Use of SDRs in the acquisition hybrid capital instruments of the prescribed holders

A hybrid capital instrument is a financial instrument with perpetual maturity that has both debt and equity properties. Such instruments are specifically designed to be subordinated to other types of debt issued by prescribed holders and may be written off to absorb losses. The specific form of such instruments could vary across channeling schemes, depending on applicable accounting standards (e.g., IFRS, US GAAP), prescribed holders’ own internal risk capital models, and the methodology of credit rating agencies for recording the instrument as equity on the balance sheet of a prescribed holder of SDRs.

The authorization allows participants in the SDR Department (currently all IMF members) to use SDRs to acquire hybrid capital instruments issued by prescribed holders (official entities authorized by the IMF to hold SDRs). This new use adds to earlier authorized uses of SDRs to buy or sell currencies and conduct seven financial operations: ((i) the settlement of obligations; (ii) loans; (iii) pledges; (iv) transfers as a security for performance of financial obligations; (v) swaps; (vi) forward operations; and (vii) donations. With the authorization, prescribed holders can issue hybrid capital instruments and receive SDRs from members as proceeds. Prescribed holders can either hold the received SDRs on their balance sheet or exchange them for currencies, including through the Voluntary Trading Arrangements (VTAs), which are bilateral arrangements between the Fund and SDR Department participants or prescribed holders.

The newly authorized use of SDRs to acquire hybrid capital instruments issued by prescribed holders is subject to a cumulative cap of SDR 15 billion until further notice. The IMF also expects any member who decides to use SDRs to acquire hybrid capital instruments issued by prescribed holders to have VTAs in place, to help ensure sufficient liquidity and an equitable distribution of potential SDR exchanges into currencies in the VTA market.

Whether to acquire hybrid capital instruments is a sovereign decision of SDR Department members and requires a bilateral agreement between a member and the issuing prescribed holder. Some member countries are impeded to engage in this type of operations due to domestic constraints.

The IMF’s Articles of Agreement authorize the Fund to prescribe as holders of SDRs (i) non-members, (ii) members that are not participants in the SDR Department, (iii) institutions that perform functions of a central bank for one or more IMF member countries, and (iv) other official entities Prescribed holders may acquire, hold and use SDRs in operations with other prescribed holders and participants in the SDR Department. Under current IMF decisions, 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, donations, and with the recent authorization also for the acquisition of hybrid capital instruments issued by prescribed holders.

Currently, there are 20 prescribed holders of SDRs. These are:

• African Development Bank (AFDB)
• African Development Fund (AFDF)
• Arab Monetary Fund (AMF)
• Asian Development Bank (ADB)
• Bank for International Settlements (BIS)
• Bank of Central African States (BEAC)
• Caribbean Development Bank (CDB)
• Central Bank of West African States (BCEAO)
• Development Bank of Latin America (Corporacion Andina de Fomento or CAF)
• Eastern Caribbean Central Bank (ECCB)
• European Central Bank (ECB)
• European Bank for Reconstruction and Development (EBRD)
• European Investment Bank (EIB)
• Inter-American Development Bank (IADB)
• International Bank for Reconstruction and Development (IBRD)
• International Development Association (IDA)
• International Fund for Agricultural Development
• Islamic Development Bank
• Latin American Reserve Fund (FLAR) - Former Andean Reserve Fund
• Nordic Investment Bank

The cumulative limit of SDR 15 billion aims to mitigate potential liquidity risks in the SDR market. While other prescribed SDR operations are not currently subject to quantitative limits, the cap is a useful tool to enable an orderly introduction of novel SDR operations by limiting liquidity risks and allowing room for monitoring their implications on the functioning of the SDR Department. The proposed SDR 15 billion cap represents a moderate volume relative to the current VTA buying capacity (about 7 percent) and cumulative SDR allocations (below 3 percent), and thus limits risks to the SDR operations, while still providing potential room for various prescribed holders to use this modality at a significant scale.

The reserve asset status of any SDRs transferred to prescribed holders in a sale of hybrid capital instruments would remain unchanged and always be maintained.

The reserve asset quality of any claims arising from the acquisition of hybrid capital instrument is separate from the reserve asset quality of the transferred SDRs. Whether any such underlying claim has characteristics that allow their classification as reserve assets depends on the design of the specific instrument adopted by the issuer. Under the applicable statistical guidance (Sixth edition of the Balance of Payments and International Investment Position Manual (BPM6)), reserve assets must be readily available in the most unconditional form (e.g., highly liquid and can be liquidated with minimum cost and time) and be generally of high quality (e.g., high investment grade).

There is no requirement under the Articles of Agreement of the IMF or the authorization of this new use of SDRs that the claims under hybrid capital instruments issued by prescribed holders in exchange for SDRs have reserve asset characteristics. This is in line with all previously authorized SDR operations. However, hybrid capital claims that possess the characteristics of a reserve asset are likely to be much more attractive for potential contributors because any acquisition would be neutral for their international reserve holdings.

In its role as administrator of the SDR Department, the IMF has authorized the use of SDRs in the acquisition of hybrid capital instruments, creating an avenue for interested members to use their SDRs for that purpose.

Whether to acquire hybrid capital instruments is a sovereign decision of SDR Department members and requires a bilateral agreement between a member and the issuing prescribed holder. Some member countries are impeded to engage in this type of operations due to domestic constraints. The IMF does not use its own SDRs (held in the General Resources Account (GRA)) for the acquisition of hybrid capital instruments and is not involved in the solicitation of potential contributors or the ensuing contractual relationship between the contributors and prescribed holders. The IMF’s role would be limited to recording relevant transfers between members and prescribed holders.

Separately, IMF staff has shared relevant experience from the design of the Poverty Reduction and Growth Trust (PRGT) and Resilience and Sustainability Trust (RST) and provided technical advice to a number of multilateral development banks (MDBs) that are prescribed holders and in the process of developing hybrid capital offerings in exchange for SDRs.

Usage of the proposed cap will be published in the Annual Report on SDR Trading Operations. Interested prescribed holders can also approach the Fund for consultation when they firm up plans for a possible issuance of hybrid capital instruments, which provides another avenue for sharing updated information on the remaining headroom under the cap. This will ensure that prescribed holders have equal access to information ex-ante, providing for a uniform treatment and minimizing evenhandedness concerns.