with residents; payments among domestic branches of foreign-headquartered companies in specified extractive sectors; financial and asset investments abroad.
- Resident FX accounts:
  - Resident FX accounts held domestically are restricted; eligible holders include international transportation companies, travel and tourism agencies, bonded warehouses, port/airport services companies, entities conducting international technical cooperation programs, trust companies under fiduciary mandates.
  - Balances from these accounts may not be used to pay mandatory channeled transactions.
- Resident FX accounts held abroad:
  - Clearing accounts: used for mandatory channeling; require registration with the BR and monthly reporting.
  - Ordinary accounts: used for non-regulated operations; do not require registration or reporting.
- Nonresident accounts in FX and COP held in Colombia:
  - Nonresident FX accounts held in Colombia are restricted; FXIs can hold such accounts for nonresident individuals/legal entities, diplomatic missions, multilateral organizations, and foreign agents acting as liquidity providers.
  - Nonresident COP accounts held in Colombia are restricted and have no possibility of international correspondent banking relationships; use cases limited (e.g., proprietary operations, FDI accounts, portfolio investment accounts, external credit accounts, central depositories, accounts to disperse payments of export services, electronic deposits and simplified accounts (CATS), term deposits with limitations on offshore investors' participation).
- Treatment of foreign investment:
  - Foreign investment free to participate in any sector except those tied to national security/defense and hazardous waste processing/disposal.
  - Investments (except financial sector) do not require prior authorization by the BR but must be registered; registration allows free movement of related capital.
  - Information declared by investors to BR is full and exclusive responsibility of investors and not examined by BR before registration.
- Derivatives regulation:
  - Commodity and financial derivatives: can be traded between residents and FXIs and eligible foreign agents subject to conditions; hydrocarbon and mining sectors may trade only with FXIs.
  - Credit default swaps: may only be issued in COP or foreign currency by external issuers; payments can be made in COP or foreign currency.

### Administrative burdens, data, and reporting issues
- Reporting vs approval:
  - Distinguishing reporting (ex-post) requirements from approval (ex-ante) requirements improves data collection optimization.
  - Replacing approvals with reporting should prompt review of data frequency, scope, and timing.
- Data and information preconditions:
  - Need for optimal data provision and access to reliable information sources.
  - Recommendations include coordination among authorities, adherence to institutional missions, intensive use of technology, continuous evaluation of data needs, ex-post reporting, and identifying overlaps with other authorities’ data needs.

### Key policy recommendations (core; sequencing and timeframes)
- Near-term: < 12 months. Medium-term: 12 to 36 months.
- Reduce administrative burden and streamline information (Priority: High/Medium):
  - Determine or revise a transaction size threshold for ex-post data provision to balance number and total amount of small value transactions. (Priority: High; Timeframe: Near-term)
  - Revise purpose, scope, and usability of information collected on FX transactions, external credit, and investments to eliminate overlaps and multiple reporting forms. (Priority: High; Timeframe: Medium-term)
  - Uphold BR procedure of not collecting underlying documentation for FX operations for compliance at transaction level; limit BR collection to ex-post data only and leave documentation assessment to supervisory authorities and FXIs. (Priority: High; Timeframe: Medium-term)
  - Assess whether regulatory framework for a risk-based approach to FX operations requires clarification or improvement. (Priority: Medium; Timeframe: Medium-term)
  - Consider extending the six-month repatriation deadline for channeling export goods revenues, aiming for elimination within the next two years. (Priority: Medium; Timeframe: Medium-term)
  - Keep enhancing capacity building and IT solutions to streamline data collection and communication of regulation. (Priority: High; Timeframe: Medium-term)
  - Coordinate a conjoint revision of FX regulatory and operational framework and transfer provisions not aligned with BR’s mission to AML/CFT and tax frameworks. (Priority: Medium; Timeframe: Medium-term)
  - Rationalize the sanction structure (e.g., progressive fines for late/incomplete submission) and clarify provisions. (Priority: Medium; Timeframe: Medium-term)
  - Broaden the “positive list” of allowed current account and financial operations and consider later transitioning to a “negative list” approach. (Priority: Medium; Timeframe: Medium-term)
- FX market development measures:
  - Improve market transparency by increasing regular public reports on FX market liquidity. (Priority: Medium; Timeframe: Near-term)
  - Establish a standing FX committee including relevant stakeholders for open discussion on market functioning. (Priority: High; Timeframe: Near-term)
  - Regularly review domestic banks’ FX net open position (NOP) limits, considering BR’s capacity to provide emergency liquidity assistance in FX. (Priority: High; Timeframe: Medium-term)
  - Explore harmonizing the domestic ISDA with global standards. (Priority: High; Timeframe: Medium-term)
  - Allow full use of nonresident COP accounts held in Colombia for proprietary transactions (requiring definitional revisions). (Priority: Medium; Timeframe: Medium-term)
  - Allow international correspondent banking relationships to be fully operational using nonresident COP accounts in a FXI Group 1 structure with appropriate oversight. (Priority: Medium; Timeframe: Medium-term)
  - Assess robustness of FX trading systems to high-frequency trading and upgrade with safeguards if needed. (Priority: High; Timeframe: Near-term)
  - Assess possibility of licensing non-resident banks to perform certain FX operations onshore without establishing a legal entity, ensuring coordinated oversight. (Priority: Medium; Timeframe: Medium-term)

### VAR analysis of hedging dynamics (Annex VI)
- Objective and sample:
  - Two VAR models with daily data from January 04, 2021, to October 31, 2023.
  - Model 1: market indicators (bid-ask spread, spot depth at 10 maturities, trading volumes fxi-other and fxi-fxi) with FX volatility measures (fx_vol_sqr, garch_fx_vol).
  - Model 2: positions (Others-FXI, Total pension funds, Total offshore) with FX rate or FX rate daily return measures.
- Selected Model 1 results (sample adjusted 1/07/2021–10/31/2023; included observations: 667):
  - Daily average inter-dealer turnover and dealer-to-customer volumes reported elsewhere in report (USD 750 million and USD 600 million respectively).
  - Key coefficients (selected):
    - BID_ASK_SPOT(-1) on BID_ASK_SPOT: 0.538204 (0.15330) [ 3.51089 ]
    - FX_VOL_SQR(-1) on GARCH_FX_VOL: 9.82E+09 (3.0E+09) [ 3.25589 ]
    - FXI_FXI_SPOT(-1) on BID_ASK_SPOT: 1.19E-07 (2.6E-08) [ 4.56875 ]
    - SPOT_DEPTH_AT_10(-1) on GARCH_FX_VOL: 0.304810 (0.05013) [ 6.08061 ]
  - Model fit (selected R-squared):
    - BID_ASK_SPOT: R-squared 0.480624
    - FX_VOL_SQR: R-squared 0.381231
    - GARCH_FX_VOL: R-squared 0.914182
    - SPOT_DEPTH_AT_10: R-squared 0.525755
- Selected Model 2 results (sample adjusted 1/07/2021–10/31/2023; included observations: 670):
  - Key coefficients (selected):
    - DIFF_FX_RATE(-1) on DIFF_FX_RATE: 1.608918 (0.41029) [ 3.92145 ]
    - DIFF_TOTAL_OFFSHORE(-1) on DIFF_FX_RATE: 21.72531 (7.32139) [ 2.96737 ]
    - DIFF_TOTAL_OFFSHORE(-1) on DIFF_TOTAL_OFFSHORE: -0.060753 (0.02040) [ -2.97796 ]
    - FX_RATE_DAILY_RETURN(-1) on DIFF_FX_RATE: -5925.263 (1741.34) [ -3.40271 ]
  - Model fit (selected R-squared):
    - DIFF_FX_RATE: R-squared 0.104278
    - DIFF_TOTAL_OFFSHORE: R-squared 0.149395
    - FX_RATE_DAILY_RETURN: R-squared 0.093399
- VAR interpretation highlights:
  - When COP depreciates versus USD, offshore investors take long USD forward positions (momentum); domestic NFCs and pension funds take short USD forward positions (mean reversion), providing stabilizing effects.
  - VAR impulse response functions computed with 95 percent Confidence Interval via Monte Carlo simulations.

