5. Memo Items: Section IV of the Reserves Data Template
- International Monetary Fund. Statistics Dept.
- Published Date:
- October 2013
Coverage of Memo Items
236 Section IV of the Reserves Data Template provides information covering (1) positions and flows not disclosed in Sections I–III but deemed relevant for assessing the authorities’ reserves and foreign currency liquidity positions and risk exposure in foreign exchange; (2) additional details on positions and flows disclosed in Sections I–III; and (3) positions and flows according to a breakdown or valuation criteria different from those found in Sections I–III.
237 Information on seven different items is to be disclosed in Section IV of the Reserves Data Template. They are as follows:
Short-term domestic currency debt indexed to foreign exchange rates.
Financial instruments denominated in foreign currency and settled by other means (e.g., in domestic currency). This item includes derivatives (forwards, futures, swaps, and options contracts), as well as other instruments.
Securities lent and on repos (as well as gold swapped).
Financial derivatives assets (net, marked to market).
Derivatives that have residual maturities longer than one year, with a breakdown between derivatives subject and not subject to margin calls.
Currency composition of reserve assets (disseminated at least once a year).
238 In reporting data on the memo items, data pertaining to assets should be separately recorded from those on liabilities wherever applicable. An exception is financial derivative asset items, for which the “net” basis means that the liabilities are netted from the assets (see discussion on financial derivatives later in this chapter).
239 Types of instruments are to be identified where applicable.
240 Where instruments are marked to market in a currency other than the reporting currency, end-period market prices and exchange rates should be used to convert the values to the reporting currency.
241 After presenting some brief comments on the recording of selected memo items as shown below, the rest of this chapter discusses in greater detail the reporting of (1) financial instruments denominated in foreign currency and settled by other means, (2) securities lent and repurchase agreements, and (3) financial derivatives assets.
Financial Instruments Denominated in Foreign Currency and Settled by Other Means
Short-Term Domestic Currency Debt—Item IV.(1)(a) of the Reserves Data Template
242 With respect to short-term domestic currency debt indexed to foreign exchange rates, consistent with the rest of the Reserves Data Template, “short-term” is determined by the residual maturity of the instruments as defined in Chapter 1. Accordingly, the data to be reported should cover such short-term debt with (1) original maturity of one year or less, (2) longer original maturity where remaining maturity is one year or less, and (3) principal and interest payments falling due within the next 12 months for debt with remaining maturity of longer than one year. Only the total nominal amount is to be reported. Detail for the three subperiods within the one-year horizon is not required. Domestic currency debt refers to debt issued by the monetary authorities and the central government, excluding social security funds. Only such short-term debt indexed to foreign exchange rates and settled in the domestic currency is to be included in item IV.(1)(a) of the Reserves Data Template. Domestic currency debt settled in foreign currencies is to be covered in Sections II and III of the Reserves Data Template as appropriate.
Financial Instruments Denominated in Foreign Currency and Settled by Other Means (e.g., in domestic currency)—Item IV.(1)(b) of the Reserves Data Template
243 The rationale for including information on these financial instruments is that they resemble instruments that are settled in foreign currency. These instruments are separately reported in Section IV of the Reserves Data Template because they are often issued in the domestic market and held by residents and thus are actually or potentially subject to different legal or regulatory restrictions. Information on this memo item should be broken down by type of instrument.
244 Financial instruments denominated in foreign currency and settled in domestic currency (and other means) include indexed securities and derivatives (forwards, futures, swaps, or option contracts). Data on the nominal/notional value should be reported, except for securities which should be valued at market value. Forwards and futures are defined in Chapter 3 (paragraphs 170–172) and options in Chapter 4 (paragraph 222). Short and long positions in derivatives should be separately reported.
245 This item includes NDFs denominated or indexed to a foreign currency but settled in a domestic currency. An NDF is typically an over-the-counter instrument. It differs from a normal foreign currency forward contract in that there is no physical settlement of the two currencies at maturity. The financial institution that sold the NDF contract will mark the notional value of the contract to market, using an index (or formula) agreed upon at the time the contract is entered into by the two counterparties. One party will make a cash payment to the other based on the contract’s intrinsic (net) value.
246 The net amount can be settled in local currency or foreign currency (usually U.S. dollars). Whereas onshore banks trade in NDFs that settle in foreign or local currencies, typically, offshore banks deal in NDFs that settle in foreign currencies.
