Enhancing transparency regarding the authorities' foreign currency liquidity position
The Asian crisis highlighted deficiencies in the availability of information relating to the on and off-balance-sheet foreign currency activities of central banks and other public sector entities. This led the G-10 Governors to ask the Euro-currency Standing Committee to establish a working group to develop a disclosure framework to address these shortcomings. Specifically, the group was asked to identify the statistical information that would enable markets to better assess the authorities' foreign currency liquidity position. This position comprises the foreign exchange resources at the disposal of the authorities that are easily mobilisable in times of need and the potential drains on those resources associated with the authorities' short-term foreign currency liabilities. The group was also asked to report on the most suitable framework for public disclosure, the specific form and content of the information to be released and the additional practical steps necessary to implement the chosen strategy. In its deliberations the group recognised that improvements in disclosure practices by G-10 countries could help to encourage similar behaviour in emerging market countries.
The analysis and recommendations of the working group should be assessed in the context of initiatives relating to disclosure currently under way in other forums. These include the work of a working party on transparency and accountability commissioned by a group of finance ministers and central bank governors from 22 economies (the "Willard Group") and planned steps by the IMF Executive Board to strengthen the Special Data Dissemination Standard (SDDS). In recognition of these initiatives, an IMF representative was invited to participate in the working group and information on disclosure practices was shared with the Willard Group working party. A representative from the European Central Bank (ECB) was also asked to participate in the group.
The working group is of the opinion that a significant move towards enhanced disclosure is justified as regards both the content and the timeliness of the information. This conclusion was reached on the basis of a review of current disclosure practices in relation to the liquidity concept outlined in previous discussions among Governors and a cost/benefit analysis of such a step. Prevailing practices generally fall well short of providing the relevant information, particularly as concerns the potential short-term drains on reserves. As most recently highlighted by the Asian crisis, the failure to disclose the forward book of the monetary authorities is one important example. The main benefits of enhanced disclosure would be to improve the accountability of the authorities and the scope for markets to exercise financial discipline. This, in turn, could help to induce an earlier correction of unsustainable policies and allow market participants to form a more accurate view of the condition of individual countries, thereby also possibly limiting contagion. It was noted that effective market discipline mechanisms also require an appropriate framework for disclosure and reporting by private sector entities. Differing views were expressed in this regard and the group acknowledged that this issue deserved further analysis. The group weighed the possible benefits of greater transparency against some potential costs. These were seen as being primarily associated with reduced operational flexibility to intervene covertly in order to counteract exchange market pressures, with the uncertainties involved in the transition towards a more demanding disclosure standard and with the logistical burdens of implementation.
The specific recommendations of the group take the form of: a "disclosure template" outlining the content of the information to be disclosed; prescribed standards of timeliness, including both periodicity and disclosure lags; a timetable for implementation; and a proposal for further work on disclosure standards for private market participants.
The disclosure template, summarised below, has three distinguishing features. Firstly, it aims to be as comprehensive as possible with respect to the coverage of both institutions and financial instruments. As regards institutions, conceptually the template is intended to apply to all the public sector entities that would be responsible for, or involved in, counteracting currency crises. In practice, this should at least include the monetary authorities, defined here to include both the central bank and the central government (excluding social security), but depending on institutional arrangements could extend to other public sector entities. As regards financial instruments, the template attempts to cover all the relevant on and off-balance-sheet liquid assets and short-term liabilities. Comprehensiveness is designed to provide a meaningful picture and to limit the scope for shifting components of the liquidity position to undisclosed items. Secondly, the template seeks to be sufficiently detailed to allow market participants to reach informed judgements about both reserves and drains on them. Detail is provided in several respects. These include, inter alia: a sectoral breakdown (notably as between the monetary authorities and other public sector entities); the separate identification of financial instruments that might vary in terms of liquidity (e.g., gold, deposits with banks headquartered in the reporting country) or cash flow characteristics (e.g., contingent vs. predetermined; time profiles, as captured by a residual maturity breakdown of the fixed-term liabilities); and complementary memorandum items (e.g., undrawn unconditional lines of credit, debt indexed to foreign currency). Finally, the template prescribes valuation principles that are consistent with the focus on liquidity. This suggests reporting, as far as possible, mobilisable foreign exchange resources at (approximate) market values and the future profile of drains on these resources in nominal terms (the cash flow value when the drain occurs).
The group recommends endorsement of the template. At the same time, it recognises that improvements are possible. A review by technical experts of the details of the presentation would be helpful in identifying improvements in the way some of the information is portrayed and in accomplishing effective implementation. The issues to be addressed include, in particular, the treatment of derivatives positions and the clarification of the relationship between the definitions used in the report and those adopted in the balance-of-payments conventions, which are largely based on the residence criterion. It is recommended that technical experts be asked to report on these issues as soon as possible.
The working group devoted much attention to the issue of timeliness, particularly in the light of the substantial element of judgement called for in examining this question. There are two features of information disclosure that affect timeliness: the disclosure lag, which determines how out-of-date the information is when released; and the frequency or periodicity of the disclosure, which determines the extent to which the information ages between releases and affects the incremental "news" content of the release. The group agreed that a common frequency and disclosure lag should apply to all the items of the template (except one memorandum item, viz. the currency composition by group of currencies). To do otherwise could greatly undermine the template's usefulness as it would provide an avenue for concealing changes in liquidity through whatever items are reported in the least timely fashion. The group also agreed that it is technically feasible to set a very high frequency and short lag. At the same time, the concomitant gains in terms of market discipline had to be weighed against the possible need for flexibility in exchange market operations, either for reserve management purposes or for covert intervention. In order to preserve flexibility in reserve management, the group decided to allow for less frequent and less detailed disclosure of the currency composition of the portfolio. Furthermore, forward positions should be reported only insofar as the domestic currency is involved, since only those transactions imply a future change in total official reserves. As concerns covert intervention, views regarding the true extent and value of such flexibility varied somewhat within the group. This reflected several factors, notably differing experiences with exchange rate regimes, institutional settings and opinions about the range and likelihood of circumstances in which it was regarded as useful to retain market uncertainty about the occurrence and/or size of the authorities' operations. Two further considerations argued against a rapid move to the highest feasible frequency and shortest feasible lag: implementation costs (especially in the context of efforts to address the "Year 2000 problem" and the introduction of the euro); and, given the residual uncertainties involved, concerns that such a step, once taken, would be costly to reverse if it proved unwarranted.
In the light of these concerns, the group recommends that a first step would be to adopt a standard of a one-month frequency and a disclosure lag certainly not exceeding one month, to be implemented on or before end-June 1999. Since the frequency and disclosure lag would apply to all the categories of the template - except one memorandum item - this would already represent a significant improvement compared with current practices. In addition, the group notes that central banks are not the only holders of foreign currency reserves or liabilities, so that the full implementation of its recommendations would also require endorsement and corresponding action by other public sector entities, in particular finance ministries or treasuries.
The group also considered the benefits associated with similar transparency about the risk positions, including foreign currency positions, of all private financial intermediaries. The group was of the opinion that further parallel work is needed in this area. It noted that an initial analysis had been carried out by the Euro-currency Standing Committee in 1994, as published in the report on "public disclosure of market and credit risks by financial intermediaries" (the "Fisher Report"). In connection with the enhanced disclosure proposed for the official sector, the group recommends that the ECSC now revisit the question of the appropriate disclosure standards for all market participants with a view to elaborating a set of good practices.