*Italic: Source: tarea2025014-print-pdf (IMF Technical Assistance Report — Preface, Chapter 5, Annexes III, IV, V, VI)*

### Preface ................................................................................................................

### Preface

### Mission and purpose
- A Monetary and Capital Markets (MCM) Department mission visited Bogota from April 22 to May 3, 2024, at the request of Banco de la República (BR) and Superintendencia Financiera de Colombia (SFC).
- Objective: assist the authorities in the regulatory framework and development strategies for the foreign exchange (FX) market, identifying regulatory and other hurdles to market development and proposing measures to overcome them without increasing financial stability risks.
- Key counterparts met: Leonardo Villar (Governor, BR), Hernando Vargas (Deputy Technical Governor, BR), and Cesar Ferrari (Superintendent, SFC).
- The mission engaged with a broad set of officials, market participants, and interpreters listed in the Preface.

### Major findings (from Executive Summary and Introduction)
- The Colombian FX market has developed notably in recent years; the exchange rate has responded flexibly to shocks, but several FX market components can be deeper and more integrated internationally.
- Convertibility and internationalization status:
  - The convertibility of the COP is incomplete; level of internationalization is moderate.
  - A fully convertible currency meets: unrestricted usability for all financial purposes, freedom to be exchanged without financial constraints, and tradability at an established exchange rate.
  - Colombia’s position is comparable to other emerging market economies (EME) in measured integration.
- FX market structure and activity:
  - FX trading is slowly increasing relative to foreign trade; the proportion of offshore trading remains comparatively low.
  - Offshore trading growth is rapid, mainly due to non-deliverable forwards (NDFs), while onshore and cross-border trading increase more slowly.
  - The spot FX market is liquid, competitive and efficient by international standards.
  - The hedging market is dominated by NDFs with limited activity in FX swaps, cross-currency swaps, deliverable forwards, and options.
  - Onshore and offshore NDF markets are segregated in settlement currencies and risk mitigation mechanisms, which undermines effectiveness and fairness.
- Economic vulnerabilities and exposures:
  - Commodity exports amount to about half of total exports.
  - Colombia is vulnerable to changing external financial conditions given a persistent current account deficit and external financing needs.
  - FX-denominated debt is about 35 percent of the private sector corporate debt, largely due to COP depreciation and contributing to increasing leverage of large corporates.
  - FX lending by banks is low; banks’ exposure to exchange rate risks is limited.
- Regulatory landscape and operational constraints:
  - Domestic use of foreign exchange among residents is generally prohibited, with notable exceptions.
  - Colombia authorizes 47 entities as foreign exchange intermediaries (FXIs); permitted activities vary by type and size.
  - Resident FX accounts within Colombia face restrictions; accounts held abroad are not similarly restricted but face different regulatory procedures depending on account usage.
  - Nonresident FX and COP accounts in Colombia are similarly restricted and lack provisions for international correspondent banking relationships.
  - Several regulatory and mainly administrative requirements increase the burden on market participants and limit market efficiency and COP internationalization.

### Institutional and policy analysis
- Regulatory preconditions for convertibility and internationalization emphasize:
  - Adequate exchange rate regimes.
  - Macroeconomic stabilization and an adequate external position.
  - Institutional development (regulatory and supervisory policies, central bank autonomy, market development).
  - Optimization of data collection and information provision.
- The BR has evolved to allow more flexibility in information requirements, including ex-post reporting provisions.
- Comparative case studies point to the importance of exchange rate policies, macro stabilization, institutional development, and data optimization for successful FX liberalization.

### Key market dynamics and risks
- Hedging dynamics are driven by changes in the exchange rate level, anticipating a mean reversion pattern.
- Segregation between onshore and offshore NDF markets with different settlement currencies and risk mitigation is detrimental to market effectiveness and fairness.
- Entry of non-resident banks into the domestic FX market is constrained by regulatory frictions, including ISDA alignment, use of non-resident COP accounts, and correspondent banking relationships.

### Core policy recommendations (high-level synthesis)
- Reduce administrative burden and streamline information:
  - Determine or revise a transaction size threshold for ex-post data provision to balance the number and total amount of small value transactions. (Priority: High; Timeframe: Near-term)
  - Revise the purpose, scope, and usability of information collected on FX transactions, external credit, and investments to eliminate overlaps and multiple reporting forms. (Priority: High; Timeframe: Medium-term)
  - Uphold the BR procedure of not collecting underlying documentation for FX operations for compliance at the transaction level; limit BR collection to ex-post data only and leave documentation assessment to supervisory authorities and FXIs. (Priority: High; Timeframe: Medium-term)
  - Assess whether the regulatory framework for a risk-based approach to FX operations requires clarification or improvement for regulated entities or clients. (Priority: Medium; Timeframe: Medium-term)
  - Consider extending the six-month repatriation deadline for channeling export goods revenues, aiming for elimination within the next two years. (Priority: Medium; Timeframe: Medium-term)
  - Keep enhancing capacity building and IT solutions to streamline data collection and communication of regulation. (Priority: High; Timeframe: Medium-term)
  - Coordinate a conjoint revision of FX regulatory and operational framework and transfer provisions not aligned with BR’s mission to AML/CFT and tax frameworks. (Priority: Medium; Timeframe: Medium-term)
  - Rationalize the sanction structure (e.g., progressive fines for late/incomplete submission) and clarify provisions. (Priority: Medium; Timeframe: Medium-term)
  - Broaden the “positive list” of allowed current account and financial operations and consider later transitioning to a “negative list” approach. (Priority: Medium; Timeframe: Medium-term)

- FX market development measures:
  - Improve market transparency by increasing regular public reports on FX market liquidity. (Priority: Medium; Timeframe: Near-term)
  - Establish a standing FX committee including relevant stakeholders for open discussion on market functioning. (Priority: High; Timeframe: Near-term)
  - Regularly review domestic banks’ FX net open position (NOP) limits, considering BR’s capacity to provide emergency liquidity assistance (ELA) in FX. (Priority: High; Timeframe: Medium-term)
  - Explore harmonizing the domestic ISDA with global standards. (Priority: High; Timeframe: Medium-term)
  - Allow full use of nonresident COP accounts held in Colombia for proprietary transactions (requiring related definitional revisions). (Priority: Medium; Timeframe: Medium-term)
  - Allow international correspondent banking relationships to be fully operational using nonresident COP accounts in a FXI Group 1 structure with appropriate oversight. (Priority: Medium; Timeframe: Medium-term)
  - Assess robustness of FX trading systems to high-frequency trading and upgrade with safeguards if needed. (Priority: High; Timeframe: Near-term)
  - Assess possibility of licensing non-resident banks to perform certain FX operations onshore without establishing a legal entity, ensuring coordinated oversight. (Priority: Medium; Timeframe: Medium-term)

### Implementation sequencing and timeframes (as stated)
- Near-term: < 12 months
- Medium-term: 12 to 36 months

*IMF Technical Assistance Report — Preface and Executive Summary*

### 5. The international use of a currency brings several benefits to both the currency issuer and

### tarea2025014-print-pdf - 5. The international use of a currency brings several benefits to both the currency issuer and

### Benefits of currency internationalization
- Prevents excessive exchange rate volatility, enhances monetary policy flexibility, and boosts economic resilience by absorbing external economic shocks; facilitates smoother adjustments to economic imbalances.
- Settling payments in domestic currency reduces transaction costs and mitigate exchange rate risk.2
- Allows domestic firms to invoice exports in their own currency, passing exchange rate risk to foreign customers.3
- Seigniorage gains4 from increased internationalization can finance government expenditures, support debt reduction, lower borrowing costs, strengthen fiscal sustainability, and support investments in economic development projects.
- Attracts foreign investors and enhances the country's position in international finance.

