By Michael Wallace, Standard & Poor’s MMS
The Swiss National Bank (SNB) is quickly moving down the path of turning monetary policy from an art into a science. Since the beginning of the year, the SNB has been quietly reforming and modernising its policy arsenal into one of the most efficient and transparent systems of its kind – in ways few in the market may fully appreciate.
The SNB spent the early days of the euro’s launch reversing a potentially expensive slide in Euro/Swiss when it dipped below 1.58 on January 13. The central bank has since succeeded in driving the currency pair back above 1.60, all the while diligently working behind the scenes on its monetary policy reforms.
Central to the SNB’s reforms is a move away from swap agreements into repo transactions to fund its short-term liquidity provisions. Repo transactions now outnumber swaps by a 3 to 1 margin. While the significance of this wholesale shift in its money market operations may not be blatantly obvious, it does say volumes within the context of its previously stated goal to move exclusively to repo operations over its real-time automated dealing and settlement system.
As long as two years ago, the Swiss government anticipated this move, revising the Swiss tax code so repos would be classified as secured loans – rather than as purchases or sales of securities – thereby exempting the instrument from the Federal Tax Authority’s stamp duty.
In fact, the repo or “repurchase agreement” is the simultaneous present sale of securities in exchange for cash/capital followed by the repurchase of the same class of securities at a date in the future (reverse repo = purchase, then resale).
In essence, such a “secured loan repo” is tax free and not subject to capital adequacy constraints, which virtually eliminates credit risk and therefore lends to its attraction and marketability. Within the November 1997 tax reforms, Article 14 of the National Bank Law effectively authorises the SNB to freely exploit repos for its funding purposes.
The goal now is to double the number of current domestic and foreign banks participating in the repo market to as many as 50 institutions, as well as to broaden the type of securities, both local and foreign, which can be used as collateral.
This Swiss innovation will put the SNB in a unique position within Europe, and indeed the world. The European Central Bank’s own refinancing operations are cross border; however, these are not considered as external because collateral is strictly in euro assets.
Plans are now in place to diversify the instruments from the current Swiss basket of Confederation, canton, township and mortgage securities presently on offer, in finite supply, to a wider array of domestic and foreign AAA corporate paper.
While a handful of Frankfurt-based German banks already participate in the SNB’s repo auctions, there are also plans to open the Swiss repo market to German bunds as well. In doing so, the SNB will create new baskets of funds available for repos – adding depth and breadth to their operations – which will ultimately have multi-currency implications.
While swaps are expected to remain a tool into the year 2000 – providing a guarantor of full liquidity over the turn of the millennium – deal matching and settlement have been online for some time, and the switch to full electronic trading was scheduled to take place in June. The SNB’s repo operations are managed on SEGA’s “SECOM” communications and “SIC” Swiss Interbank Clearing systems via the Swiss stock exchange.
Features of electronic trading include automated mark-to-market and margin transfer functions which are based on the difference between the value of the cash loan and exchanged securities -the difference being counterparty risk. The system handles the repo payments and the subsequent repayment of securities, as well as netting for both standardised and non-standardised transactions.
For borrowers, this means more efficient provisions for short-term funding, and for lenders, it provides an opportunity for low risk return on otherwise under-utilised capital.
After introducing the informal “RepoLight” (phase I) in April 1998 via telephone, which was limited to Swiss bonds, the SNB exacted phase II of its plans, “Repo”, with broader collateral. These initial phases will now be eclipsed by “RepoInternational” (phase III) which will be brought online from April through August 1999, moving the SNB and its partners into managing a multi-currency portfolio in “all usual currencies, including cross currency pairs”, for which the automated systems will have to be adapted.
The next step is to begin dealing and settling in euros, dollars, yen, sterling and of course, Swiss francs, while new foreign collateral baskets will also be introduced in such instruments as a German baskets with bunds and other state securities such as Pfandbrief and Truehandenstalt paper.
This multi-currency dimension to the Swiss repo market should attract greater foreign participation due to the efficiency of familiar FX accounting terms vis-a-vis home markets. Meanwhile, the very nature of the repo itself, an exchange of funds against securities, suggests little FX risk for authorities.
A RepoX-border final phase will ultimately link settlement capabilities with other foreign clearing organisations – a move which will have intriguing implications as European markets follow the path towards greater efficiency in repo netting across the Continent (both ex- and intra-EMU). In the US, such moves to large-scale netting have already greatly reduced bank balance sheet constraints, enhanced efficiency, reduced back office costs and increased anonymity.
According to a May 1999 Bloomberg magazine report on repo netting, the London Clearing House, Clearnet, GSCC and Euroclear are all vying to become dominant players in the push for a single platform across Europe.
Standing in the way of rapid progress is the shakeout of European Economic and Monetary Union within banks, businesses and markets, as these industries grapple with the effects of the single currency and the ongoing harmonisation of tax and legal codes across former national boundaries. This will be compounded by the head-long rush to clear up any lingering technological pitfalls before the turn of the century, which will curtail many fresh settlement/back office projects from summer onwards.
Perhaps when all the millennium bugs are exterminated, the SNB will take the lead on harmonising and modernising Europe’s monetary arsenal for the 21st century.
Michael P. Wallace is manager of currency analysis, Europe, for Standard
& Poor’s MMS in London.