Reverse Transactions 1 Complex hence long paper 2

Reverse Transactions 1. Complex (hence long paper) 2. Lack of clarity in existing standards for repos and gold swaps; securities lending and gold loans not discussed 3. Developments in markets since 1993 4. Matter considered by the IMF Committee on Balance of Payments Statistics (1995 -2001) 5. Matter referred to ISWGNA; input sought from other macroeconomic statisticians

Reverse Transactions 1. What are reverse transactions? 2. All involve sale of an asset but original owner remains exposed to asset 3. A repo involves sale of securities at a specified price with a commitment to repurchase the same or similar securities at a fixed price on a specified future date or with an “open” maturity. 4. A repo is viewed from the perspective of the seller of securities (“cash taker”). The agreement is called a reverse repo when viewed from the perspective of the securities buyer (“cash provider”).

Reverse Transactions Full, unfettered ownership passes to the “cash provider” but market risk —benefits (and risks) of ownership such as the right to holding gains (and losses) and receipt of property/investment income attached to security —retained by “cash taker” as if no change of ownership had occurred

Reverse Transactions 1. Securities lending is the same as repo except no exchange of cash (terminology may differ) 2. Same legal change in ownership but with “lender” remaining exposed to market gains/losses. 3. Collateral usually provided but usually not available for resale by “lender” until/unless default by “borrower” 4. Securities “borrower” pays fee for the “loan”

Reverse Transactions 1. Gold swaps: similar to repos; gold swapped foreign exchange, with commitment to return the gold at agreed price. 2. Market risk (of price loss/gain) remains with lending monetary authority 3. Volume of gold returned, plus accrued interest (rate of interest agreed at inception of swap)

Reverse Transactions 1. Gold loans/deposits: similar to securities lending: no cash involved but full ownership transferred, even though market risk remains with “lender”. 2. “Borrower” may record gold as foreign currency deposit liability on balance sheet 3. Volume of gold repayable. 4. Collateral (usually securities) provided by “borrower”. Not usually available to “lender/depositor” until/unless default 5. Fee payable by “borrower”

Reverse Transactions 1. Initial and/or variation margin may be payable in all four types of reverse transactions 2. Repos used commonly in developed financial market as means of providing market with liquidity; leveraging deice. 3. Repo rate ECB’s target interest rate 4. Repos often included in broader measures of money

Reverse Transactions 1. Repos usually very short term in nature, but becoming longer 2. Interest rate embedded in repurchase price 3. Initial and variation margin provided as protection for “cash provider”. “Excess” margin may or may not be returned. 4. Margin payments at variance with concept of “normal” transaction.

Reverse Transactions 1. Interest rate on repos determined by short- term, inter-bank rates, not the rate on underlying security 2. On-sale outright presents problems: “shorts” 3. Overwhelming view of market participants (and most central bankers and other market analysts) that repos are collateralized loans, not outright transactions in securities 4. Elements of financial derivatives

Reverse Transactions 1. Securities lending often used when securities dealer needs to make delivery of security which it has not purchased 2. Often made by custodian on behalf of investor, without owner's specific agreement (usually master agreement to cover all such lending, with indemnity against loss)

Reverse Transactions • Gold swaps used to provide cash taker with liquidity in situation where it is reluctant to sell gold holdings • Gold loans provide liquidity to gold market; assist “borrower” (who may be intermediary or gold miner) to make delivery when short of gold

Reverse Transactions Issues for consideration: repo 1. If repo treated as collateral loan: 1. Reflects market view 2. Reflects manner interest rate determined 3. Reflects continuing exposure of “cash taker” to market risk 4. Reflects the fact that repurchase price determined separately from market price 5. In line with margin payments 6. Creates problems of “shorts” if on-sold outright

Reverse Transactions Issues for consideration: repo 1. If repo treated as transaction in underlying security: 1. Follows legal change in ownership 2. Avoids major measurement problems 3. Avoids problem of overstatement of external debt (in event of security “repoed” from one nonresident and being on-sold outright to another) 4. Not generally considered to be as analytically valuable as collateral loan approach 5. Possible need to introduce financial derivative transaction (as “strike price” not equal to market price) even though no transfer of risk

Reverse Transactions Issues for consideration: securities lending 1. If treated in analogous manner to collateralized loan for repo 1. No transaction recorded 2. Same potential risk of double counting as for repo if/when security on-sold outright 3. Reflects market exposure of original owner 4. What does the fee represent?