### Risks and vulnerabilities from internationalization
- Can amplify exchange rate volatility due to speculative trading and sudden market sentiment shifts; volatility driven by increased capital flows may challenge businesses, investors, and policymakers.
- May limit central bank effectiveness in influencing domestic financial conditions as foreign investors gain access to local currency instruments (e.g., government bonds, securities).
- Increased capital inflows can contribute to financial fragility through risk-taking, asset price bubbles, and currency mismatches where liabilities exceed assets in a different currency.
- Requires robust risk management frameworks and monitoring of capital flows to mitigate risks and safeguard financial stability.

### Convertibility: definitions and evaluation
- Convertibility broadly: ability to freely exchange currencies without restrictions.
  - Current account convertibility: freedom to convert currency to foreign exchange for settling payments for goods and services or other current transactions.
  - Capital account convertibility: permits conversion for capital transactions and transfers, facilitating unrestricted international investment flows.
  - External convertibility: extending to foreign holders the right to convert balances into foreign exchange.
  - Internal convertibility: right given to domestic (resident) holders to convert balances into foreign exchange. (Guitián 1996)
- A currency is fully convertible when it meets three criteria: unrestricted usability for all financial purposes, freedom to be exchanged for other currencies without financial constraints, and ability to be traded at an established exchange rate.
- Levels of convertibility can vary; partial convertibility restricts usability or exchangeability and affects classification on the convertibility spectrum. (Guitián 1996)
- External convertibility incentivizes foreign participation; internal convertibility exposes domestic policies to global market forces while potentially enhancing competitiveness. (Guitián 1996)

### Assessing the Colombian Peso’s level of internationalization
- Metrics used:
  - FX market turnover (volume of FX trading associated with a currency in global FX markets).
  - Two forms of international FX trading: transactions in foreign markets without involvement of issuing country’s residents; transactions between non-residents and residents of issuing country.
- Observations:
  - Low currency internationalization and FX trading relative to economic activity (relative to GDP and international trade) indicate modest overall international financial integration in Colombia and selected EMEs.
  - FX trading is mostly with non-residents outside the currency-issuing country.
  - Colombia FX turnover rose from 0.05 percent of the total FX turnover in 2007 to 0.18 percent in 2022.
  - Average FX turnover among EMEs was 6.26 percent in 2022.
  - Offshore trading averaged around USD 7 billion between 2016 and 2022, surpassing the combined total of onshore and cross-border trading, which stood at approximately USD 4 billion.
  - Offshore trading has experienced rapid growth; onshore and cross-border trading increased more slowly.

### FX trading volumes relative to economic activity and instruments
- FX trading volumes relative to GDP and international trade remain low, reflecting modest size of financial markets in EMEs.
- Comparisons across seven countries (Colombia, Brazil, Mexico, Chile, Peru, Poland, South Korea, and South Africa) show Colombia’s FX turnover/GDP ratio is comparatively low, especially relative to South Africa.
- Instrument adoption:
  - Colombia, Brazil, Chile, and Peru have adopted NDFs as their primary derivative instruments.
  - Mexico, South Korea, Poland, and South Africa have embraced FX swaps and deliverable forwards.
- BIS data methodology for offshore trading:
  - Onshore + cross-border trading from Table 19.01.
  - Total (onshore + cross-border + offshore) from Tables 25_01 and 25.02.
  - Offshore trading = total − (onshore + cross-border).
  - Offshore average for period 2016-2022 calculated accordingly.

### FX market counterparties and turnover drivers
- Foreign Exchange Intermediaries (FXI) actively use the FX market to manage FX positions.
- Turnover growth drivers by country:
  - Colombia, Peru, and Chile: growth driven by trading in outright forwards and with reporting dealers.
  - Brazil: growth with other financial institutions.
  - Mexico, South Korea, Poland, and South Africa: growth led by trading in FX swaps with reporting dealers.
- Colombian businesses primarily use forward contracts and natural hedging to manage exchange rate and commodity price risk.
  - Many businesses cannot open foreign currency accounts with a domestic bank and instead hold such accounts abroad.
  - This limitation may lead to greater reliance on offshore accounts and instruments for hedging.

### Economic drivers and external positions
- Three building blocks for enabling internationalization: Balance of Payments (BoP), International Investment Position (IIP), and FX risk management.
- A negative current account may decrease demand for the domestic currency, contributing to limited internationalization.
- Colombia recorded a negative net IIP over 2000-2023; foreign liabilities exceed foreign assets, indicating net external liabilities and potential vulnerability for the COP.
- FX risk management practices concentrated domestically reflect limited internationalization:
  - Businesses rely on forward contracts and natural hedging.
  - Businesses hold foreign currency accounts outside the country.
  - Businesses cannot open foreign currency accounts with domestic banks.
- Survey results (Annex I) corroborate limited engagement with domestic financial institutions for currency transactions.

### Regulatory preconditions for safe convertibility
- Preconditions for liberalization and safe convertibility:
  - Financial and macroeconomic stability.
  - Sound and developed financial sector.
  - High standards of governance and disclosure.
  - Robust policy framework: credible exchange rate regime, appropriate fiscal stance, suitable level of international reserves, and low, stable inflation.
  - Adequate regulatory and supervisory policies to deepen FX and money markets and enhance resilience.
- Data and information:
  - Optimal data provision and access to reliable information sources are essential.
  - Enhance data quality and statistical capabilities; balance benefits against burdens of data collection.
  - Strategies include coordination among authorities, adherence to institutional missions, intensive use of technology, continuous evaluation of data needs, consideration of ex-post reporting, identifying overlaps with other authorities’ data needs, and adherence to international standards.
- Lessons from comparative liberalization case studies:
  - Successful liberalization associated with adequate exchange rate regimes, macro stabilization, institutional development (regulatory and supervisory policies, central bank autonomy, market development), and optimized data collection.
  - Premature liberalization outpacing capacity to manage capital flows led to crises and reversals of liberalization (Annex III).
- Reporting vs approval requirements:
  - Distinguishing reporting requirements from approval requirements improves data collection optimization.
  - Approval requirements typically involve ex-ante information; replacing approvals with reporting should prompt review of data frequency, scope, and timing.

### Colombia’s FX regulatory framework and FXIs
- FX operations classification:
  - Regulated FX operations (mandatory channeling through FXI or clearing accounts held abroad, registered at the BR) include:
    (i) import and export of goods;
    (ii) external credit, and related financial costs;
    (iii) foreign capital investments, and related yields;
    (iv) Colombian investments abroad, and related yields;
    (v) financial investments in issued securities and assets abroad, and related yield, except investments made with foreign currencies from transactions that should not be channeled through the FX;
    (vi) collaterals and guarantees in foreign currency;
    (vii) derivative transactions.
  - Nonregulated FX operations (free market): operations not mandatorily channeled through FXI or clearing accounts, such as export and import of services, migrant remittances, donations, etc. These can be settled through ordinary FX accounts abroad (not registered at the BR) or voluntarily channeled through FXI or clearing accounts.
  - Export goods revenues must be channeled through FXIs or clearing accounts within six months of receipt.
- Definitions:
  - FX market definition = foreign currency transferred or negotiated through FXI (mandatorily and voluntarily channeled) + clearing mechanism (use of clearing accounts abroad).
- Institutional responsibilities:
  - BR (Banco de la República) mandates regulation of the FX market and FXI.
  - Eligible FXIs must be registered and are entities under supervision of the Financial Superintendency of Colombia (Superintendencia Financiera de Colombia—SFC).
  - SFC and the National Tax and Customs Directorate (Dirección de Impuestos y Aduanas Nacionales—DIAN) ensure compliance with the exchange regime.
  - Superintendence for Commercial Societies (Superintendencia de Sociedades—SSOC) supervises FX activities conducted by non-financial entities.
- Authorized FXIs:
  - There are 47 entities authorized by the BR to operate as FXIs.
  - Composition includes: credit institutions (24 banks, 2 financial corporations, 2 commercial financing companies, 1 financial cooperative), stockbrokers (10), foreign exchange intermediation and special financial services companies (formerly exchange bureaus), companies specialized in deposits and electronic payments (4), and special official institutions (3).
  - Residents may buy and sell FX and traveler’s checks professionally if registered in the trade register and in the register of professional FX dealers established by the DIAN (Article 84 of External Resolution 1, 2018).
  - Residents may also purchase or sell on the unregulated market with other residents, provided it is not habitual or in a professional capacity.

