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SDRS and Hybrid Capital

FAQS

What is a special drawing right? 

  • The SDR is an interest-bearing international reserve asset. The SDR is not a currency, but its value is based on a basket of five currencies—the US dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling. The value of the SDR is set daily by the IMF based on fixed currency amounts of the currencies included in the SDR basket and the daily market exchange rates between the currencies included in the SDR basket.

 

Why would countries invest in Hybrid Capital using SDR?

  • SDR Department participants with strong external positions have historically used some of their SDR holdings to help countries in need. For example, the Poverty Reduction and Growth Trust (PRGT) is the IMF’s main vehicle for providing concessional loans and is largely funded by SDR loans provided by SDR department participants. Also, IMF member countries agreed to a SDR100bn mobilization target as part of the latest SDR allocation. Investing SDRs through an IDB Hybrid Capital could unlock billions of dollars of essential development finance for Latin America and the Caribbean. Hybrid capital can have a similar impact to paid-in capital from shareholders.

 

What other MDBs are considering this? Are you working with them? 

  • The development of the SDR-funded hybrid capital instrument is co-led by the IDB and AfDB. We have reached out to many peer institutions to share information and seek allies. Other MDBs are following the process closely and remain interested in the development of the asset class.

 

What is hybrid capital and how does it help? 

  • Hybrid capital refers to financial instruments with both debt and equity characteristics.  They can be regarded as additional sources of capital, depending on their equity content. This additional capital could be used to increase lending capacity or build up the Bank’s resilience to maintain lending during stress scenarios, or both.
  • The equity content of the instrument is typically a function of two elements: loss absorption capacity and/or cash conservation. These characteristics would translate in IDB’s capacity to avoid or defer interest payments, or to write-down the principal amount of the instrument if certain conditions are met.
  • The leading international rating agencies have published specific criteria that identify, categorize, and rate hybrid instruments. 

 

What is a prescribed holder and what does becoming a prescribed holder mean? 

  • Prescribed holders are entities not members of the IMF (or IMF members that are not participants in the IMF’s SDR department) that may acquire, hold, and use SDRs in operations with other prescribed holders and participants in the SDR Department. There are 20 prescribed holders, including the IDB and the other four recently approved multilateral institutions (CAF, CDB, EBRD, and EIB).
  • Prescribed holders may exchange SDRs for currency, and use SDRs in certain operations, including loans, settlement of financial obligations, swaps, pledges, transfer as security for the performance of financial obligations, forwards, and donations. Prescribed holders may elect to participate in SDR Voluntary Trading Agreements (VTAs) or enter into bilateral agreements to conduct their exchanges of SDRs.
  • Becoming a prescribed holder is not an endorsement of IDB’s proposal to channel SDR for hybrid capital, but it is a necessary step before the IDB could enter into such transactions.

 

What is the financial impact of being a prescribed holder?

  • There is no immediate financial impact of becoming a prescribed holder, but it is a necessary step before entering into transactions using SDR, such as issuing SDR-denominated hybrid capital to countries.

 

Has the IMF approved MDB Hybrid Capital? 

  • No. The IMF Board will consider soon a proposal to allow the use of SDRs to purchase or fund hybrid financial instruments. 
  • That said, the IMF staff has determined that the IDB’s hybrid capital proposal satisfies requirements for the instrument to be considered a reserve asset.

 

Who can invest in SDR-denominated Hybrid Capital? Can European countries or IDB borrowers invest? 

  • Upon approval by the IMF Executive Board, any IMF member (or Prescribed Holder) will be able to invest in SDR-denominated Hybrid Capital instruments provided requirements set by local law / regulation are met.
  • However, national central banks of Euro-area Member States may only lend their SDRs to the IMF if this is compatible with the monetary financing prohibition included in the Treaty on the Functioning of the European Union.
  • Additionally, to satisfy the reserve asset status requirements for the SDR hybrid capital instrument, investors will be required to commit to provide liquidity to purchase the holdings of any investor going through a balance of payment event. Most of IDB borrowing member countries in LAC would not meet the conditions of credit rating and strong balance of payment position to fulfil that role.

 

What is a reserve asset? Would IDB SDR-denominated Hybrid Capital qualify? 

  • According to the IMF BMP6[1], “reserve assets are those external assets that are readily available to and controlled by monetary authorities for meeting balance of payments financing needs, for intervention in exchange markets to affect the currency exchange rate, and for other related purposes (such as maintaining confidence in the currency and the economy and serving as a basis for foreign borrowing)”. 
  • SDRs meet the conditions established to be considered reserve assets.
  • The IMF staff has determined that the IDB’s hybrid capital proposal satisfies the requirements for the instrument to be considered a reserve asset. 

 

Would SDR-denominated hybrid capital cost shareholders money? 

  • SDR Department participants (usually central banks in MDB shareholder countries) receive interest (at the SDR interest rate) on their SDR holdings and pay interest (at the SDR interest rate) on their SDR allocation. The issuance of an SDR-denominated hybrid capital instrument would yield the investor a return calculated as the sum of the SDR interest rate and a spread. Upon investing in the SDR-denominated hybrid capital, the investor would exchange part of their SDR holdings for the SDR-denominated hybrid capital. Interest paid on the portion of the SDR allocation used to invest and interest received from the SDR-denominated hybrid capital would either net out (if spread is zero) or leave an additional return (if spread is higher than zero). 

 

Would hybrid capital be rated? What would hybrid capital be rated? What do credit rating agencies think? 

  • Once a large enough investor base has been secured, we would seek credit ratings from at least two credit rating agencies. The expectation is that the hybrid capital instrument would have at least an investment grade rating.

 

What happens if a country that invested in the SDR hybrid capital goes through a balance of payments event and needs their SDRs back?

  • If a hybrid capital investor for any reason needs SDRs back, this would trigger the Liquidity Support Agreement (LSA). The LSA is an irrevocable and first-demand commitment by an SDR investor to purchase the holdings from any one of the remaining parties in the LSA up to one fourth of the SDRs contributed by the largest investor in the MDB hybrid instrument. The LSA requires a minimum of five members of the IMF with strong external position (most likely considered part of IMF’s Financial Transaction Plan), each of them to contribute one fourth of the amount invested by the largest investor in the SDR hybrid capital.

 

[1] Sixth edition of IMF’s Balance of Payments and International Investment Position Manual

Contacts

Mena Duran,Melissa

Mena Duran,Melissa
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