Chapter

I. A Comparative Analysis of the Functions of the ECU and the SDR

Author(s):
Juanita Roushdy
Published Date:
March 1987
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As part of the Fund’s present review of the role of the SDR in the international monetary system,1 interest has been expressed in a comparison of the functioning of the SDR and the ECU (European Currency Unit). Such a comparison can be useful, as one element among many, in assessing the evolution of the SDR and in considering its potential role in contributing to the stability and performance of the international monetary system.2

The terms “ECU” and “SDR” have come to have various meanings, as financial instruments, as the units by which those instruments and transactions in them are valued, and as units used for other purposes. The valuation characteristics of each are common to all of the purposes these units may serve and are discussed in this paper under “Valuation of the ECU and SDR.” “Official ECUs and SDRs” examines the functioning of the official reserve assets created respectively in the context of the operations of the European Monetary System (EMS) and by the Fund, that is, the “official ECU” and the “official SDR.” “Private ECUs and SDRs” reviews the development of private market instruments denominated in these units of account. A summary is provided that also raises questions that might be relevant in considering the potential role of the SDR in contributing to the stability of the international monetary system. The Appendices provide additional information on the use of the ECU and SDR as units of account and as financial instruments, official and private.3

Valuation of the ECU and the SDR

Functions as Units of Value or Account

The purposes the ECU and the SDR may serve as units of value or account are not necessarily the same as those served by the instruments denominated in them. The ECU, for example, serves quite different functions as the unit of account for the European Communities (EC), as the numeraire for expressing central rates used in the exchange rate mechanism of the EMS, as the unit in which EMS intervention credits are denominated, and as the unit in which various financial assets and obligations, both official and private, are denominated.4 Similarly, the SDR serves different functions as the Fund’s unit of account and unit of value for Fund transactions, as the unit in which the official reserve assets created by the Fund are denominated, as a unit to which members’ exchange rates may be pegged, and as the unit of account for certain international organizations, conventions, and treaties. Distinguishing the ECU’s and the SDR’s roles as units of account or as numeraires for pegging exchange rates from their functions as financial instruments may help in understanding the past development of the SDR and considering its possible future role in contributing to the stability of the international monetary system.

The ECU, created in 1979 to replace the European Unit of Account (EUA), is part of a system designed to create closer monetary cooperation among the EC member states and to foster a zone of monetary stability in Europe.5 The ECU and the EMS exchange rate arrangements, of which it is a part, have a regional and integrative role in fostering convergence in the economic policies and performance of the member states. In the EMS, the ECU functions as the numeraire for the expression of the central rates for members’ currencies and as the reference point for the EMS “divergence indicator,” which acts as a signal of the presumptive need for corrective policy action by a participant. The ECU is the unit of value in which EMS intervention credits and other credit facilities of the EC are denominated. It is also the unit of account for EC institutions and the unit of value for many transactions by EC entities. As the common unit for the European Communities and the EMS, the ECU is intended to reflect the values of, and in the view of some could ultimately replace, under a new definition, European national currencies.

The SDR, which has existed since 1969, is a global unit and as such can provide a relatively stable unit of value in terms of currencies in general when one unit is needed on a worldwide basis. It serves as the unit of account and value for all of the Fund’s transactions and operations and is the unit in which members’ financial obligations to and claims on the Fund are denominated. The SDR has also been adopted as the unit of account by a number of international entities in place of gold or national currencies. While the currencies of a few smaller Fund members are pegged to the SDR, the SDR does not serve as the numeraire of a generalized system of exchange rates, as does the ECU in the EMS, although it could serve that function should members’ exchange arrangements call for such a numeraire.

As composite units of value, the ECU and SDR both provide holders of financial assets and liabilities denominated in them with potential hedges against exchange risk and channels for diversification of exposure among currencies. They potentially lower the cost of international financial dealings in an environment of widespread exchange rate instability and inadequate forward cover, especially for longer periods.

Valuation

The methods used at present for determining the values of both units relative to currencies are similar in a number of technical respects. Both are defined as fixed amounts of a number of national currency units, which are valued at prevailing (changing) market exchange rates.6 That is, they are so-called standard baskets, a valuation technique used in connection with the SDR since 1974, following the general move to floating exchange rates, and subsequently adopted for valuing the ECU. The definitions of the valuations of both units are governed by rules with respect to the number and selection of currencies, the determination of their initial weights, and the frequency of or occasions for changes in their amounts. For both baskets, movements in exchange rates result over time in changes in the weight of each component currency as compared with the weights originally assigned. Revisions of the currency amounts in the baskets are therefore needed from time to time if the original weights, or weights reflecting certain criteria, are to be maintained.7

The ECU and SDR baskets can, in principle, be replicated in the private market, by investing in the correct relative amounts of the component currencies. In practice, however, it may be impossible, because of exchange restrictions, capital controls, or other factors, to invest in one or more currencies in the baskets in the amounts and maturities needed to compose the baskets.8 Therefore, the use of these units makes it possible to obtain, in effect, the approximate behavior of the value of some currencies or financial instruments denominated in them that are otherwise difficult or impossible to obtain. The baskets may thus represent valuations that are unique and independent, in the sense that they are not simply replicas of what could be obtained in other ways. By the same token, use of a basket means that the transactor or investor must accept as part of the valuation of the unit the behavior of all of the currencies included in the unit’s definition, even if one or more of these currencies is not relevant to his purposes.

The values of each of the units and of assets and liabilities denominated in them reflect an averaging of the market values of the specific currency amounts included in each basket. In view of the regional and integrative role of the ECU, generally all currencies of members of the EC, and only those currencies, are included or are to be included in the ECU basket.9 Given the SDR’s global role, the currencies included in the SDR basket are the most important in the world’s economic and financial system, and on practical grounds it has been decided to limit their number to the currencies of the five members having the largest exports.10 Reflecting these differing orientations, the compositions of the ECU and the SDR differ in two particularly notable respects: (i) the SDR basket contains the U.S. dollar and the Japanese yen, while the ECU basket does not but includes other currencies that are not in the SDR basket; and (ii) most of the currencies included in the ECU basket are part of a mechanism designed specifically to stabilize exchange rates among the participating currencies, while the currencies in the SDR basket are generally not related by such a mechanism.

These differences have consequences for the behavior of each unit’s value in terms of currencies, which affect their stability and hence usefulness in various situations. Assessments of the units’ behavior in terms of currencies depend on the purposes for which the units are used—for example, as hedges, instruments of diversification, currency pegs—and the standard used in making the assessment. For example, if the the U.S. dollar is used as one standard of comparison, then the ECU and SDR declined in value from January 1979 to December 1985 by 6.9 and 2.7 percent a year, respectively. Their respective coefficients of variation for monthly observations over the same period were 0.24 and 0.10. The SDR’s current U.S. dollar value is virtually unchanged from that of 1971. If the deutsche mark is used (the currency with the largest weight in the ECU) as the standard of comparison, then the ECU declined in value from January 1979 to December 1985 by 1.8 percent a year while the SDR rose in value over that period by 2.2 percent a year. Their respective coefficients of variations for monthly observations over the same period were 0.05 and 0.09.11

Official ECUs and SDRs

The official ECU and the official SDR are reserve assets having a number of important features in common. The values of both assets are, as discussed above, set administratively, on the basis of the market values of baskets of currencies. Their interest rates are also set administratively, on the basis of the interest rates on financial instruments in the domestic markets of countries whose currencies are included in the valuation baskets. Their holders are all official entities. Neither official asset can be used directly for intervention in exchange markets,12 but they can be exchanged for currencies used for intervention. Both can be used in official settlements, including the settlement of intervention credits extended under the EMS exchange rate arrangement. Considerable differences exist between the two assets, however, which may be of greater interest than their common features in assessing the evolution of the SDR.