*IMF Technical Assistance Report — Extract from chapter 5*

### 29. There is a ban on the domestic use of foreign exchange among residents in Colombia. This

### 29. There is a ban on the domestic use of foreign exchange among residents in Colombia. This

### Scope of the ban and explicit exceptions
- Ban applies to deposits, financial operations, contracts, and agreements among residents.
- Exceptions (operations allowed in foreign exchange (FX)):
  - (i) Sale to other residents;
  - (ii) Purchase of goods in the country from free warehouses;
  - (iii) Freight and international transportation tickets;
  - (iv) International credit card personal expenses;
  - (v) Insurance premiums denominated in foreign currency as referred to in Decree 2555, of July 15, 2010;
  - (vi) Payment of obligations arising from reinsurance abroad;
  - (vii) Payment abroad or in the country related to claims that insurance companies in Colombia must cover in foreign currency (according to Law 9 of January 17, 1991, Article 14);
  - (viii) Purchases and sales of crude oil and natural gas produced nationally by Ecopetrol or by any other entity involved in industrial refining, carried out with other residents;
  - (ix) Payments among domestic branches of companies headquartered abroad that are involved in oil, natural gas, coal, ferronickel, or uranium exploration and mining, and companies involved in the provision of technical services in the hydrocarbons sector;
  - (x) Financial and asset investments abroad.
- Residents may settle payment of domestic operations among themselves by using FX balances in accounts abroad (clearing accounts only).

### Resident FX accounts held domestically (restrictions and eligible holders)
- Resident FX accounts held domestically are restricted. Current possibilities embrace:
  - (i) international transportation companies;
  - (ii) travel and tourism agencies;
  - (iii) bonded warehouses and free warehouses;
  - (iv) port and airport services companies;
  - (v) public or private entities conducting international technical cooperation programs with the national government for the deposit of amounts actually disbursed by foreign cooperation agencies;
  - (vi) trust companies under fiduciary mandates or acting as representatives, spokespersons, and managers of independent pools of foreign exchange assets generated by the activities indicated above.
- Balances from these accounts may not be used to pay for transactions that are mandatorily channeled.

### Resident FX accounts held abroad (classification and reporting)
- FX accounts held abroad by residents are unrestricted but subject to different regulatory procedures based on intended use.
- Two account types:
  - Clearing accounts:
    - Must be used for mandatory channeling operations.
    - May be used voluntarily for non-regulated operations.
    - Domestic transactions among residents can be settled in FX using balances in these accounts.
    - Require registration with the BR and monthly reporting.
  - Ordinary accounts (non-clearing accounts):
    - Used for non-regulated operations.
    - Do not require registration with the BR or any reporting.
- Clients may channel FX balances through an FXI or a clearing account; in the latter case, FX regulations regarding reporting requirements will apply.

### Nonresident accounts in FX and COP held in Colombia (restrictions and permitted uses)
- Nonresident FX accounts held in Colombia are restricted. FXIs can hold nonresident FX accounts for:
  - (i) Nonresident individuals and legal entities;
  - (ii) Accredited diplomatic and consular missions to the government of Colombia and their staff;
  - (iii) Multilateral organizations and their staff;
  - (iv) Foreign agents acting as liquidity providers for foreign currency clearing and settlement systems.
- Balances from these accounts may not be used to pay for transactions that are mandatorily channeled.
- Nonresident accounts in COP held in Colombia are also restricted, with no possibility of international correspondent banking relationships.
- FXIs can hold nonresident accounts in COP, but restrictions apply to their use and destination, including:
  - (i) General accounts: Proprietary operations only, related to any nonregulated transactions and to the export and import of goods, and derivatives (settled in COP);
  - (ii) FDI accounts: FDI investments (funding from domestic operations);
  - (iii) Portfolio investment accounts: Portfolio investments (funding from domestic operations);
  - (iv) External credit accounts: Disbursement and payment of local loans;
  - (v) Central depositories: Central depositories of foreign securities;
  - (vi) Accounts to disperse payment of Colombian export of services: Third-party transactions;
  - (vii) Electronic deposits and simplified accounts (CATS): Nonregulated transactions, not allowed to provide credit;
  - (viii) Term deposits: Current regulation limits the participation of offshore investors in the term deposit certificates (CDTs) market, as investors have to buy through a local administrator in the secondary market, given that this is considered foreign portfolio investment.

### Treatment of foreign investment and registration requirements
- Current regulatory framework ensures equal treatment for foreign investment, apart from specific conditions in FX regulations adopted for special regimes.
- Foreign investment is free to participate in any economic sector except:
  - sectors directly or indirectly related to national security and defense activities, and
  - the processing, disposal, and elimination of toxic, hazardous, or radioactive wastes not produced in the country.
- Specific FX regulations on international investments focus primarily on information collection:
  - Requirement to register the investment allows free movement of the related capital.
  - Except for investments in the financial sector (which require prior authorization from the SFC), foreign investments in Colombia and Colombian investments abroad do not require prior authorization by the BR.
  - Both onshore and offshore investments must be registered with the BR, which shares information with supervisory and tax authorities.
  - Foreign investment in shares declared by the investor to be intended for an extended period is considered foreign direct investment.
  - Information declared by investors to the BR is their full and exclusive responsibility and will not undergo specific examination or qualification by the BR before registration is processed.

### Cross-border lending and external credits
- Loans by residents to nonresidents and from nonresidents to residents, whether commercial or financial, may be disbursed and repaid in any currency, regardless of the term.
- Credits denominated in foreign currencies provided by FXIs to residents or to other FXIs are considered external credits according to FX regulations.
- External credits, including those obtained through placement of securities in the international market, must be channeled through FXIs, which provide all related information to the BR.
- FXIs are responsible for providing information to the BR on credits provided by residents to nonresidents.
- Regulation is extensive and detailed regarding information provision.

### Derivatives regulation
- Specific provisions apply to commodity derivatives, financial derivatives, and credit default swaps.
- Commodity and financial derivatives:
  - Can be traded between residents and FXIs, and between these parties and eligible foreign agents, subject to certain conditions.
  - Hydrocarbon and mining sectors may trade commodity and financial derivatives only with FXIs.
- Credit default swaps:
  - May only be issued in COP or foreign currency by external issuers, covering either external or local assets.
  - Related payments can be made in either COP or foreign currency, allowing for financial or effective fulfillment.

### Assessment against peers and historical context
- Colombia, like many EMEs especially in Latin America, experienced external vulnerabilities after financial or debt crises, leading to episodes of FX market control and dense regulations.
- FX trade repository systems in many economies originated to monitor capital controls; although restrictions eased over time, reporting systems persisted and adopted new functions (e.g., support for tax authorities, AML/CFT, ministries).
- As liberalization progressed, jurisdictions reduced costs and reporting burdens via thresholds or waiving non-material reporting, while retaining trade repository support for market monitoring.
- The 2022 FSAP noted significant progress in aligning Colombia’s AML/CFT framework with revised FATF standards, while recommending continued efforts to enhance effectiveness:
  - Authorities revised the national risk assessment for money laundering and terrorism financing and improved the legal and regulatory framework, including the creation of the beneficial ownership register.
  - SFC improved its risk-based approach to AML/CFT supervision, including consolidated supervision and cross-border activities for banks.
  - Based on 2022 FSAP recommendations, authorities have been working on:
    - (i) Strengthening requirements for politically exposed persons;
    - (ii) Bringing the remaining designated non-financial businesses and professions under the AML/CFT regime;
    - (iii) Addressing the money laundering and terrorism financing risks associated with crypto assets;
    - (iv) Ensuring that virtual asset service providers are properly licensed and monitored/supervised for AML/CFT compliance.

### Trade-offs: controls versus liberalization
- Strict regulations and inflexible information-gathering systems support capital control environments but can hinder optimal liberalization by:
  - Increasing compliance costs and operational frictions;
  - Discouraging foreign investment;
  - Creating difficulties responding to a dynamic economy;
  - Potentially deterring currency convertibility.
- Colombia has been progressing in liberalization and internationalization, supported by:
  - A flexible exchange rate;
  - Effective financial regulatory and supervisory policies;
  - Adequate economic fundamentals.
- Additional regulatory and information-provision reforms are essential to support continued liberalization.

