The Council On Foreign Relations recently introduced Special Drawing Rights (SDR) bonds as a way in which for the World Bank to expand its reach into frontier markets, giving loans with interest to those countries’ leaders. The article’s authors, Brad W. Setser and Stephen Paduano, concluded that expanding the scope of the World Bank’s lending should thus be an important part of the job of the new World Bank President.
How will the SDR bonds function?
Could such a bond issue help to expand the scope of the World Bank, and reliably mobilize billions of dollars for poverty alleviation and to fund investment in green technologies on the global frontier markets. Why would we want a bond in SDR terms?.
A number of countries are sitting on big stocks of SDRs, the reserve asset of the International Monetary Fund, which can be traded for dollars, euros, pounds, yen, and renminbi.
The IMF wants these countries to have the ability to hold these SDRs as part of their reserves. They would be hard-pressed to divest these SDRs, but they could put the SDRs into classical reserves assets—bonds, the IMF suggests.
An SDR-linked bond is actually the perfect fit for those countries, since technically they would have to pay SDR interest back to the IMF on whatever SDRs they are using.
The World Bank is an institution that raises funds mostly through bond issues, then uses the funds that they raise to lend out loans to lower-middle-income countries.
Right now, the private sector has been starved of cheap, viable funding in frontier markets, and Chinese policy lenders have been scaling back as well.
An SDR-denominated bond would help the World Bank safely expand lending, because it would enable the bank to access what is, essentially, a captive market.
There would be the expectation that SDR bonds would roll over into perpetuity, and so the Bank would in fact have a continuous funding source.
“A bigger Bank would allow more financing of green infrastructure, without any reduction in the Bank’s current activities,” write Setser and Paduano.
An SDR bond also could potentially help the U.S. leverage its $160 billion of SDRs.
Congress has already given the US Treasury authority to purchase securities from high-rated issuers such as the World Bank.
How would a bond issued on the basis of the SDR work in practice with the World Bank?
The World Bank could issue an SDR-denominated bond just like it issues bonds in dollars, euros, and other currencies. Countries which currently hold excess SDRs in deposits with the IMF will loan these SDRs to the World Bank, which will then convert them to usable currencies via the IMF.
Countries who loaned their SDRs to the IMF would get a SDR-linked bond in return. The IMF proposed that this bond can be settled either in dollars or euros, making it easier for these bonds to be traded — and therefore, helping to facilitate the bonds eligibility for reserve assets.
The World Bank has already issued a small bond linked to SDRs, settling in the Chinese currency (the renminbi), so this kind of bond does not need significant new innovations.
For such bonds to boost World Bank overall lending, they would have to be part of a general program of expanding the World Bank’s total capital buffer: An SDR-linked bond shouldn’t simply replace current issuance by the Bank in dollars, euros, and other currencies.
SDR bonds are an especially low-risk instrument for the World Bank, since they would be issued to the bank’s major shareholders, and there would be every expectation that the major shareholders wouldn’t really ever have to sell their bonds on the market to raise money.
As such, these bonds should be able to naturally revert back to par at maturity. They thus offer an especially appealing means of stretching out the existing capital of the World Bank just a little further, as proposed by a G-20 Working Group on Multilateral Development Bank Capital Adequacy Framework.
An SDR bond could also be combined with a larger package of reforms and financing, which would add working capital to the Bank via issuance of secondary debt or other forms of blended capital, or even via the combination of smaller increases in overall capital and increases in banks internal leverage ratios, which would all push up bank capital somewhat further.
Some countries might even be able to buy hybrid capital instruments using their existing SDRs. The main idea is to take advantage of the pool of SDRs that are now sitting in the balance sheets of major shareholders in the banks, and to offer the big banks with cheap, credible, safe financing.
Would major shareholders have to subscribe up front? Would the Treasury Department need congressional approval for this kind of SDR buyout?
The largest shareholders would have to agree to purchase bonds at par (so that they get the exact interest rate of an SDR for their bonds) as part of a larger pledge to increase the lending power of the World Bank.
They would not have to commit to holding on to the bond—the bond, after all, is supposed to be designed to be a holding, which can be sold either to another Bank shareholder or in the private markets for cash.
But the idea is that in fact, the bonds would be placed directly in front of Bank shareholders. The US Treasury probably wants to consult Congress before it underwrites a bond like this, simply to prevent any miscommunication.