Purposes

The official ECU is designed to support the exchange rate arrangements of the EMS and is used primarily, though not exclusively or extensively, in settling loans of currencies made available through the Very Short-Term Financing Facility (VSTF) of the EMS for obligatory exchange market intervention. Although not designed as a supplement to reserves from a global perspective, the creation of ECUs serves to increase the usability of the reserves of participating countries, by temporarily transforming a portion of their gold holdings into an asset that can be used, under certain circumstances, without sale of the gold.

The official SDR is designed as a supplement to international liquidity and is intended to improve the functioning of the international monetary system generally.13 It is an element of the collaborative effort of the Fund’s membership to pursue their general interest in smoothly functioning international monetary arrangements. The SDR may also serve as an instrument for diversifying the composition of official reserves.

Supply

Creation and Amount

Official ECUs are created by means of revolving three-month swaps of gold and U.S. dollars between EMS members and the European Monetary Cooperation Fund (EMCF).14 In principle, ECU creation does not entail an increase in total international reserves, when defined to include gold valued at market prices, as the swap mechanism involves only the substitution of alternative forms of reserve assets. To the extent that EMS members are more prepared to use these ECUs than they are to use the gold swapped for them, however, the creation of ECUs does effectively increase the quantity of reserves that may be regarded as liquid in certain circumstances.

SDRs are created (or cancelled) by the Fund by means of allocations (or cancellations) in proportion to members’ quotas, if and when it is determined by members representing at least 85 percent of the Fund’s voting power that there is a global need to supplement (or reduce) international liquidity. By themselves, allocations add a like amount to the stock of owned reserves. However, the access of many countries to international capital markets, which enables them to hold the level of gross reserves they desire (at a price), means that an SDR allocation may result in part in a change in the composition of global reserves (toward more owned and less borrowed reserves), rather than an increase in the total amount outstanding.

Given the mechanism for creating them—swaps of gold and U.S. dollars—the volume of ECUs outstanding is determined by four variables, at least the first two of which are not exclusively within the control of EMS members or the Community in general: the price of gold, the exchange rate of the U.S. dollar, the respective amounts of these two assets in members’ reserves, and the proportions of members’ holdings swapped for ECUs.15 It has been noted by the Commission of the EC that this mechanism may not result in a quantity of ECUs over time that is consistent with the needs of countries participating in the exchange rate arrangements of the EMS.16

The volume of SDRs held in members’ reserves is regulated by specific decisions of the Fund regarding the amount of allocations and the level of the Fund’s own holdings of SDRs. Since the last allocation in January 1981, non-gold reserves held by participants in the SDR Department have increased by about SDR 67 billion (end-November 1985), which suggests a sizable growth in the demand for reserves. Nonetheless, there have been no allocations of SDRs since 1981, so that the growth in reserves over this period has taken forms other than SDR allocations.

The amounts of ECUs and SDRs in world reserves, and their size in relation to participants’ non-gold reserves and imports, are given in Table 1. Over the period since 1981 (i.e., since the last SDR allocation), their respective supply mechanisms have resulted in reductions in the ratios of official ECU holdings to non-gold reserves of EMS members and of official SDR holdings to non-gold reserves of Fund members. (For the SDR, the pattern of members’ holdings reflects in part substantial payments of SDRs to the Fund in connection with the increase in quotas in 1983 and subsequent reductions in the Fund’s SDR holdings.) The ratio of official ECU holdings to EMS members’ imports (expressed in numbers of weeks) shows no clear trend, while the comparable ratio for the SDR has remained relatively stable at a very low level.

Table 1.ECU Holdings of Members of the EMS1 and SDR Holdings of Participants in the SDR Department

(End of period)

19811982198319841985

Est.
Amount in reserves (in billions of SDRs)
ECU42.037.142.038.037.8
SDR16.417.714.416.518.2
Share of non-gold reserves (in percent)
ECU40.438.338.333.733.5
SDR5.05.44.04.14.6
Weeks of imports
ECU4.03.53.93.33.7
SDR0.50.60.50.50.6

Excluding Greece, which has participated in the EMS swap mechanism since early 1986.

Excluding Greece, which has participated in the EMS swap mechanism since early 1986.

In contrast to official ECUs created by swaps of gold and U.S. dollars with the EMCF, activation of the EMS intervention credit facilities gives rise, temporarily, to additional amounts of ECU-denominated official assets and liabilities. Similarly, apart from official SDRs allocated by the Fund, the Fund’s financial operations give rise to a substantial volume of SDR-denominated, officially held, claims on the Fund that also form part of members’ reserves, and to substantial SDR-denominated obligations of members to the Fund. At the end of 1985, members’ reserve claims on the Fund, consisting of reserve tranche positions and loan claims on the Fund, amounted to nearly SDR 40 billion. Fund credit outstanding (including Trust Fund loans), which represents members’ SDR-denominated debt to the Fund, amounted to some SDR 38 billion on the same date. These figures compare with the amount of SDR 18.2 billion of official SDRs held in members’ reserves.

Distribution of Official ECUs and SDRs

The initial distributions of the amounts of official ECUs and SDRs also reflect different criteria. ECUs are distributed through the swap mechanism in proportion to participants’ gold and U.S. dollar holdings. To the extent these holdings are determined in part by the policies and preferences of EMS members themselves, initial ECU distributions will similarly reflect these factors. SDR allocations are distributed in proportion to participants’ quotas in the Fund, which are not necessarily related to each individual participant’s reserve demands, certainly not in the short run. However, as quotas do tend to reflect the economic size and trade of Fund members, they include factors generally regarded as relevant to longer-term demand for reserves.

Interest Rate and Other Investment Characteristics

To remunerate countries that accumulate net balances of ECUs or SDRs, and to provide these official assets with yields comparable with other reserve assets, interest is paid on a net basis on holdings of these assets in amounts above those received in allocations (or swaps). The techniques used are similar for the ECU and the SDR: interest payments are financed by charges at the same rates on the amounts by which other countries’ holdings are below their allocations (or swaps). Both the ECU’s and the SDR’s interest rates are now calculated as weighted averages of rates on high-quality, short-term (three months or less) instruments in the financial markets of the countries whose currencies comprise each valuation basket (see Chart 1).17 Thus the interest rates of both assets automatically reflect the behavior of the market interest rates on relevant instruments in the component currencies. They cannot behave independently of the rates on the underlying instruments and thus do not necessarily reflect any special investment characteristics of the ECU and the SDR.