### Policy recommendations to ease administrative burden and advance FX market liberalization
- Revise transaction size threshold for ex-post data provision to balance number and total amount of small-value transactions.
- Revise purpose, scope, and usability of information collected on FX transactions, external credit, and investments (including through clearing accounts) to:
  - Simplify data collection;
  - Eliminate overlaps and multiple reporting forms;
  - Focus on material information;
  - Reduce costs and streamline operations.
- Coordinate implementation across all authorities reliant on FX operations data.

- BR should maintain policy of not collecting underlying documentation for FX operations for compliance at the transaction level and focus solely on data.
  - Documentation assessment should be responsibility of supervisory authorities and FXIs.
  - Clients should present underlying documentation only as mandated by FXIs under their risk assessment and business purposes.
  - FXIs should retain documentation for a prescribed period, typically 5 or 10 years, and make it available to supervisory authorities under their competencies.
  - BR should evaluate whether the regulatory framework for a risk-based approach to FX operations requires improvement or clarification for regulated entities or clients.

- BR should consider extending the six-month repatriation deadline for channeling export goods revenues, aiming for its elimination within the next two years, provided favorable market conditions continue.
  - Rationale:
    - Local spot FX market is liquid, competitive, and efficient by international standards, with a robust interbank FX market.
    - No repatriation or surrender requirement to the central bank or authorized dealers for all exports of services, nor for all exports of goods.
    - Repatriation of export goods revenues can be carried out through clearing accounts held abroad.
    - Eliminating repatriation requirement would reduce operational costs for companies and FXIs and level the playing field with exporters from other countries.
  - AREAER (2022) comparison: none of the countries discussed in Annex III have repatriation requirements for export revenues.

- BR should enhance capacity building and implement technology upgrades and IT solutions to:
  - Streamline data collection;
  - Improve communication and clarification of regulations;
  - Strengthen regulatory and supervisory effectiveness;
  - Foster innovation and compliance with fewer frictions.

- Authorities should coordinate a joint revision of FX regulatory and operational framework and transfer provisions not aligned with BR’s institutional mission to AML/CFT and tax frameworks.
  - Rationale:
    - Avoid conflating FX market functioning provisions with AML/CFT and taxation mandates.
    - Clarify regulatory perimeters according to each authority’s competence.
    - Reduce unnecessary frictions and improve coherence.

- Rationalize sanction structure (e.g., progressive fines for late or incomplete submissions) and clarify provisions:
  - Avoid excessively high and disproportionate fines that incentivize a “fear of failing” mindset.
  - Promote proportionate sanctions to encourage development of risk management policies, reduce costs, encourage competition and innovation, and internalize benefits of FX market liberalization.

- Consider broadening the “positive list” of allowed current account and financial operations and later transitioning to a “negative list” approach:
  - Expand “positive list” as an initial liberalization step within current regulatory framework.
  - Subsequent transition to a “negative list” (top-down approach) would focus on listing restrictions rather than permitted operations.
  - Requires robust prudential regulation, effective supervision, and capacity of regulated entities to manage risks.

*IMF Technical Assistance Report*

### 49. A well-functioning FX market offers several key benefits to an EME with a flexible

### 49. A well-functioning FX market offers several key benefits to an EME with a flexible

### Key benefits of a well-functioning FX market
- Promotes efficient price discovery and allows exchange rates to reflect the underlying economic fundamentals accurately.
- Contributes to efficient monetary policy implementation by enabling reliance on the exchange rate channel.
- Facilitates hedging opportunities, enabling economic agents to manage exchange rate risk and helping attract foreign investment.

### Four building blocks for FX market development (conceptual framework)
- An enabling regulatory environment that facilitates effective market making in various market segments, eliminates administrative burdens and ensures legal certainty of the financial contracts, particularly derivatives.
- A robust market infrastructure, encompassing payment and settlement systems, trading platforms, market data providers, trade repositories, and the treasury and risk management systems of market participants.
- A diverse range of financial instruments, available to market participants to hedge their derivative positions if needed.
- A broad user base with heterogenous risk profiles, possessing incentives and potential gains from trade, as well as sufficient knowledge to manage financial risks.

### Assessment of Colombia’s FX market — liquidity and spot market structure
- Spot FX market described as fairly liquid, competitive, and efficient by international standards.
- Daily average market turnover in the inter-dealer segment: USD 750 million.
- Dealer-to-customer volume: USD 600 million.
  - More than half of dealer-to-customer volume attributable to relatively small non-financial customers.
  - Largest clients are domestic pension funds and foreign institutional investors.
- The 10 most active intermediaries cover about two thirds of the spot turnover; the largest intermediary is responsible for 11 percent.
- Average interbank bid-ask spreads are close to 5 basis points (noted as tighter than the typical 5-15 basis point spreads in EMEs).

### Hedging market structure and instruments
- FX hedging market is dominated by NDFs; activity in FX swaps, cross-currency swaps, deliverable forwards, and options are small.
- Historical capital control measures contributed to NDF predominance over deliverable forwards or swaps.
- Local interbank NDF market moderately competitive: two largest intermediaries cover half of the turnover.
- Most NDF tenors are up to 6 months.
- Swap and deliverable forward markets underdeveloped because non-residents’ COP settlement is inhibited by regulatory constraints.
- A financial transaction tax makes deliverable derivatives more expensive relative to non-deliverable ones.

### Banco de la República (BR) FX operations and market impact
- BR abstains from intervening in the FX market except during episodes of extreme volatility.
- BR accumulates FX reserves in transparent series of auctions of USD/COP options with a strike price linked to the moving average of the spot exchange rate.
  - Options sell by FXIs only when the COP appreciates faster than the average pace of the previous 20-days’ trend, yielding lower cost and less risk of COP depreciation.
- As banks progressively delta-hedge option positions, the impact on the spot market is dispersed over time, reducing risk of disorderly market conditions.
- BR practice incentivizes use of market-based risk management instruments and supports hedging market development.

### User base, positions, and hedging dynamics
- Domestic pension funds: accumulated foreign assets hedged with short USD (long COP) forward positions amounting to USD 19 billion.
- Foreign investors: hold about 30 percent of local currency government bonds and hedge currency exposure with short COP (long USD) forwards amounting to USD 18 billion.
- Domestic non-financial corporate sector: net importer hedging with short COP (long USD) forwards amounting to USD 3 billion against local FXIs.
- Some exporters maintain short USD (long COP) forwards against offshore banks (no quantitative data available).
- Domestic banks maintain close to neutral FX position.
- VAR analysis (see Annex VI) results:
  - When COP depreciates against the USD, offshore investors take long USD forward positions (consistent with momentum trading).
  - Domestic NFCs and pension funds take short USD forward positions, suggesting implicit expectation of mean reversion and providing an automatic stabilizer effect on the exchange rate.
  - Two VAR models estimated; impulse response functions derived using a Cholesky decomposition.
  - Ordering for model 1: [bid_ask_spot; fx_vol_sqr; fxi_fxi_spot; fxi_other_spot; garch_fx_vol; spot_depth_at_10].
  - Ordering for model 2: [diff_fx_rate; diff_others_fxi_net_fwdswp; diff_total_offshore; diff_total_pension_funds; fx_rate_daily_return].
  - Impulse response functions include a 95 percent Confidence Interval (CI) computed using Monte Carlo simulations.

