Book review: central bank reserve manager trends (Finadium subscribers only)

In this article we review the book “RBS Reserve Management Trends 2013,” a media version of which was kindly provided to us by Central Banking Publications, an affiliate of Risk Books.

The new survey on central bank reserve managers is an important data source for those interested in how central banks are thinking about their substantial investments. Firstly, we congratulate the authors for receiving replies from 60 out of 110 central banks. This in itself is an impressive feat and one that we secretly envy. In total, the survey covers US$6.7 trillion of central bank assets.

Central banks are a vital but rarely discussed part of the investment community; pension plans and asset managers get most of the attention. Yet when it comes to important topics such as future thinking about investment strategy, few surveys are able to uncover real direction in bank thinking.

The RBS Reserve Management Trends survey focuses on pressing issues for central banks in general, including acceptable reserve currencies and which asset types should be considered investable. An interesting question today is the creditworthiness of large-cap equities as compared to some sovereign debt and should equities be included in central bank reserve holdings.

We found the sections on the use of credit rating agencies and potential involvement in CCPs for OTC derivatives clearing to be of greatest interest to our subscribers. 86% of respondents said that they had made no recent changes to their use of credit rating agencies as a result of the recent Financial Stability Board recommendation to reduce the importance of these firms. Outside of the FSB, only 27% of reserve managers said that they had made any changes to reduce or eliminate reliance on credit rating agencies over the last two years. The fact that relatively few central banks have made changes in policy speaks to the continuing influence of the credit rating agencies regardless of how much government regulations may try and remove them. Dodd-Frank watchers should take note.

Central banks expressed more openness in their consideration of CCPs for OTC derivatives clearing; 38% of reserve managers said that they were looking at CCPs. A primary obstacle appears to be legal restrictions, where central banks are not allowed by law to post margin. While some reserve managers might think that a CCP is a good idea for a specific product set, the broader mindset will need to change before central banks can take action. A good companion report to this conversation is the Bank for International Settlements’ “Central bank collateral frameworks and market practices,” published in March 2013.

This gets into a tricky conversation, not in the report but on our minds, regarding sovereign risk and how banks are forced to account for the lack of sovereign collateral in bilateral transactions. We have covered this on several occasions in Securities Finance Monitor starting in November 2011, when data emerged that uncollateralized sovereign debt exposure to Italy alone was estimated at EUR10-15 billion. Globally, this figure is likely in the high billions to low trillions range. We think that this is an untenable situation for both banks and world markets; while we don’t expect central banks to fail in their counterparty obligations, a lack of collateral posted for cleared or non-cleared derivatives creates unwelcome market distortions.

The survey does not go into more depth concerning collateral management or the potential use of central bank assets in collateral transformations; these may be topics outside the remit of the reserve managers surveyed. It is useful however as a general guide to the investment thinking of central banks in the new regulatory era.

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