Chart 1.Official ECU and SDR Interest Rates, 1979–December 1985

The official ECU and the official SDR each have only one valuation and one interest rate; that is, each is a single, unique asset. In addition, both assets are without a specific maturity18 and thus cannot replicate fully the characteristics of fixed interest and fixed-term financial instruments with which they might compete in reserve portfolios; nor can the investment of currencies to replicate the ECU or SDR provide a full substitute for the units themselves, as currency investments are usually dated.

Equilibrium between the supply of and demand for assets with fixed interest returns is maintained through variations in the prices at which they trade in the market. In this way, the effective yields on previously issued instruments are continuously adjusted to changing market conditions, making them competitive with yields on new issues. A similar adjustment cannot, however, take place in the price of the official ECU or the official SDR as they are currently valued, because these assets are not allowed to be traded at a discount from or premium over their administratively established values. Their interest rates are, however, kept close to market rates for instruments in the component currencies by adjusting the rates frequently (weekly for the SDR and monthly for the ECU). This provides a partial, but not complete, substitute for pricing the ECU or SDR in foreign exchange markets as a technique for maintaining a competitive yield on these assets.19

Transferability and Use

The ability of participants in the exchange rate arrangements of the EMS and in the SDR Department of the Fund to use both official assets is assured under certain circumstances, related to the purposes of the assets, by the obligations of other members to accept them in those circumstances. ECUs may be used up to a limit to settle obligations arising from intervention required by the EMS exchange rate mechanism and financed by the use of the VSTF. Since July 1, 1985, ECUs may also be used for limited periods by members of the EMS as collateral, in the form of swaps, to acquire currency for intervention. Participants in the SDR system are obligated to accept in exchange for freely usable currency, in transactions with “designation,” SDRs from other participants having a balance of payments need to use reserves. SDRs may also be used to settle obligations to the Fund.

For both the ECU and the SDR, the obligations of participants to accept these assets, which are the primary basis for ensuring the instruments’ liquidity, are limited in amount as well as circumstance. These limits are referred to in both cases as “acceptance limits” but operate in different ways for the two assets.20 The ECU’s acceptance limit constrains the extent to which ECUs can be used by a participant on an individual occasion, normally to 50 percent of the amount of VSTF credit to be settled,21 but does not limit the aggregate amount a participant may be obligated to hold. The SDR’s acceptance limit relates not to specific transactions but is such that a participant is obligated to accept SDRs only in amounts that will not raise its holdings beyond 300 percent of its allocation. The ECU’s acceptance limit thus operates so as to constrain the use of ECUs by a participant when settling its obligations. The SDR’s acceptance limit does not constrain the extent of a participant’s use of SDRs in transactions with designation, and such use, given the existence of a balance of payments need to use reserves, may be up to the full amount of its holdings.

In addition to uses assured by participants’ acceptance obligations, official ECUs and SDRs can be transferred voluntarily against a currency agreed between the parties to the transfer. Voluntary uses of SDRs have also been extended to a number of international official entities (at present 14), so-called other holders, and the EC has set up a framework providing certain non-EC monetary entities with the possibility to acquire ECUs in swaps or under repurchase agreements from EMS participants. In addition to transactions by agreement, the Fund has adopted a series of decisions to permit the uses of SDRs among participants or participants and other holders in swap arrangements, in forward operations, in loans, in pledges, in the settlement of financial obligations, as security for the performance of financial obligations, and in donations.

Beyond uses among participating members or other holders, official SDRs are used extensively in financial dealings between the Fund and its members which generally have no counterpart in the arrangements of the EMS. Remuneration of reserve tranche positions in the Fund is generally paid in SDRs, and SDRs are used, along with currencies, to finance drawings on the Fund; the Fund is also prepared to sell SDRs to participants needing them to pay charges in the SDR Department and in the General Department. Participants must use SDRs in payment of charges to the Fund and, unless decided otherwise, in payment of the reserve asset portion of quota payments. SDRs may also be used in discharge of repurchases. These uses of SDRs to discharge obligations to the Fund entail an additional element of transferability for the SDR and account for a substantial part of the SDR’s uses.

Such possibilities do not at present exist for the ECU, although they could arise should the EMS institutional arrangements evolve in that direction. The use of ECUs, both in absolute amounts and relative to the amount held, has been small and has tended to decline in recent years. Most uses of ECUs have been related to the settlement of intervention credits extended through the VSTF and have generally been reversed. Most exchange market interventions by EMS participants have occurred before exchange rates reached their permissible margins and have consequently not involved the use of VSTF credit nor, therefore, the use of ECUs in settlement.

As can be seen in Table 2, the official SDR has been used in large amounts, particularly in relation to the amounts in existence, and has risen over the years. By far the largest volume of uses consists of transfers between the Fund and participants, reflecting the growing scale of the Fund’s financial dealings with its members in recent years. With respect to SDR transfers among participants, transactions with designation have fallen as a proportion of total SDR transfers and are now less in amount than SDR transactions by agreement, which have grown considerably as a proportion of total SDR transfers.

Table 2.Annual Average Transfers Transfers of Official SDRs and ECUs

(In millions of SDRs)

1970–751976–781979–811982–841985
SDRs
Total transfers1,1614,0197,69216,20115,918
Of which:
Transfers to and from the Fund5002,5445,54110,39210,893
Transactions
With designation2614461,4582,6381,950
By agreement3779605202,2552,593
Ratio of use to amount outstanding.15.43.44.76.74
ECUs
Total transfers2,4873,9013,063
Settlements of compulsory intervention134545
Mobilization2,447
Voluntary transactions2,1953,158611
Other transactions11581985
Ratio of use to amount outstanding.06.10.08
Note: Components may not add to totals because of rounding.

Mainly interest payments on net ECU positions.

Note: Components may not add to totals because of rounding.

Mainly interest payments on net ECU positions.

The official ECU’s relatively modest use in comparison with that of the official SDR (Table 2) reflects in substantial part the more limited circumstances in which its use is envisaged or possible under present EMS arrangements, including the absence of transfers of the asset between the EMCF and its participants such as those that take place between the Fund and participants in the SDR Department. As has been noted above, several steps were taken in 1985 to strengthen the ECU’s attractiveness and usability, by raising its interest rate to levels prevailing in markets of the component currencies, broadening somewhat its uses and the range of potential holders, and relaxing the acceptance limits in certain circumstances.

It was originally intended that a second phase of the EMS would entail the creation of a European Monetary Fund (which would replace the European Monetary Cooperation Fund) as well as the full utilization of the ECU as a reserve asset and a means of settlement. Work on the second phase of the EMS began in the Committee of Central Bank Governors and the Monetary Committee soon after the start of the EMS. One of the main issues discussed was enhancing the role of the ECU in the EMS, including the possibility of replacing the present revolving swap arrangements for creating ECUs with a permanent transfer of reserves to the European Monetary Fund (EMF).