### Market segmentation, counterparty arrangements, and benchmarks
- Direct participation of non-residents in the FX market is constrained:
  - Non-resident banks cannot open corresponding COP or FX accounts with local banks and cannot participate in the domestic FX clearing mechanism.
  - Foreign banks need to establish a local subsidiary or branches under the same regulatory requirements for subsidiaries to participate in the local FX market.
- Onshore vs offshore NDF segmentation:
  - Only resident clients can trade onshore NDFs which are settled COP; onshore clients (pension funds, domestic corporates) typically take short USD positions.
  - Non-residents investing in local government bonds typically take long USD positions in offshore NDFs settled in USD.
- Counterparty risk mitigation differences:
  - Onshore segment: clients don’t maintain margin accounts due to lack of collateral; banks apply a credit surcharge in the quoted price.
  - Offshore trading: regular ISDA and CSA arrangements govern margin maintenance.
  - Local ISDA has different arrangements and is only used by state-owned enterprises as required by the government.
- Money market instruments and benchmarks:
  - BR publishes term benchmarks (in arrears) usable to calculate USD-COP interest rate differential to price forward rates.
  - Government securities market provides arbitrage opportunities to maintain market clearing FX forward prices.
  - A liquid overnight indexed swap market exists on the CME for those without access to domestic money market.
  - An FX benchmark (TRM) is available and widely used:
    - SFC calculates and publishes TRM; BR sets the methodology.
    - Rates calculated based on t+0 spot transactions traded on electronic trading platforms and published with a one-day lag.
    - Bank clients can submit benchmark orders typically three days in advance to mitigate exchange rate risk on payments to the government.

### Market infrastructure and operational features
- Settlement conventions:
  - Standard settlement is t+0; t+1, t+2 and t+3 also possible but used to a lesser extent.
  - Only transactions executed by 1 p.m. are eligible for same-day settlement.
- Interbank spot trading is centrally cleared, improving liquidity by allowing more trading without counterparty limits.
- Concentration of back-office activity in afternoon hours due to client documentation requirements; documentation errors can complicate same-day processes.

### Constraints and operational challenges for non-residents
- Non-resident participation requires establishing local legal entities or branches due to inability to open corresponding COP/FX accounts and participate in clearing.
- Market segmentation and different settlement/collateral practices between onshore and offshore NDFs limit integration.
- Local ISDA arrangements differ from global ISDA, limiting parallel use by private sector clients.

### Policy recommendations and market development strategy
- Ease entry barriers and administrative burdens for market makers and customers, with careful sequencing and scaling to avoid increasing systemic risks.
- Harmonize infrastructure and regulatory framework with global standards in anticipation of opening the market to non-resident participants.
- Improve BR communication and market transparency:
  - Establish a standing FX committee with participation from relevant stakeholders for proactive, open discussion on FX market functioning.
  - Consider publishing aggregate market liquidity indicators of FX trading platforms on a daily basis to inform NFCs on liquidity conditions.
- Upgrade trading infrastructure to be robust to potential participation of international banks:
  - Assess robustness of foreign exchange trading and registering systems to high-frequency trading and upgrade with safeguards if needed.
- Review domestic banks’ FX net open position (NOP) limits regularly, considering BR’s capacity to provide emergency liquidity assistance in FX:
  - Adjust NOP limits over time depending on banks’ risk absorption capacity and riskiness of exchange rate exposure.
  - Ensure NOP adjustments are for prudential purposes and not to manage capital flows.
  - Note caveat: BR’s lender-of-last-resort capacity in foreign currency is constrained by FX reserves.
- Ease regulatory constraints to enable non-resident banks’ entry:
  - Explore harmonizing the domestic ISDA with global standards to offer more attractive derivatives to domestic NFCs.
  - Consider allowing full use of nonresident COP accounts held in Colombia on proprietary transactions, which would require changing the current definition of foreign investments in international treaties and domestic regulations to make investment classification indifferent to currency denomination.
  - Allow international correspondent banking relationships to be fully operational using nonresident COP accounts held in an FXI Group 1, implementing appropriate oversight and integration with FX regulation.
  - Assess possibility of licensing non-resident banks to perform certain FX operations onshore without establishing a legal entity.
  - Ensure all changes are integrated with FX regulation and effectively coordinated with other regulatory and supervisory bodies for oversight.

*IMF Technical Assistance Report*

### Annex III. Country Case Studies on Liberalization

### Annex III. Country Case Studies on Liberalization

### South Korea
- FX regime evolution:
  - Fixed exchange rate pegged to the USD before 1980.
  - Multi-basket pegged regime from 1981 until February 1990.
  - Market average exchange rate from March 1990 until December 1997.
  - Free-floating regime beginning in 1997.
- Liberalization timeline and measures:
  - Access to the Korean stock market in 1984; systematic opening of the stock market since January 1992.
  - Post-1997 acceleration under the IMF Stand-By Arrangement: lifting of ceilings on portfolio investments and opening of the bond market.
  - Introduction of Korea Treasury Bonds with terms of 10-, 20-, 30-, and 50-years and a primary dealer system implemented in 1999.
  - FDI regulations harmonized with OECD standards; individual foreign currency transactions, deposit abroad and nonresident’s deposit in Korea liberalized by 2001.
  - Policies to promote capital outflows, including the Overseas Investment Activation Plan in 2005.
- Lessons and vulnerabilities:
  - Pre-1997 liberalization prioritized easing controls on short-term capital flows over long-term ones, contributing to buildup of economic vulnerabilities and exacerbating the 1997 crisis.
  - Short-term flows described as typically more volatile and prone to capital flow reversal and financial stability risks.
- Institutional and regulatory reforms:
  - Revision of regulatory framework: Foreign Exchange Transactions Act and Foreign Investment Promotion Act, both in 1998, including ex-post reporting possibilities.
  - Bank of Korea gained more independence and adopted an inflation targeting regime; prudential regulation perspective enhanced.
- Recent measures (intended to be fully implemented until the second semester of 2024) to deepen internationalization and enhance efficiency and stability:
  - (i) KRW overdraft to be allowed to avoid settlement failures.
  - (ii) Extension of foreign investors’ usability of KRW cash account using ICSDs.
  - (iii) Streamlining of FX transactions in line with omnibus accounts practice.
  - (iv) Strengthening communication with foreign investors to clarify uncertainties surrounding FX trading and KRW transactions.
  - (v) Opening up the onshore interbank FX market to foreign financial institutions.
  - (vi) Extending onshore FX trading hours.
  - (vii) Developing market infrastructure to be in line with global FX markets.
  - (viii) Establish a cooperative relationship between foreign financial (headquartered abroad but full operation in the Korean interbank market) and local financial institutions.
  - (ix) Adjusting regulatory framework to incorporate solid external soundness (macro-prudential policy, safeguards, supervision).

### Brazil
- Historical context:
  - Many episodes of FX control over the last century, using allotment, advance deposit requirements on imports, repatriation requirements on exports, previous approval by the central bank, limits on FX operations, and electronic systems to collect data applied to capital control.
- Early liberalization step:
  - Implementation of a dual exchange rate system; in 1989 the "Mercado Flutuante" segment introduced for international travel operations, current transfers, and export/import of services, operating with its own net open positions.
  - "Segmento Livre" continued under existing regulations, restrictions, and requirements, including mandatory previous authorization of the BCB for most FX operations.
- Transition to floating and unification:
  - After Asian and Russian crises in 1997 and 1998, capital outflows and pressure on international reserves led to adoption of a free-floating regime.
  - Unification of FX market (“Segmento Livre” and “Segmento Flutuante”) in 2005 and removal of considerable exchange control; transition described as smooth with no disturbances or visible impact on exchange rate trend.
  - Removed restrictions included lifting limits on operations and requirement of previous authorizations by the central bank.
- Foreign trade liberalization steps:
  - Revision of fines applied to foreign trade operations.
  - End of stringent exchange control on foreign trade operations, including end of cross crossing of customs and FX data at transaction level.
  - Phased end of repatriation requirement of export revenues: mandatory repatriation requirement of 70 percent of export revenues in 2006; lift of mandatory repatriation requirement in 2008.
- Foundations for further liberalization:
  - Reliance on inflation target regime, pursuit of fiscal discipline, exchange rate flexibility, market development, central bank autonomy, strong prudential policy, intensive and intrusive banking supervision, and an adequate banking resolution framework.
  - New regulation on capital movement and FX operations aimed to facilitate international trade, transfers of funds, and investment flows; improve market efficiency, competition, transparency, and financial inclusion.
  - Implementation of thresholds and ex-post provision of information to ease processes and reduce frictions and bureaucracy.