247 In addition to forward-based NDFs, there also can be options on NDFs. In an NDF option, the option buyer pays a premium to protect the foreign currency value of an amount in local currency. If the option expires “in the money,” the writer pays the intrinsic value to the purchaser. There is no exercise of the option; the payment is automatic. If the option expires “out of the money,” no payment is due to either party.
248 NDFs are commonly used to hedge local currency risks in emerging markets where local currencies are not freely convertible, where capital markets are small and undeveloped, and where there are restrictions on capital movements. Under these conditions, the normal forward foreign exchange contracts generally do not work well; they may not be enforceable and they may not be liquid.
249 Item IV.(1)(b) of the Reserves Data Template requires disclosure of NDFs settled in domestic currency only.1 Such information is useful because NDFs can exert substantial indirect pressure on reserves. If market participants anticipate that a local currency will decline, they can buy derivatives that let them maintain the foreign currency value of their local currency assets; such widespread buying has the potential to further depress the value of the local currency.
250 The Reserves Data Template prescribes, where applicable, that the notional value of nondeliverable forward positions be shown in the same format as that for the notional value of deliverable forwards/futures in Section II of the Reserves Data Template.
Pledged Assets—Item IV.(1)(c) of the Reserves Data Template
251 Pledged assets refer only to reserve assets and other foreign currency assets listed in Section I that are pledged. As mentioned in Chapter 2, pledged assets that are clearly not readily available should not be included in reserves or in foreign currency assets. However, if certain pledged assets remain in reserves and other foreign currency assets, their values should be reported in item IV.(1)(c) of the Reserves Data Template. Pledged assets do not include assets encumbered under repos, securities lending, and similar arrangements. The latter arrangements are to be separately reported under item IV.(1)(d) of the Reserves Data Template.
Securities Lent and Repurchase Agreements
Securities Lent and on Repo—Item IV.(1)(d) of the Reserves Data Template
252 This memo item is to provide additional information on the repo and securities lending activities that are covered by the Reserves Data Template. It concerns such activities of the monetary authorities and the central government that are settled in foreign currency. Thus, whether or not the repo and securities lending activities have been included in Section I of the Reserves Data Template along with associated liabilities in Section II, the Reserves Data Template requires that securities lent and repoed be recorded in item IV.(1)(d) of the Reserves Data Template. The Reserves Data Template also requires that the securities lent and repoed be reported in two separate categories, depending on whether or not the repo and related activities have been included in Sections I and II. Such reporting is necessary in order to differentiate repos from traditional loans and from traditional securities transactions. The identification of repo activities would facilitate the assessment of the level of reserve assets before the repo activities and the extent of leverage the authorities have undertaken.
253 In addition, the Reserves Data Template calls for the separate reporting of securities provided as collateral under repo transactions and the securities collateral taken in reverse repos. The data to be reported are the values of the securities. Institutions normally use market values (bid side), including the amount of any accrued interest, to determine the price of securities sold under repos and in security lending transactions.
254 Securities lent/acquired with no cash involved should be recorded in Section IV of the Reserves Data Template. Similarly, foreign currency flows associated with repos and securities lending that fall due beyond the one-year time horizon and are not reflected in Section II of the Reserves Data Template; nonetheless, such securities lent or repoed should be reported in Section IV of the Reserves Data Template. So the value of securities provided (or lent) in repos and the value of securities received (or borrowed) in reverse repos are to be reported separately under item IV.(1)(d) irrespective of the time horizon of the related cash flows. As was discussed in paragraph 85(ii), securities borrowed or acquired in reverse repos should never be included in Section I but always need to be reported under item IV.(1)(d): “borrowed or acquired but not included in Section I.” To inform the user of deviations from this guidance, the item “borrowed or acquired and included in Section I” can additionally be used to report repo assets recorded in Section I. But if this approach is taken, it should be clearly specified in the country notes.
255 As discussed in Chapter 2 (see also BPM6, paragraphs 7.58–7.59), gold swaps are to be treated similarly to repos. The gold that is swapped should be included, as appropriate, among securities lent or repoed in item IV.(1)(d) of the Reserves Data Template (see also Appendix 3). Notwithstanding that Section IV. (1)(d) refers to securities lent and on repo, gold should be reported in this section with additional information in country notes.