In subsequent discussions, a more gradual approach to the development of the EMS has emerged. In early 1982, the European Commission submitted to the European Council a set of proposals intended to further the step-by-step development of the EMS in certain key areas, including three concerning development of the ECU: (i) the method of issuing ECUs, with the aim of limiting the volatility in the amount of ECUs created; (ii) abolition of the acceptance limit for the use of the ECUs in intra-EMS settlement of intervention debts; and (iii) increased private use of ECUs.22 Consideration of these proposals to date has resulted in certain improvements in the official ECU’s attractiveness and usability noted above, though these fall short of those proposed.

It may not be precluded that at some point the ECU’s continued development could make it a more prominent factor in the global volume of international reserves and reserve transactions. The development of the wide range of ECU-denominated financial instruments discussed in the following section may be of relevance in this context, as private ECUs can be held in countries’ reserves and as the existence of large and well-developed ECU money and capital markets could enhance the attractiveness of the official ECU as a reserve asset.

Private ECUs and SDRs

Supply and Demand

In a world characterized by exchange rate variability, greater exchange risk has led transactors to seek various means of cover. Perfect cover can be obtained by matching the currency composition of assets and liabilities, or resources and obligations. To obtain asset portfolio (liabilities) valuation characteristics similar to the units in which obligations (assets) are denominated, individualized baskets can be constructed and utilized. There are, however, potentially significant advantages in using standardized composite units for denominating obligations and the assets that cover them, even if their composition does not fit precisely the needs of individual users. This is because the complementary infrastructure that tends to accompany widening use (such as clearing arrangements for the unit’s use in making payments) lowers transactions costs, and the wider range of similarly denominated financial instruments also tends to lower the cost of their use. Therefore, for some transactors and situations, currency composites like the ECU and SDR can provide an efficient and low-cost hedge.

The use of the ECU for denominating financial obligations and traded goods in Europe has created a growing demand for financial instruments denominated in ECUs. Similarly, the adoption of the SDR in place of other units by a number of international conventions and agreements for establishing values, and by a number of international organizations as their unit of account and denominator of their financial dealings, has created some demand, but of a much smaller size so far, for financial instruments denominated in SDRs.

These uses of the two composite units have encouraged development of markets in “private” ECUs and to some extent “private” SDRs, that is, financial instruments held and traded in the private sector (or at least outside the official domain of the EC or the Fund) whose values are denominated in ECUs or SDRs. Private ECUs and SDRs are usually created by changing the denomination of assets already in existence. A private ECU deposit, for example, can be created by a bank accepting currency and recording the value of the deposit in ECUs. The bank will generally wish to cover its newly created ECU liability by exchanging the currency deposited in a way that establishes an asset of the same value in terms of the ECU. If no true ECU assets are available or suitable, the bank may exchange the currency deposited for the ten EC currencies in the ECU valuation basket in the same proportions (a process referred to as “unbundling”).

Private ECUs and SDRs are subject to market conventions and are not constrained by the rules governing the uses of the official assets. Their values are normally determined by reference to the same baskets of currencies as the official ones, at least when the open basket definitions are used.23 The European Commission has so far successfully encouraged use of the open basket definition of the ECU by private or official entities adopting the unit. Although some lenders to the Fund (all are official entities) have an option to hold closed basket SDRs, this option has not been used and does not affect the use of the unit outside the Fund, which has not been restricted by the Fund in any way.

The first private SDRs appeared in mid-1975 (a bond issue and bank deposit facility). The first ECU deposit (actually denominated in the ECU’s identical predecessor, the EUA) followed a year later. Users of the ECU and the SDR in the private market initially experienced start-up costs and encountered (and to some extent still encounter) a number of legal or institutional problems, such as restrictions as to the units in which contracts can be stated, limitations on foreign exchange exposure, and the need to adapt contracts for the possibility that the composition of either basket could be changed, that one of the component currencies might not be available, or that the value of a component currency could not be determined. For many, however, the potential benefits of using either unit appear to have outweighed the inconvenience of dealing with these problems, and, as the use of these assets developed and expanded, the associated costs and certain limitations imposed by governments were reduced.

It is estimated that by the end of 1981, some 40 to 50 banks were prepared to accept and manage SDR deposits and that such deposits amounted to some SDR 5–7 billion, net of interbank deposits.24 The largest depositors were private international corporations, especially oil companies, but a number of central banks and other official institutions also placed SDR-denominated deposits with commercial banks and with the Bank for International Settlements (BIS). Also by the end of 1981, SDR 563 million in SDR-denominated bonds had been issued, and five syndicated bank credits amounting to SDR 908 million had been extended. In contrast, by the end of 1981, ECU deposits are estimated to have been on the order of SDR 300 million, while ECU bonds and credits amounted to SDR 188 million and SDR 233 million, respectively.

Since that time, there have been no new SDR bond issues. Nor have there been new bank credits in SDRs following two SDR bank loans amounting to SDR 300 million in early 1982. Officially reported gross SDR deposits of Belgian, Luxembourg, and U.K. banks and the BIS amounted to SDR 2.2 billion at the end of September 1985, about the same as at the end of 1983 (see Appendix Table 17). (The Fund’s SDR-denominated investments, which are included in these figures, amounted to SDR 0.4 billion at the end of September 1985 and SDR 0.9 billion at the end of 1983.) The development of private ECU instruments has differed dramatically. A wide range of financial instruments and services has developed for the ECU, which does not exist for the SDR. Private ECUs now include a variety of money market instruments, for which there is an active interbank market, syndicated bank loans, warrants, options, futures contracts, and Eurobonds with fixed or floating interest rates. By the end of June 1985, gross ECU bank liabilities had increased to SDR 33.3 billion, of which SDR 4.3 billion was due to nonbank clients, and ECU bonds issued, all of which are thought to be outstanding, amounted to some SDR 11.6 billion (see Table 3).

Table 3.ECU and SDR Denominations in Private Markets

(In millions of SDRs)

End-1981End-June 1985
InstrumentECUSDRECUSDR
Amounts outstanding
Bonds and notes218856311,64760
Bank deposits330010,000–33,3421,666
14,000
Loans extended
Publicized syndicated loans42339084,1141,208
Sources: Bank of England; National Bank of Belgium; BIS; ECU Newsletter (Istituto Bancario San Paolo di Torino); and Fund staff estimates.

Where data were originally expressed in ECUs, they have been converted into SDRs using the exchange rates of the last business day of the period to which each figure pertains.

ECU amounts reflect amounts of bonds issued, all of which are thought to be still outstanding in January 1986.

Amounts for 1981 are rough estimates. See footnote 24, below, as regards the amount of SDR deposits.

All syndicated SDR loans have been repaid. Most syndicated ECU loans were made in the last two years and most of the amounts extended are thought to be still outstanding.

Sources: Bank of England; National Bank of Belgium; BIS; ECU Newsletter (Istituto Bancario San Paolo di Torino); and Fund staff estimates.