### Iceland
- Crisis and controls:
  - Substantial balance sheet expansion and subsequent financial collapse driven by interactions between debt and asset prices, large carry trade inflows, and exceptionally large capital inflows that fueled a boom-bust cycle culminating in massive bank failures.
  - Comprehensive capital controls implemented to curb disorderly outflows, support more accommodative monetary policies, and create conditions for balance sheet restructuring and enhancement of policy frameworks; controls also assisted in managing resolution of failed banks’ assets.
- Liberalization strategy:
  - Initial liberalization strategy launched in 2009 focusing on opening FDI and addressing balance of payments difficulties, including mitigation of potential outflows (CBI 2022).
  - Strategy updated in 2015 to include further liberalization measures.
- Supporting measures:
  - Enhancements in Monetary Policy Committee transparency, support for FX interventions, establishment of macroprudential policies and fiscal rules.
  - Prioritized stabilizing conditions of failed bank estates using backstop taxation, followed by an auction for offshore krona assets and gradual removal of restrictions on residents.
- Challenges highlighted:
  - Managing large carry trade inflows, resolving large bankruptcies in a small monetary system, and careful assessment and mitigation of risks associated with liberalization.

### Chile
- Early liberalization and vulnerabilities:
  - Financial account liberalization began in 1974 with aggressive privatizations and deregulations intended to develop the financial sector but resulted in vulnerabilities due to lack of supervision and prudential regulation.
  - Macroeconomic background: low international interest rates, large capital inflows from oil-producing countries, and a fixed exchange rate policy.
  - Financial vulnerabilities included high leverage in the corporate sector, currency mismatches in the non-tradable sector, and overgrowth of credit.
- Crisis and regulatory response:
  - Financial crisis in the early 1980s led to implementation of capital controls and regulatory reforms focused on stabilizing the financial system.
  - New banking act issued in 1997 (General Banking Law —GBL), complying with international best practices such as Basel standards.
  - GBL facilitated internationalization of domestic banks, allowed foreign subsidiaries from countries with highest investment grade or with Memorandum of Understanding with Chilean supervisory authorities, and admitted foreign branches under Chilean supervision.
- Structural developments supporting liberalization:
  - Growth of pension funds from early 1980s into a crucial pillar channeling domestic savings into banking system and deepening the domestic capital market.
  - September 1999 program to liberalize the economy influenced partly by the Asian Financial Crisis and Russian default; allowed the peso to float freely and required review of exchange rate risks in the banking sector.
  - Liberalization supported by an autonomous central bank, development of the capital market, a floating exchange rate, an inflation targeting regime, and long-term fiscal policy.
- Approach emphasized:
  - Gradual approach, implementation of reforms, and consideration of country-specific circumstances as crucial to successful liberalization.

### Annex IV. Colombian FXIs’ Permitted Activities (excerpt)
- Source: Banco de la República.
- FXI categories and institution types (excerpted labels preserved):
  - FXI group 1: Credit Establishments, National Development Financial Institution (FDN in Spanish) and Bancoldex — Equity requirement (PT) in 2024: PT >= COP 48.5 b
  - FXI group 2: Credit Establishments, National Development Financial Institution (FDN in Spanish), and Bancoldex — PT =< COP 48.5 b
  - FXI group 3: Stockbrokers — PT => COP 34.4 b
  - FXI group 4: Foreign Exchange Intermediation and Special Financial Services Companies (SICSFE in Spanish), and Companies Specialized in Deposits and Electronic Payments (SEDPE in spanish) — PT=> COP 16 b
  - FXI group 5: SEDPE — PT =< COP 16 b
  - FXI group 6: FINDETER, FINAGRO, ICETEX, ENTerritorio, and FNA — N/A
- Selected permitted activities by FXI group (notation: • indicates permitted; placement corresponds to groups in source table):
  - Conduct capital investments overseas: •• ••
  - Execute COP-denominated derivative transactions: •••
  - Professionally engage in currency derivative operations: • (must be compensated through counterparty central risk chamber)
  - Provide guarantees and sureties: ••
  - Purchase and sell currencies channeled (mandatory and voluntary) through the foreign exchange market: •••
  - Execute currency transactions with the BR and FXIs, and compensation account balances: ••• not with the BR Only with FXI
  - Facilitate the sending or receiving of foreign currency payments and transfers, including conducting currency remittances to or from abroad: •••
  - Send or receive foreign currency from non-mandatory channeled operations. Can buy/sell foreign currency for this purpose: (• entries)
  - Accept foreign currency deposits from clients: •
  - Accept demand deposits from non-resident client: •• Only for SEDPE, they can accept electronic deposits
  - Distribute and sell market prepaid debit cards, whether reloadable or not, and similar instruments issued by foreign financial institutions: ••
  - Obtain foreign currency financing from non-residents: ••
  - Obtain legal tender-denominated financing from non-residents: •••
  - Provide external credit: ••

### Annex V. Brazil’s Regulation on Cross-border Virtual Assets
- Evolution and legal framework:
  - Progressive regulatory development since 2015.
  - Key Legislation:
    - Law 14478, issued in December 2022: on the Virtual Asset Service Provider.
    - Presidential Decree 11563, enacted June 2023: regulates the Law, central bank as the main regulatory and supervisory authority.
  - Public consultation from December 2023 to January 2024.
- Legal and regulatory design:
  - Three-legged: Constitution + Law + Presidential Decree + BCB by-law.
  - BCB designated as regulatory and supervisory authority; launched a public consultation in 2024 to identify core elements for regulation and supervision.
  - Law incorporates four important elements: specific and clear provisions about VASPs; definition of VASPs as financial institutions; criminalization of frauds committed with use of VAs; amendment of AML/CFT law to explicitly include VASPs and VAs-related provisions.
- Decree 11563 (of 2023) effects:
  - Licensing requirements and operational guidelines for VASPs.
  - Management and supervisory mandates.
  - Specific provisions for sanctioning non-compliance.
- Public consultation focal points:
  - Asset segregation and juristic impact.
  - How to manage and mitigate risk.
  - Cross-border payment risks (circumventing regulation, use in FDI, external credit and portfolio operations).
  - Derivatives with the use of VA.
  - Licensing procedures for VASPs and eligibility criteria for offering VAs.
  - Sound custody and access to custody provided abroad.
  - Safe partnership and correspondent relationships.
  - Compliance of AML-CFT measures; governance (responsibility and risk of each business model).
  - Sound price formation; mitigation of risks related to cybersecurity; consumer protection elements; transition rules for existing VASPs.
- Key issues and policy considerations:
  - Need for regulatory policy to be as dynamic as the market.
  - Core role of coordination among regulatory bodies and countries.
  - Need to balance data gathering and streamlined market operations.
  - Integration of VA regulation with FX market and capital flow regulations.
  - Understanding the role and potential risks of stablecoins, particularly given strong growth in their use.
  - Proper regulatory and supervisory treatment is key to continued efficiency of foreign exchange and monetary policies, including the effectiveness of capital flow management measures.
- Statistics and trends (as presented):
  - Growth trends since 2017 and integration into Brazil's Balance of Payments.
  - Guidance from the IMF on treating crypto assets in macroeconomic statistics.
  - Steep growth on crypto imports.
  - High prevalence of stablecoins.
- Final remarks from the source:
  - Emphasis on need for dynamic regulatory policies to keep pace with market changes.
  - Importance of domestic and international coordination among regulatory bodies.
  - Significant role of stablecoins, especially those denominated in foreign currencies.
  - Data gathering is essential.