256 Note that under repos or securities lending, either initial or variation margins (or both) are usually paid. As a result, the purchaser of the securities normally pays less than the market value of the securities, including the amount of any accrued interest, with the difference representing a predetermined margin. Also, there are cases where the borrower of securities has a need for a specific security; the lender of the securities may receive cash collateral in excess of the value of the securities lent, with the difference representing the margin. That is, due to margining, the value of securities lent or repoed reported in Section IV of the Reserves Data Template may not be equivalent to the cash exchanged; the same applies for reverse repos. The level of the margin is usually determined by the size and maturity of the repos, the type and maturity of the underlying securities, and the creditworthiness of the counterparty. Margin requirements allow for the anticipated price volatility of the security until the repos mature. Less marketable securities often require an additional margin to compensate for less liquid market conditions.2
257 The Reserves Data Template calls for comprehensive information on repos and security lending because of the importance of these instruments in global financial markets. Repos can be a useful asset management tool for the authorities, but repos can expose the authorities to serious risks if they are not managed appropriately. In particular, the authorities can face credit risks if they do not have effective control over the securities collateralizing the transaction and the counterparty defaults. Such credit risk can be considerable if the authorities engage in repo transactions in volume and in large amounts of foreign currency and if the creditworthiness of the counterparty is uncertain. Similarly, the authorities can use repos to acquire funds, which is a useful tool for managing liabilities. In these circumstances, the authorities would not want to provide the counterparty with excessive margins.
258 As with repos, experience has shown that the collateral securities in security lending may not serve as protection if the counterparty becomes insolvent or fails and the purchasing institution does not have control over the securities. If control of the underlying securities is not established, the authorities may be regarded as an unsecured general creditor of an insolvent counterparty. Under these circumstances, substantial losses are possible.
Financial Derivatives Assets (Net, Marked to Market)
Financial Derivatives Assets, net—Item IV.(1)(e) of the Reserves Data Template
259 The market values of the authorities’ financial derivatives are to be reported in Section IV of the Reserves Data Template under the memo items. Item IV.(1)(e) of the Reserves Data Template mentions only “financial derivatives assets,” but data on financial derivatives liabilities also are to be included; the positive (+) sign should accompany the asset data, and the minus (−) sign should precede the liability data.
260 The “net, marked to market” designation refers to the following: the difference between asset and liability positions yields the “net”3 asset position. Financial derivatives are to be shown at their market values on a marked-to-market basis. “Marking to market” refers to revaluing the financial derivative using the prevailing market price.
261 This memo item relates to all financial derivative positions of the monetary authorities and the central government that are settled in foreign currency, irrespective of whether the positions are vis-à-vis residents or nonresidents.
262 Financial derivatives are to be disclosed by types of instruments (viz., forwards, futures, swaps, options, and others). All financial derivatives settled in foreign currency are to be disclosed, regardless of whether they have been reported in other sections of the Reserves Data Template.
263 With netting by novation, the legal obligations of the counterparties to make payments under the terms of the financial derivatives are extinguished and a new contract that requires only a net payment is created. Netting by novation is allowed if offsetting positions are maintained with the same counterparty and have the same maturity, and insofar as there is a legally enforceable netting agreement in place allowing settlement in net terms. Netting by novation also is allowed for matched positions on organized exchanges. Netting refers to the right to set off, or net, claims between two or more parties to arrive at a single obligation between the parties.4
264 As alluded to in previous chapters, the market value of a financial derivative generally can be derived from the difference between the agreed contract price(s) and the prevailing, or expected prevailing, market price(s) of the underlying instrument, appropriately discounted. If the prevailing market price differs from the contract price, the financial derivative contract has a market value, which can be positive or negative, depending on which side of the contract a party is on. In addition, the market value of a derivative contract can be positive, negative, or zero at various points in the life of the contract. Financial derivatives can be recorded as assets if their market values are positive; they can be shown as liabilities if their market values are negative. Note that options usually have a market value but do not change from asset to liability, or vice versa.
265 Prevailing market prices of an underlying instrument ideally should be observable prices on financial markets. Where they are not, as in some over-the-counter contracts, estimates of the prevailing market price can be derived from other available information.