Where data were originally expressed in ECUs, they have been converted into SDRs using the exchange rates of the last business day of the period to which each figure pertains.

ECU amounts reflect amounts of bonds issued, all of which are thought to be still outstanding in January 1986.

Amounts for 1981 are rough estimates. See footnote 24, below, as regards the amount of SDR deposits.

All syndicated SDR loans have been repaid. Most syndicated ECU loans were made in the last two years and most of the amounts extended are thought to be still outstanding.

As the use of the ECU, and to a much lesser extent the SDR, as a unit of account has grown, and with it the demand for financial instruments denominated in these units, the demand for payments in these units has increased. In the case of the private ECU, payments have grown in such volume that a rather extensive, organized system for payments in that unit has been established.25

Reasons for Differences in Market Growth

Why has the supply of and demand for private ECUs been so much greater than for private SDRs? Explanations vary, but the answer appears to lie to a considerable extent in the differing degree of support by each unit’s “parent” and the member countries involved with it, certain characteristics of the units themselves, and the special capital market situation of certain EC members.

Official Support

EC institutions and certain European governments have actively supported the use of the ECU in private markets through suasion, through market operations in the unit, and in some cases through preferential treatment. In proposals submitted to the European Council in April 1983,26 the European Commission stressed that the development of the role of the ECU is an essential factor for financial integration in the EC, both as a vehicle for increased transferability of financial assets within the Community and as an expression of emerging monetary union. The Commission proposed that the ECU be recognized as a foreign currency in all EC member states, that financial transactions in ECUs receive privileged treatment within the EC, that any new instrument for tapping savings introduced at Community level be preferably denominated in ECU, and that the official role of the ECU be enlarged. Although these proposals have not been fully realized, progress has been made.

The European Economic Community (EEC), the European Investment Bank (EIB), the European Coal and Steel Community, the European Atomic Energy Community (EURATOM), and the Council of Europe Resettlement Fund have all launched bond issues in ECUs (using the open basket and requiring payment and servicing in ECUs) and have been active depositors in ECUs. The EIB has, in addition, extended part of its loans in ECUs and has made it a part of the loan agreement that the proceeds be deposited in ECU accounts, another important factor encouraging commercial banks to establish ECU-denominated accounts. The EC Commission also initiated the establishment of a banking group to study the possibility of a clearing institution in ECUs, which has led to the establishment of an ECU Banking Association whose immediate aim is to conclude an agreement with the BIS to set up a multilateral clearing system in ECUs.

All EC member countries except one have recognized the ECU as a foreign currency, and some have taken certain steps to facilitate and promote use of the ECU in financial markets. For example, some member governments of the EC have been prepared to permit their citizens and companies to deal in ECUs to a greater extent than in other currencies or units. This freer use of ECU in some countries has served as part of a gradual approach to reducing capital restrictions and has provided a temporary impetus to the growth in the ECU’s use.

Also, in part stemming from the ECU’s official status, interest in the ECU among private European residents may have a noneconomic dimension that contributes to its popularity. It is the official unit of the EC, and each EC member’s currency (with the exception of members that have joined only recently) is included in it. Europeans may therefore have both a national and a Community-wide interest in the unit that does not exist for the SDR. The SDR does not serve or reflect a tightly defined geographical area, nor would it appear that noneconomic factors have stimulated private sector interest in its development.

The Fund has provided technical and legal assistance to international entities interested in adopting the SDR as their unit of account. It has also simplified the valuation basket and unified it with the interest rate basket, in part to facilitate the development of SDR-denominated financial instruments in private markets. But, while the Fund has expressed interest in private uses of the SDR, it has not so far taken as active a role in promoting the SDR as has the EC with respect to the ECU.

It may be mentioned that commercial banks also play an increasingly important and independent role in promoting the private ECU. This represents a significant shift from banks’ earlier activities in promoting development of the SDR and, to a large extent, may also represent a case of “success breeding success.” Commercial banks’ incentives and profits lie in developing and promoting what their customers want and find useful; they would presumably be similarly prepared to facilitate and promote private SDR instruments if they perceived a potential demand for such instruments by official or private entities.

Characteristics of the Units

The most fundamental and durable source of demand for private ECUs and private SDRs comes from those for whom it is advantageous, convenient, or required to use one or the other unit for denominating, accounting, or paying for their financial and commercial activities. Official EC demand and support appear to have been important in fostering development of the private ECU, as discussed above. More generally, as a hedge against exchange risk for private transactors, no single unit will be best for all activities and purposes. A composite unit (which usually will not provide a perfect hedge) may be preferred to more exact but generally more costly hedging techniques if the value of the composite unit is expected to be relatively stable in relation to the units relevant to the parties using it. The particular success of the private ECU market may therefore be due in part to the facts that all of the ECU’s component currencies are in a trading area consisting of countries with close economic ties, and that the operation of the EMS exchange arrangements and the ECU’s composition tend to assure that the value of the ECU will remain reasonably stable in terms of most participating currencies compared with other units that might be used, such as the SDR. In the present environment, the EMS is seen as having achieved a growing degree of exchange rate stability among participating EC currencies; as a result, the exchange risk of the ECU may be perceived as modest or small in relation to the interest rate differentials that exist at present among these currencies. All ECU component currencies have been more stable in terms of the ECU than in terms of the SDR, and generally more stable in terms of the ECU than in terms of other EC currencies (see Appendix I, “Behavior of Value,” pp. 43–44).

The relative success of the private ECU compared with the private SDR may reflect in part a larger number of commercial dealings for which the ECU is a more natural unit than exist for the SDR. Given the importance of intra-European trade for most European companies, there may be more firms involved in regional European trade than are involved in trade on a worldwide scale and for which the SDR might be regarded as a more suitable unit. The ECU is more representative of European currencies and more stable in terms of these currencies than is the SDR or, in general, any single currency. Consequently, for European firms, the ECU may serve as a convenient unit involving only a small exchange risk in terms of their own domestic currencies, providing a mutually acceptable and low-cost (compared with the U.S. dollar, the SDR, or other external units) compromise means of sharing exchange risk. For non-European firms, the ECU may serve as a good single proxy for EC currencies in general, diminishing exchange risks and operational costs involved in dealing with several European currencies.

From a more global perspective, the SDR’s broader currency representation may offer an attractive unit for reducing or sharing exchange risks between, for example, U.S. dollar-based and European-based firms, as well as with firms whose operations are based on other non-European currencies or are worldwide. Companies operating on a world scale, however, often handle such large sums that either hedging in individual currencies or setting up a tailor-made basket becomes warranted economically.27

Similar considerations apply to the choice of units in which to denominate financial assets and obligations. While effective yields across currencies (adjusted for expected exchange rate changes) tend toward equality, there are likely to be perceived and real differences in the stability of yields as between instruments denominated in ECUs, SDRs, or currencies. For many smaller investors, it may be infeasible or too costly to obtain foreign exchange cover, so that as a practical matter they must take an open position if they are to invest abroad. For risk-averse investors, the choice of the unit of denomination is influenced by the stability of its value in terms of the investor’s own currency. The risk-return characteristics of the ECU may make it more attractive for many borrowers and lenders than transactions denominated in national currencies.