*IMF Technical Assistance Report*

### Annex VI.  VAR Model of Hedging Dynamics in

### Annex VI. VAR Model of Hedging Dynamics in the FX Market

### Methodology
- Objective: investigate the impact of Foreign Exchange (FX) volatility on market indicators and market participants using two VAR models with daily data from January 04, 2021, to October 31, 2023.
- Model 1 specification:
  - Y_t = α + Σ_{i=1}^{p} β_i Y_{t−i} + γ_1 FX_VOL_t + ε_t
  - Y_t represents the vector of market indicators: bid-ask spread in the spot market, market depth at 10 maturities, liquidity indicators (trading volumes with FXI-other in the spot market and FXI-FXI in the spot market).
  - FX volatility measured as either the variance of the FX rate daily return (fx_vol_sqr) or GARCH FX volatility (garch_fx_vol).
- Model 2 specification:
  - P_t = α + Σ_{i=1}^{p} β_i P_{t−i} + γ_2 FX_VOL_t + ε_t
  - P_t represents the vector of positions: Others-FXI, Total pension funds, Total offshore.
  - FX volatility measured using either the FX rate or the FX rate daily return; FX rate daily return defined as log(FX rate_{t−1}/FX rate_t).

### Variables Definition
- bid_ask_spot: Bid-ask spread in the spot market.
- spot_depth_at_10: Market depth at 10 maturities.
- fxi_other_spot: Trading volumes with FXI-other in the spot market.
- fxi_fxi_spot: Trading volumes with FXI-FXI in the spot market.
- fx_vol_sqr: Variance of the FX rate daily return.
- garch_fx_vol: GARCH FX volatility.
- diff_others_fxi_net_fwdswp: Long/short term position of others-FXI.
- diff_total_pension_funds: Long/short term position of total pension funds.
- diff_total_offshore: Long/short term position of total offshore.
- diff_fx_rate: FX rate.
- fx_rate_daily_return: FX rate daily return (log ratio).

### Results — Model 1 VAR Estimates (sample and fit)
- Date: 05/01/24 Time: 19:38
- Sample (adjusted): 1/07/2021 10/31/2023
- Included observations: 667 after adjustments
- Determinant resid covariance (dof adj.): 7.80E-13
- Determinant resid covariance: 6.93E-13
- Log likelihood: 3658.682
- Akaike information criterion: -10.73668
- Schwarz criterion: -10.21011
- Number of coefficients: 78

Key coefficient estimates (selected, coefficient (standard error) [t-statistic]):
- BID_ASK_SPOT(-1) on BID_ASK_SPOT: 0.538204 (0.15330) [ 3.51089 ]
- BID_ASK_SPOT(-1) on FX_VOL_SQR: 0.000363 (0.00023) [ 1.61151 ]
- FX_VOL_SQR(-1) on BID_ASK_SPOT: -93.72943 (96.1866) [ -0.97445 ]
- FX_VOL_SQR(-1) on GARCH_FX_VOL: 9.82E+09 (3.0E+09) [ 3.25589 ]
- FXI_FXI_SPOT(-1) on BID_ASK_SPOT: 1.19E-07 (2.6E-08) [ 4.56875 ]
- FXI_FXI_SPOT(-1) on FX_VOL_SQR: 1.36E-10 (3.8E-11) [ 3.57192 ]
- GARCH_FX_VOL(-1) on BID_ASK_SPOT: 0.000707 (0.00034) [ 2.05225 ]
- GARCH_FX_VOL(-1) on FX_VOL_SQR: 9.53E-07 (5.1E-07) [ 1.88221 ]
- SPOT_DEPTH_AT_10(-1) on GARCH_FX_VOL: 0.304810 (0.05013) [ 6.08061 ]
- Constant (C) on GARCH_FX_VOL: 15111.64 (2754.78) [ 5.48560 ]

Model fit statistics (by equation):
- BID_ASK_SPOT: R-squared 0.480624; Adj. R-squared 0.471094; S.E. equation 0.000118; F-statistic 50.43358
- FX_VOL_SQR: R-squared 0.381231; Adj. R-squared 0.369877; S.E. equation 1.74E-07; F-statistic 33.57811
- FXI_FXI_SPOT: R-squared 0.268420; Adj. R-squared 0.254997; S.E. equation 184.8856; F-statistic 19.99630
- FXI_OTHER_SPOT: R-squared 0.020645; Adj. R-squared 0.002675; S.E. equation 22.50159; F-statistic 1.148846
- GARCH_FX_VOL: R-squared 0.914182; Adj. R-squared 0.912607; S.E. equation 0.012968; F-statistic 580.5623
- SPOT_DEPTH_AT_10: R-squared 0.525755; Adj. R-squared 0.517053; S.E. equation 3708.309; F-statistic 60.41955

Sum sq. resids (selected):
- BID_ASK_SPOT: 9.14E-06
- FX_VOL_SQR: 1.98E-11
- FXI_FXI_SPOT: 22355468
- FXI_OTHER_SPOT: 331134.4
- GARCH_FX_VOL: 0.109984
- SPOT_DEPTH_AT_10: 8.99E+09

### Results — Model 2 VAR Estimates (sample and fit)
- Date: 05/01/24 Time: 20:02
- Sample (adjusted): 1/07/2021 10/31/2023
- Included observations: 670 after adjustments
- Determinant resid covariance (dof adj.): 5.85E-09
- Determinant resid covariance: 5.38E-09
- Log likelihood: 1624.929
- Akaike information criterion: -4.686354
- Schwarz criterion: -4.316354
- Number of coefficients: 55

Key coefficient estimates (selected, coefficient (standard error) [t-statistic]):
- DIFF_FX_RATE(-1) on DIFF_FX_RATE: 1.608918 (0.41029) [ 3.92145 ]
- DIFF_FX_RATE(-2) on DIFF_FX_RATE: -1.005310 (0.40810) [ -2.46340 ]
- DIFF_OTHERS_FXI_NET_FWDSWP(-1) on DIFF_OTHERS_FXI_NET_FWDSWP: -21.18158 (15.9272) [ -1.32990 ]
- DIFF_OTHERS_FXI_NET_FWDSWP(-1) on DIFF_TOTAL_OFFSHORE: 0.093093 (0.04438) [ 2.09761 ]
- DIFF_TOTAL_OFFSHORE(-1) on DIFF_FX_RATE: 21.72531 (7.32139) [ 2.96737 ]
- DIFF_TOTAL_OFFSHORE(-1) on DIFF_TOTAL_OFFSHORE: -0.060753 (0.02040) [ -2.97796 ]
- DIFF_TOTAL_PENSION_FUNDS(-1) on DIFF_TOTAL_OFFSHORE: -0.058941 (0.02958) [ -1.99263 ]
- FX_RATE_DAILY_RETURN(-1) on DIFF_FX_RATE: -5925.263 (1741.34) [ -3.40271 ]
- FX_RATE_DAILY_RETURN(-2) on DIFF_FX_RATE: 3886.972 (1732.05) [ 2.24415 ]
- Constant (C) on DIFF_FX_RATE: 0.842755 (1.43827) [ 0.58595 ]

Model fit statistics (by equation):
- DIFF_FX_RATE: R-squared 0.104278; Adj. R-squared 0.090685; S.E. equation 37.00275; F-statistic 7.671900
- DIFF_OTHERS_FXI_NET_FWDSWP: R-squared 0.112700; Adj. R-squared 0.099235; S.E. equation 0.103107; F-statistic 8.370234
- DIFF_TOTAL_OFFSHORE: R-squared 0.149395; Adj. R-squared 0.136487; S.E. equation 0.222218; F-statistic 11.57426
- DIFF_TOTAL_PENSION_FUNDS: R-squared 0.042235; Adj. R-squared 0.027702; S.E. equation 0.137876; F-statistic 2.906031
- FX_RATE_DAILY_RETURN: R-squared 0.093399; Adj. R-squared 0.079642; S.E. equation 0.008787; F-statistic 6.789067

Sum sq. resids (selected):
- DIFF_FX_RATE: 902305.0
- DIFF_OTHERS_FXI_NET_FWDSWP: 7.005864
- DIFF_TOTAL_OFFSHORE: 32.54199
- DIFF_TOTAL_PENSION_FUNDS: 12.52738
- FX_RATE_DAILY_RETURN: 0.050883

Italic: Source: Annex VI. VAR Model of Hedging Dynamics in the FX Market (tarea2025014-print-pdf)

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_Source: https://www.imf.org/-/media/files/publications/tar/2025/english/tarea2025014-print-pdf.pdf_