But the legislation that regulates Treasury’s Exchange Stabilization Fund already gives the U.S. Treasury legal authority to purchase a bond from the World Bank, since Exchange Stabilization Fund is explicitly allowed to engage in securities transactions. Congress granted the Exchange Stabilization Fund this power.
The ECB has expressed concerns over re-channeling SDRs into the Multilateral Development Banks.
Would European countries be able to purchase an SDR bond?
The IMF thinks that most European countries will be able to underwrite an appropriately designed issue of SDR bonds.
ECB president Lagarde has noted, in the context of discussions about other proposals for using spare global SDRs, that “keeping the status of reserve assets for resulting claims is paramount”.
A bond linked to a World Bank SDR would be explicitly designed to qualify as a reserve asset, and create a claim linked to the SDRs “that is highly liquid and has a high credit quality.”
The ECB has also expressed concerns over SDRs being routed through the MDB instead of through the IMF.
The IMF differs in that it would use the SDRs to finance directly on the balance sheet: funds obtained through SDR bonds would be combined with funds raised via World Bank borrowing in the current market, in order to support its general activities.
There would similarly need to be ways of structuring an SDR bond that would not trigger concerns over using Eurosystem reserves assets for monetary funding.
Conceptually, purchasing a bond in SDR terms is not unlike the conversion of existing SDRs to dollars by one of the member Eurosystem central banks, and purchasing existing World Bank bonds in these dollars.
Such a set of transactions clearly will have no effect on the Eurosystems unified monetary policy, will help to finance budget deficits within the eurozone, and will not alter the monetary conditions within the eurozone.
We therefore argue that the ECB could simply exempt an SDR bond issued by the World Bank from prohibitions on money funding, just as it has done so for the IMFs Poverty Reduction and Growth Trust (PRGT) and Resilience and Sustainable Development Trust (RST).
The issues involved in a World Bank SDR bond are less complicated than the ones raised by the hybrid capital proposals of the AfDB and IDB.
There are other potential paths to take. Eurozone countries may be able to purchase sovereign debt notes on the secondary market—possibly direct from countries such as the US and UK.
Such purchases would be in line with existing euro-area practices to purchase bonds, including bonds issued by European supranational institutions, on the secondary market.
Alternatively, eurozone countries could adjust their holdings of the SDR in order to match other countries’ practices, for example, with the United States, which holds its SDRs with the Treasury rather than with the Federal Reserve.
In many countries, the tax authorities, as well as the monetary authorities, both hold the international reserves, and the IMF views member countries (not their central banks) as the required holders of the SDRs.
There is no ECB-specific policy preventing the eurosystems national central banks from exchanging reserves, like-for-like, with the fiscal authorities.
How much SDR is out there to use?
There are $935 billion worth of SDRs outstanding globally today. A fraction of that—not much more than $45 billion—has already been committed to supporting an IMF Trust for Resilience and Sustainable Development.
A larger proportion are held by countries which are short of reserves of their own, and thus are not necessarily willing to invest in SDR-denominated bonds. Several hundred billion SDRs are held by G-10 countries and China—countries that are unlikely ever to directly trade their SDRs for cash.
The precise size of a bond issue—or, more realistically, series of bond issues—would probably be limited by the World Bank’s capital framework. But, hopefully, the World Bank will think big.
The European Union, United Kingdom, United States, Japan, and China have received, together, more than $300 billion of the new allocations for SDRs—a pledge from the Bank that doubling the size of IBRDs, non-concessional loans from the bank—could be funded entirely with an array of bonds linked to the SDR.
Could bond issuers conventional Wall Street firms?
An SDR bond ideally would be placed directly with the bank’s major shareholders, and therefore would have a minimal role for Wall Street firms. There would be no need to build books or anything like that.
The only real need is for bonds to be structured so they can trade on a trader basis, should that become necessary.
The fact that bonds could easily and effectively be traded on a private market will go a long way toward helping to make it clear they are eligible as liquid reserves assets.
Some Wall Street firms may be willing to pledge themselves to building and maintaining an associated infrastructure, as part of a larger commitment to good global citizenship.
The existing precedent is somewhat unique: The first SDR bonds issued by the World Bank were issued in China, designed to attract “private” investors—in this case, China’s largest state-owned commercial banks, along with HSBC, were the primary managers.