The incentive for capital to flow in response to interest rate differentials of course exists independently of the use of the ECU. The ECU may facilitate such flows, however, because, as already noted, the perceived exchange risk associated with it may be smaller than the risk associated with individual European currencies, and because of the preferential treatment that has been given to it by some EC members. In general, residents of low interest rate countries wanting to invest in countries with higher interest rates would tend to prefer the ECU over the national currency, if the ECU’s yield is seen as more certain.

The risk and return relationship among EC currencies and the ECU may look quite different from that associated with U.S. dollar investments and the ECU or EC currencies. During the first half of the 1980s, U.S. dollar-denominated financial instruments enjoyed a combination of high interest rates and strong appreciation of the dollar. Over this period, U.S. dollar investments yielded a high effective return to foreign investors and attracted huge capital flows into the United States, which may have been, to some extent, at the expense of ECU-denominated investments.

The development of the private SDR may have suffered in the first half of the 1980s by comparison with U.S. dollar-denominated financial instruments for the same reason. In fact, to the extent that capital movements within Europe motivated by longer-term business interests may be somewhat less sensitive to U.S. dollar or other external yields—because of the concentration of intra-European commercial and financial relationships—the unusually high yields on U.S. dollar instruments and the consequent attraction of dollar investments may have affected the development of the private SDR more strongly than that of the private ECU. If this is so, a restoration of more normal yield relationships might tend to increase relative interest in SDR-denominated investments.

Capital and Exchange Controls and Tax Considerations

One EC member (France) with controls on foreign investments has relaxed some of these controls with regard to the ECU. It will allow, for example, its residents to exchange domestic currency for private ECUs to acquire securities denominated in ECUs and issued in the domestic market by EC institutions, without having to use the devise titre rate of exchange; such transactions are not allowed for acquiring other foreign securities. It will also allow forward purchases of ECUs up to six months against payments for traded goods invoiced in ECUs. Such preferential treatment for the ECU adds a source of demand for private ECUs that is possibly transient but has presumably added to their growth. At the same time, some EC members restrict the holding of foreign currencies, including ECUs, by their residents, which would tend to limit the growth of ECU deposits.

EC members do not have uniform tax treatments of investment income. Thus a possible source of demand for ECU assets arises because the withholding tax of another EC member cannot be easily enforced on Euro-investments, and individuals may acquire and hold some amount of their investments externally in order to escape taxation. This source of demand for foreign assets has often taken the form of demand for ECU assets because of their lower exchange risk, as already discussed. In addition, borrowing or investing in the ECU-denomination can provide access to currencies that are otherwise unavailable, for example, because of exchange controls.

Prospects for Further Growth

Any prediction of growth in the ECU and SDR markets is highly uncertain; however, it is likely that the recent rapid growth of private ECU markets will moderate of its own accord. Some part of the ECU’s recent growth has probably been the result of a new “product” developing its sustainable market share. If so, as that process is completed, the ECU market will likely grow at rates bearing a closer relationship to the overall growth of financial markets. Some part of the ECU’s growth is also probably a result of incomplete economic integration in Europe, exchange and capital market restrictions, and the willingness of some EC member countries to give preferential treatment to dealings in ECUs. To the extent that economic integration proceeds and controls are relaxed further, their special impetus to growth in private ECUs would diminish. Some controls, however, have tended to impede the ECU’s growth, and relaxation of these controls could provide support for further development of the market.

The more enduring source of demand for private ECUs and SDRs is likely to come from their use for denominating all kinds of contractual obligations. The activities of the “parents”—the EC and its member countries, the Fund and its members—in creating demand for instruments denominated in these units, including their activities in the official ECU and SDR, will continue to be important in influencing overall demand. Apart from strong official impetus, the ECU, given its composition and regional context, may also be a natural or appropriate unit in more market situations than the SDR. Although the rate of growth of the ECU market may moderate, the market would now seem to have attained a reasonably firm basis in official interest and support, the ECU’s characteristics, and the stage of development of the market itself.

Development of the private SDR has not been adopted as an objective of the Fund, and the SDR may also be too diffuse a hedge for many entities that are exposed to the risks of dealing with only a few currencies or that have no difficulty in constructing their own tailor-made basket. There are instances, however, where a single unit must be agreed upon on a worldwide basis by official or quasi-official bodies, or for use in arrangements and conventions and where a global unit rather than a national or regional unit is regarded to be more attractive or appropriate. The SDR has been adopted in a number of such cases, and these uses are a continuing basis for demand for private SDRs. That basis is at present modest, however, and there is little current indication that the private SDR market will begin to develop at a more vigorous pace.

Summary

As part of the Fund’s examination of the role of the SDR in the international monetary system, this paper has compared the functioning of the ECU and the SDR as units of value and account, as official reserve assets, and as private financial instruments. The methods of determining the values of the two units in terms of currencies, which is relevant to all of their functions, are similar in a number of technical respects: both are composites of a number of national currencies, and their values and yields are determined administratively by reference to the component currencies. Their currency composition and roles as official instruments, however, differ in important respects. Though both units are at a relatively early stage of evolution, the differences have already contributed to a number of contrasting developments in their uses in official and private circles.

(a) The functions of the ECU and the SDR as official instruments differ markedly. The ECU unit serves as “numeraire” of the regional exchange rate arrangements of the EMS, and the “official ECU”—representing in essence a redenomination of other existing reserve assets—is used in settlements in support of those arrangements. The SDR serves no comparable “numeraire” or settlement function under present global exchange arrangements. It does, however, serve as the unit of account and denomination for all of the Fund’s transactions and operations, and the “official SDR” serves as a global supplement to other reserve assets, designed to contribute to a smoothly functioning international monetary system.

(b) The differing degrees of emphasis on the various functions of the official ECU and SDR have led to substantial contrasts in their use. The official ECU, while forming a significant part of EC members’ reserves, has been used relatively little in actual transactions, primarily owing to the limited circumstances and ranges of use at present envisaged under the EMS arrangements. Official SDRs have been created in relatively small amounts. Their use is less narrowly constrained, however, and demands arising primarily in connection with participants’ transactions with the Fund have given rise to a relatively large volume of official dealings in SDRs.

(c) The ECU’s regional currency composition, its link to the exchange arrangements of the EMS, demands and promotion by EC entities, and to some extent the effects of restrictions and tax considerations have contributed to the rapid development of a market for private ECU financial instruments, primarily though not exclusively in European capital markets. The SDR by contrast, as a more “global” unit, has not attracted comparable interest in private markets, although it has been adopted as a unit of account by a number of international organizations. Indeed, after a brief surge of private interest in the early 1980s, which may have arisen in part in anticipation of significant Fund borrowing denominated in SDRs in private markets that did not materialize, the development of private SDRs has essentially stagnated.

