Reverse Transactions

1
Reverse Transactions

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

2
Reverse Transactions

• What are reverse transactions?
• All involve sale of an asset but original owner
  remains exposed to asset
• 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.
• 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).

3
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
   

4
Reverse Transactions

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

5
Reverse Transactions

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

6
Reverse Transactions

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

7
Reverse Transactions

• Initial and/or variation margin may be payable in
  all four types of reverse transactions
• Repos used commonly in developed financial market
  as means of providing market with liquidity
  leveraging deice.
• Repo rate ECBs target interest rate
• Repos often included in broader measures of money

8
Reverse Transactions

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

9
Reverse Transactions

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

10
Reverse Transactions

• Securities lending often used when securities
  dealer needs to make delivery of security which
  it has not purchased
• 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)

11
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

12
Reverse Transactions

• Issues for consideration repo
• If repo treated as collateral loan
• Reflects market view
• Reflects manner interest rate determined
• Reflects continuing exposure of cash taker to
  market risk
• Reflects the fact that repurchase price
  determined separately from market price
• In line with margin payments
• Creates problems of shorts if on-sold outright

13
Reverse Transactions

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

14
Reverse Transactions

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

15
Reverse Transactions

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

16
Reverse Transactions

• Issues for consideration gold swaps
• If treated in analogous manner to collateralized
  loan for repo
• Potential for overstating reserve assets
• Demonetization not necessary if swapped with
  non-monetary authority commodity gold for
  outright purchaser and short for on-seller
• Consistent with payment of interest on foreign
  exchange received
• View of central bankers and market exposure of
  original owner

17
Reverse Transactions

• Issues for consideration gold swaps
• If treated as outright sale of gold
• Follows legal change of ownership
• Possible need to create financial derivative
• Avoids potential overstatement of reserve
  assets
• Contrary to central bankers views and with
  market exposure of original owner
• Interest payment difficult to explain/interpret
• Demonetization necessary if swapped with
  non-monetary authority

18
Reverse Transactions

• Issues for consideration gold loans
• If treated in analogous manner to collateralized
  loans for repos
• No transaction recorded by monetary authority
• Possible deposit liability with no deposit asset
• Consistent with payment of fee
• No demonetization necessary if swapped with
  non-monetary authority
• Reflects market exposure of original owner
• Consistent with view of central bankers

19
Reverse Transactions

• Issues for consideration gold loans
• If treated as transaction in gold
• Contrary to central bankers views
• Contrary to market exposure of original owner
• Central bankers unlikely to provide information
• Avoids potential double count
• Requires demonetization if deposited/lent to
  non-monetary authority
• Creation of financial derivative probable

20
Reverse Transactions

• Funds 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

21
Reverse Transactions

• Funds 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

22
Reverse Transactions

• Funds 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

23
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

24
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
  practice will be hard to enforce at present)

25
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

26
Reverse Transactions

• Questions for OECD joint meeting of national
  accountants and financial statisticians
• Does the meeting endorse the Committees
  conclusion?
• Does the meeting endorse the Committees view
  that more work is required on the fee?
• Does the meeting endorse the view that more work
  is required on reverse transactions?