266 Key characteristics of internal models used to calculate the market values of financial derivatives are to be disclosed in country notes accompanying the data reported in the Reserves Data Template (see also Appendix 2, footnote 16 of the Reserves Data Template).
267 For purposes of the Reserves Data Template, the reference date for the market valuation should be the last day of the reporting period.
268 The market value of a forward or a swap can be derived from the difference between the agreed contract price and the prevailing market price or the expected market price discounted accordingly, but the market valuation of options can be complex.
269 Four factors influence the market value of options: the difference between the contract (strike) price and the value of the underlying item; the price volatility of the underlying item; the time remaining to expiration; and interest rates. In the absence of an observable price, market value can be approximated using a financial formula, such as the Black-Scholes formula, which incorporates the four factors.5 An option contract at its inception has a market value equal to the premium paid. Its market value, however, is adjusted as the reference price changes and the settlement date approaches. During the life of an option, the writer of the contract has a financial derivative liability and the purchaser of the option has a financial derivative asset. An option contract can expire without value to the holder, that is, it is not advantageous for the purchaser to exercise the option.
270 Unlike forward contracts, futures contracts are marked to market at the end of each trading day and the resulting gains or losses are settled on that day.6 This means that at the end of each trading day the value of outstanding futures contracts is zero. This is in contrast to forwards, for which settlement payments are not usually made on a daily basis and contracts can build up considerable marked-to-market positions.
Financial Derivatives that have a Residual Maturity Greater than One Year—Item IV.(1)(f) of the Reserves Data Template
271 Financial derivatives with a residual maturity of greater than one year are to be reported in item IV.(1)(f) of the Reserves Data Template. Derivatives instruments subject to margin calls should be separately identified from those not subject to margin calls.
272 Financial derivatives to be reported in this item of the Reserves Data Template are similar to those called for in items II.2 and III.5 of the Reserves Data Template. That is, they refer to foreign currency commitments in the various types of financial derivative contracts. Such contracts are in foreign currency vis-à-vis domestic currency. The data to be reported are the nominal/notional values of the contracts.
Currency Composition of Reserves—Item IV.(2) of the Reserves Data Template
273 Regarding the currency composition of reserve assets, the Reserves Data Template does not require listing of individual currencies; only groups of currencies are to be identified. At a minimum, data on currency composition are to be disseminated under two major categories: currencies in the SDR basket and currencies outside of the SDR basket. This reporting is required at least once a year, with more frequent reporting encouraged. Currencies in the SDR basket at the time of writing include the U.S. dollar, the euro, the Japanese yen, and the pound sterling. By convention, in the Reserves Data Template, gold and claims denominated in SDRs (including SDR holdings and reserve position in the IMF) are considered to be denominated in currencies in the SDR basket (see also BPM6, paragraph 5.108). Countries can provide detailed information in country notes accompanying the data on the currency composition of their reserve assets if they so choose.
The notional value of NDFs settled in foreign currency vis-à-vis domestic currency is to be included in item II.2 of the Reserves Data Template, and its market value is to be included in financial derivative assets under item IV.(1)(e) of the Reserves Data Template, preferably on a separate line.
Written repo contracts normally require that repo securities be marked to market and the gains and losses be settled daily. Margin calculations also usually consider accrued interest on underlying securities and the anticipated amount of accrued interest over the term of the repos, the date of interest payment, and which party is entitled to receive the payment.
This is different in this context from the term “netting by novation.”
In financial market transactions, netting can serve to reduce the credit exposure of counterparties to a failed debtor and thereby to limit “domino failures” and systemic risks. As concerns limiting credit exposure, the ability to net contributes to market liquidity by permitting more activity between counterparties within prudent credit limits. This liquidity can be important in minimizing market disruptions due to failure of a market participant.
Institutions that undertake significant options operations often use more complex variants of the Black-Scholes formula.
The price of a futures contract is set in such a way that no cash changes hands when a contract is entered into (outside of any margin arrangements). The payments associated with the contract occur as daily price movements are reflected in cash flows into and out of margin accounts of the contract parties. To ensure that market participants pay for their losses, the exchanges require futures contract users to pay an initial margin (collateral). If the daily settlement process results in a loss, which, in turn, reduces the initial margin below a specified amount, the user is required to restore the initial margin by paying additional sums of money. The level of margin called is set by the exchanges and is usually a function of the volatility of the cash market of the underlying asset.