The differences in the official uses to which the ECU and the SDR have been put, and in the volume of their uses, derive essentially from the specific arrangements of which they are a part, decisions that have been taken to regulate their creation and use, and holders’ attitudes toward their use. Perhaps the greater contrast between the ECU and the SDR, however, lies in the vastly different experience of the two units in the private sector. Although there have no doubt been a number of factors underlying the ECU’s rapid development in private markets, it is likely that an important impetus has been provided by the activities of EC entities and member states, not only in promotion of the ECU “name,” but in creating practical demands through denominating various payments obligations, borrowing, and other transactions in ECUs. The questions arise whether the Fund and the membership in general have an interest in similarly promoting and fostering the development of the private SDR and, if so, how that would be accomplished.

The Fund does have a certain direct interest in development of the SDR market, deriving from its need to make investments denominated in SDRs; that interest would multiply should it be decided that the Fund should borrow in private markets. Irrespective of this specific issue, however, a number of more fundamental questions would need to be addressed, including whether the private use of the SDR (or ECU) contributes to international financial stability and whether the functioning of the SDR as an official reserve asset would be enhanced by the development of the private SDR market or, indeed, by some form of integration of the private and official markets. If it were considered desirable for the Fund to actively encourage development of the private SDR at a pace faster than might occur naturally, it would seem appropriate to re-examine both the composition of the basket from the viewpoint of its suitability for private uses and the basic mechanisms by which the SDR’s value is determined.

Exploration of such questions is beyond the scope of the present paper. The definition of the role the SDR is to play in contributing to the stability of the international monetary system, and the context of the broader monetary arrangements in which that role is to be played, will to a significant extent determine the attributes that would be appropriate for the asset. If the view were to prevail that the SDR should be placed “on the shelf in readiness for possible future need, there might be little purpose or interest in actively pursuing significant modifications in its characteristics and uses at this time. Interest in some further refinements may nonetheless be justified, even if the relatively modest role currently played by the SDR is to be maintained. If it were determined that the SDR could and should play a more significant stabilizing role in world monetary arrangements, consideration could be given to more substantial adaptations of its characteristics and uses, including adaptations that could give the instrument a stronger market orientation or develop its use as a unit among governments and central banks, in light of that objective. Given the SDR’s relative development as an asset used in official transactions, extensions of its use by the Fund and by other official entities would be possible areas for further exploration.

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    TriffinRobertand A. A. L. Swings eds. The Private Use of the ECU (Brussels: Kredietbank1980).

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1

See the Communique of the Interim Committee of the Board of Governors of the International Monetary Fund, International Monetary Fund (1985), pp. 282–83.

2

See Part One, Section II.

3

The Appendices are background for the discussion presented here.

4

As of the end of January 1986, the member states of the European Communities (EC) were Belgium, Denmark, France, the Federal Republic of Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, and the United Kingdom. With the exceptions of Spain and Portugal, which joined the EC only recently, the central banks of all of these countries are members of the EMS and their currencies are included in the ECU. All EMS members are now parties to the EMS swap mechanism, but Greece and the United Kingdom do not participate in the EMS exchange rate arrangements.

5

See extract from the conclusions of the Presidency of the European Council of July 6 and 7, 1978, Bremen, in Commission of the European Communities (1979), p. 93.

6

The Fund’s Articles of Agreement do not prescribe a particular method for the valuation of the SDR but include provisions establishing voting majorities required for determination of the method by the Fund.

7

Further detail on the definition of the baskets and provisions for change is provided in Appendices I and II, “Valuation,” pp. 42–43 and 53–54.

8

Also, revisions of the currency amounts in the baskets may give rise to a need for banks covering a position in the unit to make adjustments in the composition of their individual currency positions, leading to additional costs and inconvenience of covering operations.

9

Portugal and Spain have been members of the European Economic Community since January 1, 1986, but the escudo and the peseta have not yet been included in the ECU basket. The inclusion of these currencies will be considered on the occasion of the next five-yearly review of the weighting of the currencies in the ECU.

10

The basket as of January 31, 1986 comprised the U.S. dollar, the deutsche mark, the Japanese yen, the French franc, and the pound sterling.

11

Further information on the value of the ECU and SDR in terms of major currencies is provided in Appendices I and II, “Behavior of Value,” pp. 43–44 and 54.

12

This does not apply to official holdings of private ECUs and SDRs, and it is understood that there has been some intervention using private ECUs.

13

For a more detailed discussion of the SDR’s historical role in the international monetary system, see Part One, Section I.

14

The swap mechanism itself is periodically renewed by unanimous agreement of the EEC central banks.

15

While swaps must consist of a minimum of 20 percent of participants’ gold and 20 percent of U.S. dollar holdings, participants may engage in larger swaps for ECUs on a voluntary basis. This has not been done so far. See Ungerer (1983), p. 16.

16

Commission of the European Communities (1982a), p. 44.

17

Prior to July 1985, the ECU interest rate was based on official discount rates. For further details on the ECU and SDR interest rates, see Appendices I and II, “Interest Rate,” pp. 46 and 56–57.

18

Although the stock of official ECUs is adjusted quarterly as a result of the three-month swaps that create them, the use of these ECUs need not ever be reversed unless a member’s holdings become negative, which could result from a new swap reducing the amount of ECUs distributed on a renewal date below the amount used by a member. In fact, however, members have tended to reconstitute their ECU allocations.

19

The Fund can prescribe “operations” in SDRs that allow use of market-determined interest rates and exchange rates. It has done so with respect to loans, swaps, and forward dealings in SDRs. No comparable possibilities exist at present for the ECU.

20

For details, see Appendices I and II, “Uses,” pp. 46–48 and 57–58.

21

Since July 1, 1985, the 50 percent acceptance limit has been waived if and to the extent that the recipient central bank is itself a net debtor in ECUs.

22

For the full text of the proposals, see Commission of the European Communities (1982a), Annex D, pp. 88–91.

23

An “open” SDR basket, for example, is defined as consisting of whatever currency amounts are specified by the Fund as comprising the SDR basket at any time, whereas a “closed” SDR basket is defined as the currency amounts specified by the Fund at a particular point in time. A closed SDR basket can thus differ from the Fund’s current definition of the SDR following a revision by the Fund of the currency amounts in the SDR basket.

24

Although no comprehensive data on SDR deposits were collected at that time, it is estimated on the basis of conversations with market participants that about half of total SDR deposits were interbank deposits.

25

See Appendix I, “Deposits,” pp. 49–50.

26

For the full text of the proposals, see Commission of the European Communities (1983), pp. 183–84.

28

The EUA served as a unit of account for the European Coal and Steel Community, the European Development Fund, the European Investment Bank, and the European Communities budget; for the Common Agricultural Policy and the operations of the European Monetary Cooperation Fund the gold-based unit remained in use.

29

Council Regulation (EEC) No. 3180/78 of December 18, 1978, in Commission of the European Communities (1978), p. 1.

30

The post-1975 EUA and pre-September 1984 ECU were identically valued, the only difference being that the EUA had a closed basket definition and the ECU an open one, which means, in the latter case, that any change in the official definition of the ECU is automatically applied to contracts denominated in that unit.