Reverse Transactions Issues for consideration: securities lending 1. If treated as transaction in underlying security 1. Transaction recorded so follows legal change of ownership 2. Possible need for creation of financial derivative 3. Contrary to market view; fee hard to explain 4. Avoids potential double count if/when on-sold

Reverse Transactions Issues for consideration: gold swaps 1. If treated in analogous manner to collateralized loan for repo 1. Potential for “overstating” reserve assets 2. Demonetization not necessary if swapped with non-monetary authority; commodity gold for outright purchaser and “short” for on-seller 3. Consistent with payment of interest on foreign exchange received 4. View of central bankers and market exposure of

Reverse Transactions Issues for consideration: gold swaps 1. If treated as outright sale of gold: 1. Follows legal change of ownership 2. Possible need to create financial derivative 3. Avoids potential “overstatement” of reserve assets 4. Contrary to central bankers’ views and with market exposure of original owner 5. Interest payment difficult to explain/interpret 6. Demonetization necessary if swapped with non-

Reverse Transactions Issues for consideration: gold loans 1. If treated in analogous manner to collateralized loans for repos: 1. No transaction recorded by monetary authority 2. Possible deposit liability with no deposit asset 3. Consistent with payment of fee 4. No demonetization necessary if swapped with non-monetary authority 5. Reflects market exposure of original owner 6. Consistent with view of central bankers

Reverse Transactions Issues for consideration: gold loans 1. If treated as transaction in gold: 1. Contrary to central bankers’ views 2. Contrary to market exposure of original owner 3. Central bankers unlikely to provide information 4. Avoids potential double count 5. Requires demonetization if deposited/lent to non-monetary authority 6. Creation of financial derivative probable

Reverse Transactions Fund’s proposals to IMF Committee Balance of Payments Statistics: • Given ambiguous nature of transactions (which recognized by accounting bodies IASB and FASB) and overwhelming view that “reverse” nature of transactions should be recognized: • Create an extra transaction, thereby • Legal ownership recognized

Reverse Transactions Fund’s proposals to IMF Committee Balance of Payments Statistics: • For repos and gold swaps, record outright sale and loan simultaneously thereby having four transactions (for each party) • Counterpart entry to transaction in security would be “other asset/liability” representing an unsettled transaction – value would fluctuate with changes in value of asset to be returned, plus the accrual of interest

Reverse Transactions Fund’s proposals to IMF Committee Balance of Payments Statistics: • For securities lending and gold loan, record as if sale of asset had occurred • Counterpart entry to transaction in security would be “other asset/liability” representing unsettled transaction – value would fluctuate with changes in value of asset to be returned, plus the accrual of interest • In addition, for gold loans, demonetization required where counterparty not a monetary authority

Reverse Transactions Conclusion of IMF Committee on Balance of Payments Statistics: • Where possible, treat all reverse transactions in like manner • Record repo and gold swap as collateralized loans • Record no transaction for securities lending and gold loans/deposits • Provide supplementary information on assets involved in reverse transactions, and on counterparties

Reverse Transactions Conclusion of IMF Committee on Balance of Payments Statistics: • Record any outright on-selling as “short” • Treatment applies to positions and transactions • Reverse repo followed by repo should be recorded gross (different counterparties) • For gold loans, the gold “borrower” record the gold off-balance sheet. • Any on-lending by the “borrower” should be recorded as a “short” in commodity gold (this

Reverse Transactions Conclusion of IMF Committee on Balance of Payments Statistics: • Some countries may not be able to record as collateralized loans. In which case, • Provide supplementary information on assets involved in reverse transactions, and on counterparties • The “additional” entry too hard at this stage • More work needed on treatment of “fee” on securities lending and gold loans

Reverse Transactions Questions for OECD joint meeting of national accountants and financial statisticians: • Does the meeting endorse the Committee’s conclusion? • Does the meeting endorse the Committee’s view that more work is required on the “fee”? • Does the meeting endorse the view that more work is required on reverse transactions?