31

These criteria included the share of each country, whose currency is included in the basket, in EC gross national product, its share in intra-EEC trade and in the quotas of the Short-Term Monetary Support Credit Facility of the EC. No formal weighting scheme of such economic criteria, however, has been established.

32

The Resolution of the European Council of December 5, 1978 establishing the European Monetary System (EMS) and the ECU as its unit of account provided that “the weights of currencies in the ECU will be re-examined and if necessary revised within six months of the entry into force of the system and thereafter every five years or, on request, if the weight of any currency has changed by 25%.

“Revisions have to be mutually accepted; they will, by themselves, not modify the external value of the ECU. They will be made in line with underlying economic criteria,” Commission of the European Communities (July 1979), p. 95. The next regular review is to be in September 1989.

33

Portugal and Spain joined the EC on January 1, 1986.

34

Council Regulation (EEC) No. 2626/84 and Declaration of September 15, 1984, in Commission of the European Communities (1984a), pp. 1–2.

35

All EC members whose currencies are in the ECU valuation basket participate in the EMS exchange rate arrangements except for Greece and the United Kingdom.

36

In 1978, the members of the European Communities were Belgium, Denmark, France, the Federal Republic of Germany, Ireland, Italy, Luxembourg, the Netherlands, and the United Kingdom. Greece became a member on January 1, 1981 and Portugal and Spain became members on January 1, 1986. With the exceptions of Spain and Portugal, the central banks of all of these countries are members of the EMS and their currencies are included in the ECU. All EMS members are now parties to the EMS swap mechanism for creating ECUs, but Greece and the United Kingdom do not participate in the EMS exchange rate arrangements. For documents concerning the EMS, see International Monetary Fund (1979), pp. 81, 93 and Supplement “The European Monetary System,” pp. 97–100; Ungerer, Evans, and Nyberg (1983); “The European Monetary System: Structure and Operation” (1979), pp. 11–18; Commission of the European Communities (1979), pp. 63–111.

37

For further details on the functioning of the divergence indicator, see Commission of the European Communities (1979), pp. 74–75, 85–91; Ungerer, Evans, and Nyberg (1983), pp. 15–16; Rey (1982), pp. 3–15; and Salop (December 1981), pp. 682–97.

38

Resolution of the European Council of December 5, 1978 on the establishment of the European Monetary System (EMS) and related matters (the list was not meant to be exhaustive).

39

For a discussion of possible reasons, see Commission of the European Communities (1984a), p. 12 and p. 15.

40

The swap mechanism was originally set up by the EMS central banks for a period of two years, that is, the duration of the originally envisaged transitional stage for the EMS. Since the stage of establishing the European Monetary Fund (EMF) has not been achieved so far, central banks, by unanimous consent, have extended the mechanism every two years for a new period.

41

The yields used in this calculation are the three-month interbank deposit rate in the Federal Republic of Germany, the market yield for three-month U.K. Treasury bills, the three-month interbank money rate on private paper in France, the three-month interbank deposit rate in Belgium, the three-month money market rate in Denmark, the three-month interbank deposit rate in convertible drachma, the three-month interbank deposit rate in Ireland, the tender rate for three-month Italian Treasury bills, and the three-month interbank deposit rate in the Netherlands. The weighted average is calculated on the basis of the average of daily observations during each month and applies during the following month. Before July 1, 1985, the ECU interest rate was based on the weighted average of the official discount rates of the EC member states.

42

Article 18 of the EMS Agreement as amended June 10, 1985.

43

Settlement in other reserve components must be in accordance with the composition of the debtor central bank’s reserves at the end of the month preceding the settlement. For this purpose, the composition of the debtor’s reserves is determined on the basis of assets denominated in SDRs and in currencies and, among these, the debtor central bank may choose which assets it will deliver in settlement. These provisions may be overridden, however, by other forms of settlement agreed between creditor and debtor central banks. See Article 16 of the EMS Agreement as amended June 10, 1985.

44

See Wolf (1984), p. 2; Guimbretiere (1984).

45

Data used in this section are expressed in ECUs. Where data were originally expressed in other units they have been converted into ECU using the applicable ECU exchange rate of the last business day of the period to which each figure pertains.

46

See Bank for International Settlements (1985b), p. 132.

47

Bank for International Settlements (1985c), Table 7.

48

The quoted rates referred to here are the average of rates quoted by commercial banks to the Financial Times in London.

49

See Istituto Bancario San Paolo di Torino (1984a), p. 10.

50

Lloyds Bank, London; Credit Lyonnais, Paris; Kredietbank, Brussels; Kredietbank, Luxembourg; and Societe Generate de Banque, Brussels.

51

Banque Bruxelles Lambert, Brussels, and Istituto Bancario San Paolo di Torino, Turin, joined in October 1985.

52

Based on data published in Bank for International Settlements (1985b), p. 129.

53

Istituto Bancario San Paolo di Torino (1985a), p. 22.

54

Istituto Bancario San Paolo di Torino (1985c), p. 14.

55

Morgan Guaranty Trust (August 1985), p. 8.

56

Bank for International Settlements (1985b), p. 128.

57

Italy has also issued substantial amounts of ECU bonds domestically, which are not reflected in these figures. See Table 12, footnote 1.

58

As part of measures to ease exchange regulations in France, French importers have been authorized since March 2, 1985 to obtain forward cover not exceeding six months in settlement for imports invoiced in ECUs.

59

See Executive Board Decision No. 6631–(80/145) GS, September 17, 1980, International Monetary Fund (1986c), pp. 307–308.

60

International Monetary Fund, Articles of Agreement, Article VIII, Section 7.

61

International Monetary Fund, Articles of Agreement, Article XVIII, Section 1(a).

62

Ibid., Section 4(a).

63

International Monetary Article of Agreement, XVIII, Section 2.

64

See International Monetary Fund, Articles of Agreement, Article XVIII, Sections 1 and 2.

65

See International Monetary Fund, Articles of Agreement, Article XXIV, Sections 2–5.

66

See International Monetary Fund, Articles of Agreement, Article XXV and Schedule I.

67

The yields used in this calculation are the market yield for three-month U.S. Treasury bills, the three-month interbank deposit rate in the Federal Republic of Germany, the three-month interbank money rate on private paper in France, the discount rate on two-month (private) bills in Japan, and the market yield for three-month U.K. Treasury bills.

68

International Monetary Fund, Articles of Agreement, Article XVII, Section 3.

69

International Monetary Fund, Articles of Agreement, Article V, Section 6.

70

International Monetary Fund (1986b), p. 84.

71

An open SDR basket is defined as consisting of whatever currency amounts are currently stipulated by the Fund, whereas a closed SDR basket is defined as specific amounts of currencies which do not change, even if the Fund’s definition changes.

72

For a more detailed discussion see “Evolution of the SDR Outside the Fund” in von Furstenberg (1983), pp. 561–86.

73

Ibid., p. 571.

74

Wragg (1981), Euromarket Supplement, Part I, p. 93.

75

Based on data published in Bank of England (1982), p. 47.

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